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  • 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
    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
    Field Data on Accounting Error Rates and Audit Sampling
    research summary last edited July 20, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.02 Sample Selection – use of statistical sampling, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.08 Evaluation of Errors – Statistical and Non-statistical 
    Title:
    Field Data on Accounting Error Rates and Audit Sampling
    Practical Implications:

    This study provides several important practice implications. First, prior research on audit sampling that relied on the assumption of relatively large error rates may not provide useful guidance for post-SOX audit sampling populations. Second, auditing educators, regulators, and standard setters benefit from an updated understanding of how auditors apply audit sampling guidance in auditing standards when using audit sampling in the field. For example, knowing the relatively high compliance (compared with prior periods) with requirements in auditing standards should impact the way audit sampling is taught in universities and firm trainings, how peer and federal inspectors address audit sampling issues, as well as the need for further clarity of auditing standards. Auditors also benefit as they consider the sampling techniques and input assumptions that will produce the most effective and efficient sampling plans. Specifically, an important implication of our study is related to the impact of standardized sampling templates. The firm in this study mandated the use of such templates, which contributed to levels of explicit consideration of error projection, sufficiency of sample sizes, and of sampling risk in planning and evaluating sample testing.

    For more information on this study, please contact Steve Glover.

    Citation:

    Durney, M., R. J. Elder, and S. M. Glover. 2014. Field data on accounting error rates and audit sampling. Auditing: A Journal of Practice and Theory 33 (2): 79-110

    Keywords:
    Sampling, error rates, error projection, sampling risk
    Purpose of the Study:

    Prior research has examined error characteristics of accounting populations. Many studies investigating audit sampling techniques rely on assumptions concerning the error characteristics of accounting populations. Prior research studies examining auditor performance when using audit sampling have reported:

    • Decreasing sample sizes for tests of details.
    • Auditors frequently fail to project sample errors.
    • Auditors do not consider sampling risk when projecting sample errors.

    These studies involve data from periods preceding the events resulting in the Sarbanes–Oxley Act (hereafter, SOX). Much has happened since SOX, including a renewed focus on audit quality, new auditing and accounting standards, and the creation of the PCAOB. Using proprietary post-SOX data from a large accounting firm, the authors report on:

    • Error rates in populations subject to audit sampling.
    • Auditor compliance with auditing standards with regards to error projection, sample size, and consideration of sampling risk.
    Design/Method/ Approach:

    Data for the study is comprised of the results of 160 different sampling applications from a large auditing firm in 2005 and 2006. The sampling applications were applied across a range of financial statement accounts including accounts receivable, inventory, loans, expenses, plant additions, and revenues. All the tests were substantive tests of details and meant to be representative of the population.

    Findings:

    The authors find the following:

    • Error rates in populations subject to audit sampling are significantly lower in magnitude and frequency than researchers have traditionally assumed.
    • Significantly larger sample sizes and higher error projection rates than reported in previous studies using pre-SOX data.
    • Explicit consideration of sampling risk by auditors.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Conclusions Based on Samples, Evaluation of Errors - Statistical and Non-statistical, Sample Selection – use of statistical sampling
  • Jennifer M Mueller-Phillips
    The Effects of Professional Role, Decision Context, and...
    research summary last edited July 16, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.04 Moral Development and Individual Ethics Decisions, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism 
    Title:
    The Effects of Professional Role, Decision Context, and Gender on the Ethical Decision Making of Public Accounting Professionals.
    Practical Implications:

    In the study, subjects who are less relativistic are less likely to concede to the client. This study identifies an interesting gender difference with respect to the ethical decision-making process between male and female accountants. Given that the lines dividing auditors and tax professionals are increasingly being blurred, firms’ training programs should take into consideration both differences in context and individual differences in experiences due to professional roles. With the increased emphasis on firms’ ethics training, these results add to the premise that one size fits all training programs are unlikely to achieve the desired results, and that firms’ ethics training may need to be tailored to account for different individual approaches to decision making.

    Citation:

    Bobek, D. D., Hageman, A. M., & Radtke, R. R. 2015. The Effects of Professional Role, Decision Context, and Gender on the Ethical Decision Making of Public Accounting Professionals. Behavioral Research in Accounting 27 1: 55-78.

    Keywords:
    ethical decision making, auditors, tax professionals, gender, context, professional role
    Purpose of the Study:

    The purpose of this study is to investigate how professional role (auditor or tax professional), decision context (an audit or tax issue), and gender influence public accounting professionals’ ethical decision making.

    U.S. auditors are bound by professional standards to function as independent, objective evaluators of evidence, and to operate as professional skeptics. In the past decade, auditors have been under increasing attack for abandoning their professional skepticism charge.  Unlike auditors, tax professionals, while also having an obligation to the tax system, face a unique professional position of being required to advocate for their clients. U.S. tax professionals have faced increasing oversight and stiffened penalties in response to the marketing of tax shelters by CPA firms and the provision of overly aggressive tax advice. Tax professionals in the U.S. have become increasingly involved in audits with respect to clients’ tax provisions and the requirements of FASB ASC 740, particularly because income taxes are one of the most frequent causes of the Securities and Exchange Commission’s (SEC) Comment Letters sent by the SEC to its registrants. Thus, while auditors and tax professionals face different environmental constraints, they have both been under increased scrutiny in recent years due to lapses in professional judgment. the marketing of tax shelters by CPA firms and the provision of overly aggressive tax advice. Thus, while auditors and tax professionals face different environmental constraints, they have both been under increased scrutiny in recent years due to lapses in professional judgment. 

    Design/Method/ Approach:

    This study investigates the effects of professional role, decision context, and gender in ethical decision making using an experiment with 134 public accounting professionals with a mixture of auditing and tax backgrounds as participants. Participants are from seven different public accounting firm offices in two different U.S. states. The sample contained 87 auditors and 47 tax professionals separately, and 76 males and 58 females separately.

    Findings:

    The results show that male participants’ professional experience influences their ethical decision making, as auditors are less likely than tax professionals to recommend conceding to the client and to indicate that they would concede when faced with a contentious client issue. The results also indicate that context plays an important role in ethical decision making, as male professional accountants are less likely to recommend that a third party concede to the client in an auditing context than in a tax context, and are less likely to indicate that they themselves would concede.

    Furthermore, the results highlight the importance of individual attributes in making ethical decisions; in particular, accountants’ ethical judgments are influenced by relativism and firm size. In addition, an interesting gender effect is identified in that females appear to use a different decision-making process than males with respect to ethical situations. Specifically, except for the effect of relativism on behavioral intentions, the results obtained for the full sample of 134 professionals appear to be driven by the male participants. When males and females are analyzed separately, professional role, context, firm size, and moral intensity are not significantly related to females’ ethical decision making.

    Category:
    Auditing Procedures - Nature - Timing and Extent, Independence & Ethics
    Sub-category:
    Auditors’ Professional Skepticism, Moral Development and Individual Ethics Decisions
  • Jennifer M Mueller-Phillips
    Audit risk Assessments Using Belief versus Probability
    research summary last edited November 10, 2014 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
    How Do Auditors Behave During Periods of Market Euphoria?...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.04 Going Concern Decisions 
    Title:
    How Do Auditors Behave During Periods of Market Euphoria? The Case of Internet IPOs
    Practical Implications:

    Due to the potential for future market bubbles, the findings of this study may be of interest to audit regulators and standard setters. These finding suggest mixed conclusions regarding the Big 5’s behavior during periods of market euphoria. The presence of going concern opinions varies inversely with variables that represent client viability and auditor self-interest. Evidence that points to a decrease in the predictive value of Big 5 opinions signed during the Internet IPO bubble may also have consequences for investors.
     
    For more information on this study, please contact Andrew J. Leone.
     

    Citation:

    Leone, A. J., S. Rice, J. P. Weber, and M. Willenborg. 2013. How Do Auditors Behave During Periods of Market Euphoria? The Case of Internet IPOs. Contemporary Accounting Research 30 (1).

    Keywords:
    auditors’ opinions; going concerns; initial public offerings; online information services
    Purpose of the Study:

    The study of periods of market euphoria is a long-standing topic of interest to economists. Theorists specify conditions under which market participants and institutions cause bubbles to form. This study looks at how auditors behave during these periods of euphoric market conditions, specifically around the time of the wave of Internet companies’ IPOs in the late 1990s and early 2000s. The goal was to discover how audit decisions change with fluctuations in the external marketplace. The authors address whether auditors are maintaining their responsibility to act in the public’s best interest during these unique market conditions, and how going concern decisions of these Internet IPO companies might vary based on these conditions.

    Design/Method/ Approach:

    The authors obtained a sample of 756 Internet IPO filings from 1996 to 2000 using an online database, as well as a sample of non- Internet IPO registrants. Using descriptive statistics, the authors tested these samples for determinants that could lead auditors to shift their going concern decision criteria during euphoric market conditions.

    Findings:
    • The presence of going concern opinions varies with variables that proxy for both economic reasons and for less independence and skepticism by the Big 5.
    • Some evidence points to associations between costs to investors and a decrease in Big 5 going concern opinions during the bubble.
    • Big 5 firms were not a major cause of the Internet IPO bubble, but large audit firms did little to slow it from inflating.
       
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment, Client Acceptance and Continuance
    Sub-category:
    Auditors’ Professional Skepticism, Business Risk Assessment (e.g. industry - IPO - complexity), Going Concern Decisions
  • Jennifer M Mueller-Phillips
    Do changes in audit actions and attitudes consistent with...
    research summary posted October 22, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 10.0 Engagement Management, 10.04 Interactions with Client Management 
    Title:
    Do changes in audit actions and attitudes consistent with increased auditor scepticism deter aggressive earnings management? An experimental investigation
    Practical Implications:
    • Regulators and standard setters have been concerned that we do not know which audit actions most likely detect fraud.  An understanding of what audit procedures are likely to discourage managers from committing fraud is valuable. 
    • Specifically, the study shows that changes in the nature and extent of audit procedures combined with increased skepticism via critical inquiry are helpful in deterring potentially fraudulent behavior. 
    • Similar changes in audit procedures also affect management’s judgment about the ethicality of potentially fraudulent behavior. 
       
    Citation:

    Chen, Q., K. Kelly, and S. Salterio. 2012. Do changes in audit actions and attitudes consistent with increased auditor scepticism deter aggressive earnings management? An experimental investigation. Accounting, Organizations and Society 37 (2): 95-115.  

    Keywords:
    Fraud, Audit Procedures, Professional Skepticism, Earnings Management
    Purpose of the Study:

    Recent years have brought increased focus on the financial statement audit as not just a means of detection but a deterrent to fraud.  The link between detection and deterrence is made in practice because an increase in the ability to detect fraud on the part of the auditor (if widely known) should also lead to an increase in the ability of the audit process to deter fraud.
    The current study seeks to identify whether different audit procedures and attitudes toward management deter aggressive earnings management that is possibly fraudulent.  Using the experimental research approach allows the authors to focus on a scenario where the increase in deterrence is not due to an increase in the probability of detection but is most likely due to the specific changes in the audit approach tested. 
     

    Design/Method/ Approach:

    Corporate managers were placed in different experimental conditions to examine differences in their assessments about potentially fraudulent behavior.  Participants were told they were the manager of a firm for which rotational audits are performed.  In the current year, the manager’s division was not being audited, but they were made aware of the audit procedures being performed in other divisions.  In one condition, the procedures were the same as last year (SALY).  In another condition, the extent or quantity of evidence collected would be increased.  In the third condition the nature of evidence collected was increased (i.e. confirmations rather than internal documentation).  Within each of these three conditions half of the participants would also note an increase in auditor skepticism via more critical inquiry procedures while the other half would not.  Managers were then asked to assess a level of potential earnings management in their division as well as the ethicality of any potential earnings management.  The experiment was web-based.

    Findings:
    • When managers find out about a change in the nature of audit work being performed at other divisions, they respond by reducing earnings management in their own division as compared to the condition where procedures were the same as last year or where the change in procedure is an increase in audit evidence only. 
    • Managers exhibited this behavior even though the changes in procedures did not affect their division. 
    • Combining a more skeptical auditor attitude toward a manager with a change in the nature of audit evidence, the extent of evidence collected, or a change in the nature of the evidence, reduces earnings management as compared to the same as last year condition
    • An increase in evidence collected alone, or more critical inquiry alone does not significantly deter earnings management relative to the condition where procedures were the same as last year.
    • The results of management’s assessment of the ethicality of potential earnings management mirrors the results for the planned level of earnings management described above.  These results hold, even after considering manager ethical disposition.
       
    Category:
    Auditing Procedures - Nature - Timing and Extent, Engagement Management, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Auditors’ Professional Skepticism, Earnings Management, Interactions with Client Management
  • The Auditing Section
    The Effect of Audit Inquiries on the Ability to Detect...
    research summary last edited May 25, 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 
    Title:
    The Effect of Audit Inquiries on the Ability to Detect Financial Misrepresentations
    Practical Implications:

    The results of this study show that inquiry, including repeating questions and providing deception training do not increase the accuracy of those observing interviews.  However, the participants were less likely to believe interviewees when they observed the open ended question inquiry than when they observed the yes/no questions only. Therefore, there is some evidence that by observing an inquiry, professional skepticism is increased.       

    The authors recognize that their results may not generalize to experienced auditors, who may have general or specialized knowledge and abilities that enable them to detect deception better than undergraduate accounting students and recommend further research on experienced auditors.  

    Citation:

    Lee, C. C. and Welker, R. B. 2007. The effect of audit inquiries on the ability to detect financial misrepresentations. Behavioral Research in Accounting 19 (1): 161-178.

    Keywords:
    fraudulent financial reporting, audit inquiry, deception detection, deception training
    Purpose of the Study:

    There has been a recent emphasis placed on inquiries for fraud risk assessments. The present study assesses how well deception can be detected during audit inquiries.  Due to the nature of an audit inquiry, the authors predict that the inquiries will create an environment where deception is more difficult to carry out and is therefore easier to catch. Using two experiments, the authors examine whether a student observing an interview (as opposed to performing the interview) is effective at detecting deception and whether training increases the ability to detect deception. 

    Design/Method/ Approach:

    The authors performed two experiments using undergraduate accounting students.  The experiment involved a simulated interview where an interviewer (former auditor and CPA) asked an interviewee (MBA student) questions and observers (accounting students) reviewed a video of the interviews and determined whether the interviewee was telling the truth or lying.  Observers were exposed to one of three sections of the interview: just the representations of the interviewee (just yes or no questions), the representations and the inquiry (yes/no and open ended questions), or the entire interview (including repeated questions). 

    A second experiment was conducted which was consistent with the first experiment. A new set of undergraduate accounting students were observers of the same interviews used in experiment one. However, half of the observers received training and half did not. 

    Findings:
    • Students are not any better at detecting deception by observing an interview than random chance.
    • Those who observed the inquiry (open ended questions) are no better at detecting deception than those who just observed the representations (yes/no questions).
    • Those who observed the entire interview with repeated questions are no better at detecting deception than those who observed the inquiry without repeated questions.
    • Those who received training were not any better at detecting deception than those who did not receive training.
    Category:
    Risk & Risk Management - Including Fraud Risk, Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Fraud Risk Assessment, Auditors’ Professional Skepticism
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  • The Auditing Section
    Exploring Trust and the Auditor-Client Relationship: Factors...
    research summary last edited May 25, 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, 10.0 Engagement Management, 10.04 Interactions with Client Management 
    Title:
    Exploring Trust and the Auditor-Client Relationship: Factors Influencing the Auditor’s Trust of a Client Representative
    Practical Implications:

    The findings provide evidence that auditors do hold a level of trust in client representatives and that the level of trust is associated with commonplace behaviors of client representative that attract trust.  The results of this study are important to make auditors and auditing standards setters aware of factors that may lead to greater auditor trust of client management and perhaps consider whether there may be a potential for excessive trust to overwhelm the auditor’s professional skepticism. Note that the study was unable to determine whether the levels of trust that the auditors had for the client were such that auditor judgment would be compromised.

    Citation:

    Rennie, M. D., L. S. Kopp, and W. M. Lemon. 2010. Exploring Trust and the Auditor-Client Relationship: Factors Influencing the Auditor’s Trust of a Client Representative. Auditing: A Journal of Practice and Theory 29 (1): 279-293

    Keywords:
    Trust, Professional Skepticism, Auditor-Client Relationship
    Purpose of the Study:

    A financial statement audit cannot be conducted in the absence of the auditor’s trust of client management.  The auditor needs information provide by management and the cooperation of management to carry out the audit.  Thus, the auditor has no option but to bestow some degree of trust upon client management.  Yet, if trust is too strong, professional skepticism could be impaired.  Below are the objectives of this descriptive, exploratory study: 

    • To shed light on auditors’ trust of client management using the context of an auditor-client disagreement.
    • To learn about client behaviors (e.g. openness of communication and demonstration of concern) that may influence the auditor’s trust of a client.
    • To learn about aspects of the auditor-client relationship (length of association and frequency of past disagreements) that may influence the auditor’s trust of a client.
    • To gather auditors’ opinions about the importance of trust and about managing the balance between trust and professional skepticism.
    Design/Method/ Approach:

    The authors collected their evidence via a survey questionnaire prior to June 2007. Participants surveyed include 71 experienced auditors (48 partners, 2 principals, 20 senior managers, and 3 managers) from Canadian international accounting firms. Participants were asked to briefly describe a disagreement they had previously had with a client and were asked specific questions about that disagreement.

    Findings:
    • A disagreement experience with the client is relevant to the auditor’s trust of that client.
    • A client’s openness of communication during the course of a disagreement is positively associated with the auditors’ trust of that client representative.
    • A client’s demonstration of concern toward the auditor appears to be trust-relevant.
    • The frequency of disagreements with the client is negatively associated with the auditor’s trust of the client.
    • The length of the auditor-client relationship is positively associated with the auditor’s trust.
    • An auditor’s satisfaction with the outcome of the disagreement is positively associated with the auditor’s trust. 
    • The auditor’s predisposition to trust is not associated with the auditor’s trust of the client.
    • Auditors believe it is important to trust their clients but they also attempt to ensure that trust does not impede professional skepticism.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment, Engagement Management
    Sub-category:
    Auditors’ Professional Skepticism, Prior Dispositions/Biases/Auditor state of mind, Interactions with Client Management
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  • The Auditing Section
    Attention to Evidence of Aggressive Financial Reporting and...
    research summary last edited May 25, 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
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