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  • Jennifer M Mueller-Phillips
    A Field Survey of Contemporary Brainstorming Practices
    research summary posted February 20, 2017 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 06.07 SAS No. 99 Brainstorming – process, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 10.0 Engagement Management, 10.03 Interaction among Team Members 
    Title:
    A Field Survey of Contemporary Brainstorming Practices
    Practical Implications:

    Understanding that auditors allocate greater resources to fraud brainstorming when engagement risk is significant fosters brainstorming of a superior caliber corresponds to stronger regulatory compliance.  Auditors report that engagement teams are holding fraud brainstorming sessions earlier in the audit, document more detailed risk assessments, plan more specific procedures, and retain more documentation.  These characteristics contribute to adequately addressing increased PCAOB regulatory scrutiny.  Additionally, brainstorming sessions are highly regarded when they occur in a face-to-face fashion and are attended by multiple levels of firm personnel—whether that is “core” or “non-core” professionals.  Fraud brainstorming sessions are executed less mechanically (as determined by PCAOB inspectors) by using fewer checklists and increase the amount of time auditors prepare for brainstorming sessions.  

    Citation:

    Dennis, S. A., and K. M. Johnstone. 2016. A Field Survey of Contemporary Brainstorming Practices. Accounting Horizons 30 (4): 449–472. 

    Keywords:
    audit planning; engagement risk; field survey; fraud brainstorming; professional skepticism
    Purpose of the Study:

    The purpose of this study is to further understand current fraud brainstorming practices minding regulatory climate and its impression of brainstorming practices.  The authors seek to understand the auditing profession’s existing framework to effectively brainstorm by evaluating audit team characteristics; attendance and communication; structure, timing, effort; and brainstorming quality.  Fraud brainstorming environment is considered with respect to client characteristics; particularly, inherent, fraud, and engagement risks, and if the client is publicly traded or privately held.  The authors refer to the characteristics as “partitions”.  The partitions allow the study to better examine how each characteristic effects the deployment of resources in response to risk levels and trading status. 

                The study poses further exploration into the implementation of Statement of Auditing Standards No. 99 and its effect on fraud brainstorming practices.  Particularly addressing the Public Company Accounting Oversight Board’s report suggesting auditing professionals were “mechanically” addressing fraud-related auditing standards.  SAS 99 sought to blend experienced audit professionals—those with greater client experience—with less-seasoned auditors to brainstorm how a fraud could occur specific to the client.  As part of the brainstorming framework, the study seeks to understand if senior-level auditors (partners and managers) and seniors and staff members, along with “non-core” professionals, cultivate meaningful brainstorming sessions. 

    Design/Method/ Approach:

    The authors collected field data from audits conducted between March 2013 and January 2014, per a survey of 77 audit engagements.  Information pertaining to the client, audit team, and brainstorming sessions were called upon in the survey.  The majority (93 percent) of observations were obtained by two Big 4 firms—7 percent from one non-Big 4 global firm.  Each engagement’s partner received instructions for the distribution of the survey to lead managers and lead seniors on the respective engagement while the partner withheld that the survey was for research purposes.  A total of 75 managers and 73 seniors participated.  

    Findings:
    • Surveyed auditors rarely interacted with engagements where fraud in financial reporting was identified.
    • When fraud risk and inherent risk are both elevated for a particular engagement, perceived professional skepticism is also elevated.
    • Risk-based resource deployment is consistent when considering high- versus low-risk clients—particularly, when inherent risk is elevated, audit team size is also greater.
    • Public clients cultivate larger audit teams where managers and seniors have more client experience.
    • With respect to contributions made at brainstorming sessions, the audit partner and manager make the greatest contributions along with forensic specialists and audit seniors.  Interestingly, when fraud brainstorming is more important with respect to the engagement, seniors make lower relative contributions. 
    • Media richness theory is robustly at work with respect to attendance patterns at brainstorming sessions.  Specifically, when engagement risk is elevated, staff and seniors are more likely to attend face-to-face. 
    • Fraud brainstorming sessions are most commonly open-discussion (86 percent) where the session is held during the planning stage of the engagement (87 percent).
    • Results propose that audit partners are open-minded to suggestions made during fraud brainstorming.
    • Fraud risk assessments appear to be independent from brainstorming tactics; however, when inherent risk is elevated and if the client is public versus private, audit teams exert more effort.  
    Category:
    Auditing Procedures - Nature - Timing and Extent, Engagement Management, Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Auditors’ Professional Skepticism, Changes in Audit Standards, Fraud Risk Assessment, Interaction among Team Members, SAS No. 99 Brainstorming – process
  • The Auditing Section
    Attention to Evidence of Aggressive Financial Reporting and...
    research summary posted May 7, 2012 by The Auditing Section, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind 
    Title:
    Attention to Evidence of Aggressive Financial Reporting and Intentional Misstatement Judgments: Effects of Experience and Trust
    Practical Implications:

    The results of this study are important for audit firms to consider when making audit personnel assignments in order to take advantage of individual traits and experiences.  Audit firms may benefit from audit team structures that include members with varying levels of trust and varying levels of prior fraud experience.  Diversifying audit team composition may improve fraud detection while maintaining audit efficiency. 

    Citation:

    Rose, J.M. 2007. Attention to evidence of aggressive financial reporting and intentional misstatement judgments: Effects of experience and trust. Behavioral Research in Accounting 19(1): 215-229.

    Keywords:
    aggressive reporting; experience; fraud; skepticism; trust
    Purpose of the Study:

    Auditors face increased pressure to detect and prevent fraud and increased responsibilities to maintain professional skepticism as a result of SAS No. 99.  Yet their ability to do so may be constrained by their individual traits or experiences.  Previous research has not sufficiently addressed auditors’ ability to detect potentially fraudulent reporting or auditors’ judgment concerning misstatements and has not evaluated auditor characteristics that can influence attention to evidence of aggressive reporting. 
    This paper investigates the following factors:  

    • Whether professional skepticism increases auditors’ attention to evidence of aggressive reporting. 
    • Whether dispositional trust affects auditor’s critical evaluation of audit evidence.  Dispositional trust is a personality trait which affects professional behavior by influencing the degree to which an individual believes that people are typically trustworthy or that they will personally benefit by trusting others.
    • Whether fraud-specific audit experience results in the development of knowledge structures that are useful for the detection of potentially fraudulent and aggressive reporting practices. 
    Design/Method/ Approach:

    The authors collected their evidence using a simulated task completed by practicing auditors from Big 4 and national accounting firms with an average of 3.6 years of experience.  Participants were given background information along with 45 pieces of audit evidence for a hypothetical audit client, and told that they were performing workpaper reviews for the client. Then, participants were asked to perform a surprise free recall of the information. Finally, participants were asked to make a judgment on the likelihood that the client’s financial statements were intentionally misstated.  Participants were assigned to either a higher or lower level of client-related skepticism and aggressive or non aggressive individual audit evidence items.

    Findings:
    • The authors find that increased skepticism is associated with increased attention to aggressive reporting, and as a result, increased belief that intentional misstatement has occurred.
    • Less trusting auditors appear to pay more attention to evidence of aggressive reporting than do more trusting auditors.  
    • The authors find that prior fraud-specific experience positively influences auditor’s judgments of intentional misstatement.  Prior fraud experience may allow auditors to develop fraud-based explanations for aggressive reporting and develop knowledge structures that include potential indicators of fraud. 
    Category:
    Risk & Risk Management - Including Fraud Risk, Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Fraud Risk Assessment, Auditors’ Professional Skepticism, Prior Dispositions/Biases/Auditor state of mind
    Home:
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  • Jennifer M Mueller-Phillips
    Audit risk Assessments Using Belief versus Probability
    research summary posted October 29, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism 
    Title:
    Audit risk Assessments Using Belief versus Probability
    Practical Implications:

    The primary contribution of the paper is the presentation of four alternative concepts or definitions of audit risk. The feasibility and impact on auditor judgments of auditors applying these approaches to audit risk assessments are tested in an experimental setting where a second aspect of auditing – how assertions are framed – is also examined. Both the risk assessment approach and assertion framing had a significant impact on risk assessment both before and after audit evidence was evaluated. Importantly, auditors who were given a negatively stated audit assertion tended to be more skeptical than those who were given a positively framed assertion. This result has possible audit effectiveness and efficiency implications. 

    Citation:

    Fukukawa, H., and T. Mock. 2011. Audit risk assessments using belief versus probability. Auditing: A Journal of Practice and Theory 30 (1): 75-99.

    Keywords:
    auditors’ risk assessments; belief functions; probability; assertion framing effects
    Purpose of the Study:

    To present and experimentally compare alternative approaches to defining audit risk based on probability theory and the theory of belief functions and the effects of these approaches and of assertion framing on audit judgment. The risk measures studied were:

    1. Belief that an assertion is false
    2. Plausibility that an assertion is false, which is the sum of the belief that an assertion is false and the explicitly measured ambiguity and thus is the most conservative measure
    3. Probability that an assertion is false
    4. Cobb-Shenoy transformed belief that an assertion is false

    The first two approaches are belief-based, while the third is a probability-based approach. The logical connection between probability and belief assessments is used to define and operationalize the forth measure.

    Additionally, this study experimentally tests the effects of positive and negative  assertion framing on risk assessment and whether or not these effects are contingent on the approach to risk assessment and the evidence presented.

    Design/Method/ Approach:

    An experiment was conducted using practicing auditors drawn from Big 4 firms in Japan. Each participant was randomly assigned to one of four conditions where the factors manipulated were assertion framing and approach to risk assessment. The participants were presented with tasks for which they made a series of audit risk assessment judgments related to assertions presented about trade accounts receivable.

    Findings:

    The authors found the risk assessment approach effects to be significant with the belief-based risk assessments being smallest, the plausibility assessments being largest, and the probability assessments and the Cobb-Shenoy transformed belief assessments being in-between. Most of the paired comparisons between these measures were statistically significant. These results imply that any audit methodology that focuses on any one of these risk assessment measures is likely to result in substantially different risk assessments and potentially significant effects on audit efficiency and effectiveness.

    The authors also found evidence of significant audit assertion framing effects. Firstly, auditors who were given a negatively stated audit assertion tended to be more skeptical than those who were given a positively framed assertion. Also, the results showed that auditors are prone to confirm a given assertion regardless of whether it is stated positively or negatively. The pervasive framing effects are more significant after audit evidence is presented, more significant when stronger audit evidence is presented, and are influenced by the risk assessment approach. The existence of such assertion framing effects clearly may directly affect audit effectiveness and efficiency.

    Category:
    Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Auditors’ Professional Skepticism
  • Jennifer M Mueller-Phillips
    Auditing Fair Value Measurements: A Synthesis of Relevant...
    research summary posted March 31, 2016 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism 
    Title:
    Auditing Fair Value Measurements: A Synthesis of Relevant Research.
    Practical Implications:

    The authors believe that when armed with knowledge of how management may intentionally or unintentionally introduce error into their FVMs, auditors will be better able to take steps to adjust for this error. Currently, professional skepticism is the best way to combat this problem. Researchers and policy makers within firms need to grapple with the possibility that existing audit team structure and incentives may not be compatible with audits that require more and more specialized valuation knowledge.

    Citation:

    Martin, R. D., J. S. Rich, and T. J. Wilks. 2006. Auditing Fair Value Measurements: A Synthesis of Relevant Research. Accounting Horizons 20 (3): 287-303.

    Purpose of the Study:

    In order to contribute to the PCAOB project on auditing fair value measurements (FVMs), the authors synthesize and discuss the implications of academic research that should be relevant to auditors, standard-setters, and academics who increasingly deal with the complexities of auditing FVMs. The authors structure their synthesis of prior research along two dimensions:

    1. An emphasis on the auditor’s need to understand how FVMs are prepared, including an awareness of the potential pitfalls and biases inherent in preparing FVMs, and
    2. The audit steps and procedures necessary to verify and attest to FVMs, including an awareness of the potential biases inherent in auditing FVMs.
    Design/Method/ Approach:

    Structuring the synthesis along the aforementioned dimensions, the authors first focus on the generation of FVMs because they believe auditors cannot exercise due care in the audits of FVMs without a thorough understanding of the underlying valuation techniques and inputs used in assessing FVMs. They focus second on research related to verification and attestation procedures for FVMs, even though very little research directly examines the auditing of FVMs.

    Findings:
    • FVMs frequently incorporate forward-looking information reflected in market place exchanges as well as judgments about the applicability of those market inputs to company-specific conditions.
    • Future events and conditions cannot be predicted with certainty, so an element of judgment is always involved.
    • Specialists are often required to audit FVMs.
    • The structures of audits teams may inhibit the utilization of knowledge of such specialists in today’s audit firms. 
    • A number of errors and biases likely affect prepares’ valuation judgments, and auditors should be aware of those.
    • Auditors may rely on internal controls over FVM estimation process.
    • Auditors must be able to identify key assumptions and inputs in the FVM process.
    Category:
    Audit Team Composition, Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Auditors’ Professional Skepticism, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • Jennifer M Mueller-Phillips
    Auditor Mindsets and Audits of Complex Estimates.
    research summary posted July 22, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 11.0 Audit Quality and Quality Control 
    Title:
    Auditor Mindsets and Audits of Complex Estimates.
    Practical Implications:

    The study provides new direction for improving audits of complex estimates, and it adds to growing evidence that improved critical thinking, rather than increased doubt or increased demand for evidence, is key to improving audit quality. The authors show that changing auditors’ mindsets through a brief intervention allows them to make better use of the evidence that they have. The study demonstrated how a simple mindset intervention can improve audit quality, and thus, potentially improve financial reporting quality, when complex estimates are important to the financial statements. The authors expect that a deliberative mindset can help other decision makers, including investors and managers, make higher quality decisions by improving their critical analysis of a complete set of information.

    Citation:

    Griffith, E. E., Hammersley, J. S., Kadous, K., & Young, D. 2015. Auditor Mindsets and Audits of Complex Estimates. Journal Of Accounting Research 53 (1): 49-77.

    Keywords:
    accounting estimates, audit quality, fair value, professional skepticism, mindset
    Purpose of the Study:

    Complex accounting estimates, including fair values, impairments, and valuation allowances, are increasingly important to financial statements. However, auditors experience significant difficulty in auditing complex estimates, suggesting that audit quality may be low in this area. Some of these difficulties can be attributed to high levels of uncertainty about valuations given volatile financial markets and innovative securities. However, others arise from problems with auditor judgment and the audit process. Analysis of PCAOB inspection reports for the largest accounting firms reveals that fair value measurements, including impairments and other estimates, are among the most frequently cited accounts for auditor errors and that, while other audit deficiencies have decreased over time, deficiencies involving fair values and impairments have not. Chief among auditors’ judgment problems associated with auditing complex estimates are that auditors fail to adequately test the data and assumptions underlying management’s estimates and fail to notice and incorporate into their analyses inconsistencies among the assumptions, other internal data, and external conditions.

    In this paper, the authors examine whether and how changing auditors’ mindsets can improve audits of estimates, thereby enhancing audit quality in this important area. Mindsets are the set of judgment criteria and cognitive processes and procedures that produce a disposition or readiness to respond in a certain manner. Mindsets are not merely a template or framework for approaching a particular type of task; they represent a more global readiness to respond in a particular way.

    Design/Method/ Approach:

    The authors test their hypotheses in an experiment in which they manipulate mindset between participants at three levels (deliberative mindset, implemental mindset, and control). They obtained 94 usable responses from experienced audit seniors who participated while attending national or local training sessions sponsored by their firms. Participants come from three Big 4 firms and their audit experience ranges from 30 to 72 months. Seventy-eight percent are CPAs. The evidence was gathered prior to February 2014.

    Findings:
    • Auditors in the deliberative mindset condition assess the client’s biased fair value as less reasonable than do auditors in the control and implemental mindset conditions.
    • Auditors in the deliberative mindset condition are also more likely to choose a next action step that reflects more urgent concern that the fair value is unreasonable.
    • Deliberative mindset condition auditors’ explanations for their decisions are more likely to include the seeded issues and more valid issues with the estimate, generally, than are those of other auditors.
    • Additional analyses demonstrate that auditors in the deliberative mindset condition are not less trusting of management in general; rather, they target the specific assumptions with seeded errors. They also evaluate evidence about the appropriateness of the aggressive discount rate more critically than do auditors in other conditions.
    • Identification of the seeded inconsistencies and more critical evaluations of the appropriateness of the discount rate jointly fully mediate the relationship between the deliberative mindset condition and the assessed reasonableness of the fair value.
    • The deliberative mindset facilitates identification of the seeded issues and critical analysis of the discount rate, which increase concern about the reasonableness of the fair value.
    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Auditors’ Professional Skepticism
  • Jennifer M Mueller-Phillips
    Auditors’ Professional Skepticism: Neutrality versus P...
    research summary posted July 28, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism 
    Title:
    Auditors’ Professional Skepticism: Neutrality versus Presumptive Doubt.
    Practical Implications:

    Presumptive doubt has a greater effect on auditors’ skeptical judgments when client risks are higher than does neutrality. In particular, auditors with higher levels of presumptive doubt exhibit pronounced skeptical judgments and decisions in the higher control environment risk setting.

    Since the findings indicate inversed RIT is a better predictor of desired auditor skeptical judgments, this measure warrants further consideration in practice to develop adequate recruitment, staffing, and training guidance. Also a consideration for practice and future research is whether quality control processes, such as audit reviews, mitigate cases where auditors lack sufficient individual skepticism.

    Citation:

    Quadackers, L., Groot, T., & Wright, A. 2014. Auditors' Professional Skepticism: Neutrality versus Presumptive Doubt. Contemporary Accounting Research 31 (3): 639-657.

    Keywords:
    auditor independence, professional ethics, neutrality, professional skepticism
    Purpose of the Study:

    Professional skepticism is considered to be an essential element of the financial statement audit, as reflected in professional auditing standards and the audit methodologies of international audit firms. Analyses of fraud-related U.S. Securities and Exchange Commission (SEC) cases conclude that a lack of sufficient professional skepticism is often cited as the reason that auditors fail to detect material misstatements. While there is no universally accepted definition of professional skepticism, two perspectives have emerged in the current literature and auditing standards: neutrality and presumptive doubt.

    • Neutrality refers to a perspective in which the auditor assumes no bias in management’s representations.
    • Presumptive doubt represents an auditor’s attitude in which some level of dishonesty or bias by management is assumed, unless evidence indicates otherwise.

    Importantly, there is a lack of consensus on which of these two perspectives of skepticism is most appropriate for audit practice. The purpose of this study is to examine the relationship between auditors’ skeptical perspective (neutrality and presumptive doubt) and auditor skeptical judgments and decisions across client risk settings (higher versus lower control environment risk). Neutrality is measured by the Hurtt Professional Skepticism Scale (HPSS; Hurtt 2010), and presumptive doubt is measured by the inverse of the Rotter Interpersonal Trust Scale.

    Design/Method/ Approach:

    All of the participants come from one Big 4 firm. There were 96 participants in the experiment: 25 partners, 41 managers, and 27 seniors (3 participants did not provide staff-level information). On average, the auditors had 15.36 years general auditing experience and 14.75 years of experience with conducting analytical procedures. The number of participants was relatively balanced across the two control environment risk conditions. The evidence was collected prior to September of 2014.

    Findings:

    The results of this study show that inversed RIT (Rotter’s Interpersonal Trust Scale), a trait measure of presumptive doubt, is more closely associated with auditors skeptical judgments than HPSS (Hurtt Professional Skepticism Scale), a trait measure of neutrality. This relationship particularly holds when control environment risks are higher and, thus, the risk of material misstatement is of particular concern. Since auditing standards direct greater skepticism in a higher-risk setting than in a lower-risk setting, this finding suggests that inversed RIT is more likely to reflect the desired skepticism than HPSS. This result suggests that the presumptive doubt perspective of professional skepticism is more predictive than neutrality of auditor skeptical judgments and decisions in higher-risk situations.

    There is no normative solution to the case, so it is not possible to determine which skepticism measure is more closely related to optimal judgments and decisions.

    Category:
    Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Auditors’ Professional Skepticism
  • Jennifer M Mueller-Phillips
    Audits of Complex Estimates as Verification of Management...
    research summary posted October 19, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience, 11.09 Evaluation of Evidence 
    Title:
    Audits of Complex Estimates as Verification of Management Numbers: How Institutional Pressures Shape Practice.
    Practical Implications:

    Based on the interviews and problems identified, the authors conjecture that potentially suboptimal auditing methods are being used to evaluate complex estimates which are an important and growing part of the financial statements. This may be negatively impacting audit quality. More specifically, auditors over-rely on management estimates because they lack the knowledge and incentives to behave otherwise. This possibility has direct consequences for auditor professional skepticism because increasing professional skepticism may be less effective unless auditors are also given the requisite knowledge to properly use it. These problems are reinforced by auditing standards and regulators which generally outline/criticize the current auditing methods without suggesting new or better ones.  

    Citation:

    Griffith, E., J. Hammersley, and K. Kadous. 2015. Audits of Complex Estimates as Verification of Management Numbers: How Institutional Pressures Shape Practice. Contemporary Accounting Research 32 (3): 833-863.

    Keywords:
    Complex Estimates, Subjectivity, Institutional Theory, Valuation Specialists, Professional Skepticism, Interviews
    Purpose of the Study:

    Complex estimates are increasingly important to financial statements and of growing concern to both regulators and investors. While auditors have well-established procedures for auditing more objective account balances (i.e., valued at historical cost), little is known about the process auditors use to evaluate more subjective, complex estimates. This article conducts interviews with experienced audit personnel to determine how auditors evaluate such estimates, determines the problems with such approaches, and uses “institutional theory” to theorize the reason such problems exist and persist. The authors consider the influence of both audit firms themselves and regulators (i.e., information from PCAOB inspection reports) on auditors’ complex estimate audit procedures.

    Design/Method/ Approach:

    The authors conducted semi-structured phone interviews with experienced audit personnel. Participants are from 6 large accounting firms with at least manager level experience. Interviews were conducted between October and November 2010. The authors analyzed the audit process steps discussed by participants for complex estimates and coded these steps according to the PCAOB auditing standards related to accounting estimates (AU 342 and 328).  For steps that could not be appropriately classified into ones discussed by the auditing standards, the authors developed additional classifications.

    Findings:

    While auditing standards allow for different approaches to evaluating complex estimates (e.g., testing management process, preparing independent estimate, etc.), the authors find that auditors usually just test management’s process (i.e., verifying inputs such as historical cost, understanding who and how estimate is generated, testing controls surrounding process, and testing sensitivity of assumptions used).  

    Based on institutional theory, the authors theorize two key reasons that auditors mainly use management process verification when auditing complex estimates instead of other (potentially more creative and skeptical) approaches. The reasons are:

    • Both audit firm policies and professional standards generally emphasize management process verification techniques over other potential techniques. Additionally, regulators (i.e., PCAOB) reinforce/encourage this behavior because inspection findings largely focus on problems with auditing management’s process instead of suggesting alternative, superior auditing methods.
    • Audit firms employ valuation specialists who have the necessary knowledge to more critically analyze complex estimates. This fact means that financial statement auditors generally do not have the necessary knowledge to critically analyze management’s models or develop an independent expectation. When auditors do use such specialists, they over-rely on their work.
    • Given the lack of guidance regarding complex estimates, firms tend to use practices that have been previously legitimized. For auditing of complex estimates, verification (which works well to audit less subjective accounts) is used to audit more subject complex estimates. Auditing standards also mainly emphasize verification.
    • Given inspection pressures, firms find it safer and more legitimate to mimic each other’s policies and procedures for auditing complex estimates instead of develop new ones.
    Category:
    Audit Quality & Quality Control, Audit Team Composition, Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Adequacy of Evidence, Auditors’ Professional Skepticism, Evaluation of Evidence, Impact of potential post-audit review (e.g. PCAOB - internal firm inspections), Sustainability ServicesTraining & General Experience, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • Jennifer M Mueller-Phillips
    Client Identification and Client Commitment in a Privately...
    research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.09 Individual & Team Conduct - e.g., premature signoff, underreporting hours, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.06 Adequacy of Disclosure 
    Title:
    Client Identification and Client Commitment in a Privately Held Client Setting: Unique Constructs with Opposite Effects on Auditor Objectivity.
    Practical Implications:

    The results of this study suggest a course of action for enhancing professional skepticism, so they are important for audit firms specializing in privately held clients, which is an institutional setting where auditors may find it more difficult to maintain their objectivity. The authors suggest that audit firms can use their internal messaging to help individual auditors decrease the harmful effects of client identification. Specifically, audit firms can encourage auditors to (1) take the perspective of financial statement users (e.g., shareholders), (2) view themselves and clients as members of a group assigned the goal of providing accurate financial statements to shareholders, and/or (3) identify more strongly with the audit firm or the audit profession. Furthermore, the authors suggest that audit firms increase client commitment by encouraging auditors to be more attentive and available to clients (e.g., catching up with clients periodically and spending more time at the client site) and encouraging clients to feel free to reach out to auditors.

    Citation:

    Herda, D. N. and J. J. Lavelle. 2015. Client Identification and Client Commitment in a Privately Held Client Setting: Unique Constructs with Opposite Effects on Auditor Objectivity. Accounting Horizons 29 (3): 577-601.

    Keywords:
    organizational identification, organizational commitment, social identity theory, social exchange theory, auditor objectivity
    Purpose of the Study:

    Prior accounting scandals raised concerns that auditors’ relationships with their clients lower auditor independence, which in turn lowers professional skepticism, and ultimately decreases audit quality. Accounting research attempting to shed light on the social processes related to such concerns suggest that client identification can decrease auditor. However, the authors argue that client identification (i.e., “the extent to which an auditor’s self-concept and self-definition are derived from perceived oneness with the client”) differs from client commitment (i.e., “a responsibility for and a dedication to the client, but the auditor and client remain separate psychological entities”). The purpose of this study is to discover if (1) client identification and client commitment are two different ideas, (2) client identification detracts from auditor objectivity, and (3) client commitment enhances auditor objectivity.

    Design/Method/ Approach:

    The authors collected their evidence via research questionnaires emailed to auditors, ranging from staff auditors to partners, at a large regional public accounting firm during the summer of 2013. Survey participants were asked questions about client identification and client commitment, and then were asked to perform a case that dealt with auditors’ behavior in an audit conflict situation.

    Findings:
    • The authors find that client identification and client commitment really are two different ideas.
    • The authors find that client identification is associated with lower auditor objectivity.
    • The authors find that client commitment is associated with higher auditor objectivity.
    • The authors find that number of years of audit experience impacts auditor objectivity for auditors at lower levels in the audit firm’s hierarchy (i.e., staff auditors and seniors), but not those at higher levels in the hierarchy (i.e., manager and above). In other words, more junior staff exhibit greater audit objectivity if they have more years of audit experience.

    These results suggest that audit firms specializing in privately held clients may enhance audit quality by decreasing auditors’ client identification and increasing auditors’ client commitment.

    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment, Independence & Ethics
    Sub-category:
    Adequacy of Disclosure, Auditors’ Professional Skepticism, Individual & team conduct (e.g. premature signoff - underreporting hours)
  • Jennifer M Mueller-Phillips
    Construal instructions and professional skepticism in...
    research summary posted February 17, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.02 Documentation Specificity, 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence 
    Title:
    Construal instructions and professional skepticism in evaluating complex estimates.
    Practical Implications:

    The findings of this study have important implications for practice. Given the concern from the PCAOB regarding auditors’ lack of professional skepticism, this paper finds a mechanism to increase and improve the level of professional skepticism. In addition, the technique the author finds (providing high-level construal instructions) to auditors is “simple to use, inexpensive, and can easily be tailored for a firm’s specific needs or language

    Citation:

    Rasso, J.T. 2015. Construal instructions and professional skepticism in evaluating complex estimates. Accounting, Organizations and Society 46: 44-55.

    Keywords:
    professional skepticism, material misstatement, auditor judgment
    Purpose of the Study:

    The purpose of this study is to examine whether instructing auditors to create summaries of their audit findings during evidence evaluation in a broad/abstract manner (creating high-level construals) increases professional skepticism. Theoretical research suggests that using these high-level construals (or interpretations) helps individuals to process and understand numerous pieces information. The author suggests that this method could help auditors to ‘see the big picture’, which could help identify patterns in the evidence or possible material misstatements. Then, auditors may be more willing to gather and evaluate additional evidence to test for these potential problems.

    Design/Method/ Approach:

    Data for this paper was collected prior to April 2015 by using a computerized experiment. Auditors were used as participants in the study, and they averaged 5.4 years of audit experience (ranging from staff auditor to partner). In addition, ninety percent of the auditors had audited fair value estimates in the past.

    Findings:

    Auditors that were given documentation instructions to create high-level construals were more likely to exert professional skepticism compared to auditors given low-level construals (identifying specifically how an estimate could be fairly stated or misstated) or auditors given no instructions. Specifically, they spent more time collecting and evaluating audit evidence, collected more evidence, and rated the risk of the fair value estimate higher. These findings suggest that auditors using the high-level construal instructions process the information from their findings better and recognize a need to gather more evidence when given an incomplete amount of evidence. In addition, when evidence suggests that the fair value is overstated, auditors given the high-level construal instructions are more likely to realize the high risk.

    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent, Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Auditors’ Professional Skepticism, Documentation Specificity, Evaluation of Evidence
  • The Auditing Section
    Development of a Scale to Measure Professional Skepticism
    research summary posted May 2, 2012 by The Auditing Section, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind 
    Title:
    Development of a Scale to Measure Professional Skepticism
    Practical Implications:

    This study provides accounting firms with the first instrument theoretically designed to measure professional skepticism in auditors.  Objective measures of professional skepticism may be helpful to firms looking to increase audit efficiency or effectiveness, specifically in critical areas such as hypothesis generation, risk identification and fraud detection.

    Citation:

    Hurtt, R. K. (2010). Development of a Scale to Measure Professional Skepticism. Auditing: A Journal of Practice & Theory 29(1): 149-171.

    Keywords:
    Professional skepticism, scale development, trait skepticism
    Purpose of the Study:

    Professional standards have stressed the importance of individual auditor professional skepticism from the earliest codification. Although the concept of professional skepticism is widely accepted, there has been little research on exactly what comprises skepticism and how it can be measured. Professional skepticism is a complex characteristic; scales previously used to measure skepticism were not developed with the multi-dimensionality of professional skepticism in mind.  It can therefore, become difficult to draw appropriate conclusions or make comparisons with these measures. The study identifies two distinct types of professional skepticism: 1) trait skepticism, (defined as: relatively stable, an enduring quality of an individual) and 2) state skepticism (defined as: a temporary condition aroused by a given situation).  This particular study focuses only on the former and further delineates six character components of trait skepticism.  These characteristics are drawn from a careful review of the auditing standards as well as research in auditing, psychology, philosophy, and consumer behavior. The six characteristics are as follows:

    • A questioning mind
    • A suspension of judgment
    • A search for knowledge
    • Interpersonal understanding
    • Self-esteem
    • Autonomy      

    The author considers each of these component characteristics and develops a scale to more adequately and appropriately measure the trait skepticism of auditors. 

    Design/Method/ Approach:

    The author gathers 220 potential questions measuring each of the component characteristics identified. This large group of questions was further reduced based on several pre-tests performed on groups of varying size of undergraduate and graduate level business students. Once the scale had been reduced to a 30-item test, it was administered to 200 auditors from a major international accounting firm. To ensure that the scale was reliable, the test was re-administered to 88 auditors from the same international firm.  It is important to note that the scale was validated using auditors from only one major firm and was validated prior to the passage of the Sarbanes-Oxley Act of 2002.

    Findings:
    • The results provide preliminary evidence that the skepticism scale developed here is an instrument with appropriate reliability and validity.  
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Auditors’ Professional Skepticism, Prior Dispositions/Biases/Auditor state of mind
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