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  • The Auditing Section
    The Effect of a Justification Memo and Hypothesis Set...
    research summary posted May 7, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.11 Auditor judgment in the workpaper review process, 11.0 Audit Quality and Quality Control, 11.06 Working Paper Review – Conduct, Biases and Predispositions 
    Title:
    The Effect of a Justification Memo and Hypothesis Set Quality on the Review Process
    Practical Implications:

    The results of this study indicate that the justification memo, while functional for the preparer, may impair a reviewer’s effectiveness due to the impact on information processing. Due to the positive impact on preparer’s efforts, the memos should not be eliminated but firms should be aware of the impact on reviewer effectiveness. Firms could train reviewers to evaluate audit evidence prior to looking at a justification memo. Firms may also try to control the types of justification memos used. For instance, prior research shows that balanced memos may have fewer negative impacts on the review process.  Lastly, making reviewers aware of this unconscious bias may be a successful way of ensuring reviewer’s effectiveness is not impacted by the memo.

    Citation:

    Asare, S. K. and Wright, A. M. 2008. The Effect of a Justification Memo and Hypothesis Set Quality on the Review Process. Behavioral
    Research in Accounting
    20(1): 1-12.

    Keywords:
    Review process
    Purpose of the Study:

    In conducting substantive analytical procedures, preparers generate and test multiple hypotheses, based on test results, before selecting and documenting the most likely cause of an unexpected fluctuation. Part of this documentation includes a justification memo.  Requiring justification has been shown to positively affect the quality of preparers’ work. However, the impact that justification memos have on reviewers is less understood. Prior research indicates two different tendencies in reviewers:

    • Reviewers who are unduly persuaded by the preparer’s justification or stylization – For this type of reviewer, the memo’s presence will lead to more attention spent on corroborating the evidence that supports the preparer’s position.
    • Reviewers who take a different perspective from the preparer and focus on inconsistent evidence – For this type of reviewer, the memo will have no impact on judgment, as they will evaluate the underlying pieces of audit evidence and interpret the memo as the preparer’s rationale rather than the basis for the preparer’s conclusion. 

    The authors consider a setting in which preparers document all of the causes for a ratio fluctuation considered by the audit team as well as the preparer’s conclusion regarding which is the most likely cause. The authors expect reviewers judgments will be different based on whether the documentation they are given includes the “actual cause” (i.e. the only explanation that fully accounts for the size and direction of the observed fluctuation) and whether the preparer wrote a justification memo. When the documentation includes the actual cause, reviewers will match all available evidence to a cause and will assume the preparer also appropriately considered all of the available evidence. The reviewer’s assumption is bolstered when a justification memo is included, and thus agreement with the preparer’s position will increase. However, if the documentation does not include the actual cause, evidence suggestive of the actual cause cannot be linked to one of the identified causes.  Therefore, the reviewer will spend more time processing all of the evidence regardless of the presence of a justification memo.

    Design/Method/ Approach:

    Participants (reviewers) were audit seniors with an average of 32 months of experience. Participants were asked to review the work of a staff auditor related to an unexpected increase in the gross margin ratio. Reviewers were presented with five potential causes of the fluctuation as identified by the staff auditor, six test results, and the staff auditor’s conclusion as to the most likely cause. Half of the participants (reviewers) reviewed workpapers that contained the “actual cause” while the other half reviewed papers that did not include the actual cause as one of the five potential causes identified by the staff auditor (although in each case the six test results contained information that would allow the reviewer to identify the “actual cause”).  In all cases the staff auditor’s conclusion was incorrect.  Half of the reviewers also received a memo written by the preparer justifying this incorrect conclusion. Reviewers were then asked to indicate whether they agreed or disagreed with the preparer’s conclusion.

    Findings:
    • When presented with the actual cause and four possible causes of the unexpected increase in the gross margin, reviewers who received a justification memo incorrectly agreed with the preparer more often than those who did not receive the memo (i.e. they seemed to be improperly influenced by the justification memo).
    • When presented with five incorrect causes of the unexpected increase in the gross margin ratio, reviewers who received the justification memo incorrectly agreed with the preparer as often as those who did not receive the memo. 
    Category:
    Auditor Judgment, Audit Quality & Quality Control
    Sub-category:
    Prior Dispositions/Biases/Auditor state of mind, Auditor judgment in the workpaper review process
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  • The Auditing Section
    The Effect of Alternative Types of Review on Auditors’ P...
    research summary posted May 2, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.02 Documentation Specificity, 09.11 Auditor judgment in the workpaper review process, 11.0 Audit Quality and Quality Control, 11.06 Working Paper Review – Conduct, Biases and Predispositions 
    Title:
    The Effect of Alternative Types of Review on Auditors’ Procedures and Performance
    Practical Implications:

    The results of this study are important for audit firms to consider when designing their audit review process.  Though the initial reason for using interactive review was to increase efficiency and enhance training, the results of this study show that the use of interactive review can potentially increase audit effectiveness.  The anticipation of an interactive review enhanced auditors’ efforts toward more cognitively demanding, conclusion-oriented audit procedures.  At the same time, the type of review anticipated had no effect on the performance of the mechanical steps in the audit program (both groups performed well in the mechanical, documentation-oriented audit steps).

    Citation:

    Payne, E. A., R. J. Ramsay, and E. M. Bamber. 2010.  The Effect of Alternative Types of Review on Auditors’ Procedures and Performance.  Auditing: A Journal of Practice & Theory 29 (1): 207-220.

    Keywords:
    audit review process; review formats; interactive review; written review; auditor judgment
    Purpose of the Study:

    Audit review is a primary means of audit quality control and auditor training.  Given the significant amount of total audit hours allocated to review, audit firms are constantly examining ways to increase both the effectiveness and the efficiency of review.  Traditionally, reviewers examine documentation, prepare written review comments, and then either meet with the preparer face-to-face or provide the written notes to the preparer to be addressed.  An alternative approach that has gained in popularity is a real-time interactive review.  In this type of review, reviewers do not prepare written review notes prior to the review.  Instead, the reviewer sits down with the preparer and the review is done face-to-face with the file reviewer.  The interaction generates the written comments for the preparer to follow-up rather than written comments being prepared in advance.  Given the unique features of an interactive review, the purpose of this study is to examine how preparers’ anticipation of this type of review (as compared to a review with written notes) affects their performance of audit procedures and, in turn, audit effectiveness.  Specifically, the study examines the following:

    • Whether auditors anticipating an interactive review will more thoroughly perform the more cognitively demanding, conclusion-oriented steps of an audit program than auditors anticipating receipt of written review notes.
    • Whether auditors anticipating an interactive review will perform the more mechanical, documentation-oriented steps of the audit program differently than auditors anticipating receipt of written reviewnotes.
    • If performance on the conclusion-oriented steps of an audit program is positively related to conceptual error identification.
    • If performance on the documentation-oriented steps of an audit program is positively related to mechanical error detection.
    Design/Method/ Approach:

    The research evidence is collected prior to November 2008.  The authors use a group of staff- and senior-level auditors from three international accounting firms to complete a simulated audit task involving completing a test of internal controls for write-offs of accounts receivable.  Half of the participants were told they would receive written review notes and half of the participants were told they would be asked to meet face-to-face with a manager in an interview format to discuss/review the participant’s work. 
    All participants then performed mechanical, documentation-oriented procedures, conceptual, conclusion-oriented procedures, prepared a summary memo, and performed test of controls.  Completion of the procedures would allow them to identify two misstatements in the audit support and one fraud red flag.

    Findings:
    • Auditors anticipating an interactive review performed a more thorough examination of the audit evidence in the conceptual, conclusion-oriented audit steps than auditors anticipating a written review notes.
    • Auditors anticipating both types of reviews performed similarly in the mechanical, documentation-oriented audit steps.
    • A more thorough review of the audit evidence in the demanding, conclusion-oriented steps of an audit program is positively associated with (1) the identification of the fraud red flag (as predicted) and (2) detections of mechanical errors (not predicted).  To clarify, auditors who performed better in the conclusion steps of an audit program were more likely to identify the fraud red flag and the misstatements.
    • Performance of the mechanical, documentation-oriented audit steps is positively associated with detections of mechanical errors.  To clarify, auditors who performed better in the documentation steps of an audit program were more likely to identify the misstatements.
    Category:
    Auditor Judgment, Audit Quality & Quality Control
    Sub-category:
    Documentation Specificity, Auditor judgment in the workpaper review process, Working Paper Review – Conduct - Biases & Predispositions
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  • The Auditing Section
    The Effects of Audit Review Format on Review Team Judgments
    research summary posted April 23, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.11 Auditor judgment in the workpaper review process, 11.0 Audit Quality and Quality Control, 11.01 Supervision and Review – Effectiveness, 11.06 Working Paper Review – Conduct, Biases and Predispositions 
    Title:
    The Effects of Audit Review Format on Review Team Judgments
    Practical Implications:

    The results of this study are important for audit firms to consider when planning how workpaper reviews will be performed, when setting preparers’ review expectations and when reviewing electronic workpapers.  Though the paper does not discuss these implications explicitly, the findings point to the following potential implications auditors may consider:

    • Anticipation of face-to-face review by preparers tends to result in workpapers of higher quality.
    • Face-to-face reviews tend to be of higher quality than electronic reviews.
    • Workpapers prepared in anticipation of an electronic review tend to be lower in quality than the workpapers prepared in anticipation of a face-to-face review.  Thus, electronic reviewers may consider decreasing their reliance on such workpapers, spending more time reviewing the workpapers, providing more review notes, and/or increasing the amount of rework they require from the preparers.
    Citation:

    Agoglia, C.P., R. C. Hatfield, and J. F. Brazel. 2009. The Effects of Audit Review Format on Review Team Judgments. Auditing: A Journal of Practice and Theory 28(1):95-111.

    Keywords:
    documentation; review process; judgment quality; electronic review; face-to-face review.
    Purpose of the Study:

    The increasing use of electronic workpapers enables reviewers to review workpapers electronically (i.e., remotely, communicating via email), rather than face-to-face (i.e., reviewing on-site with the opportunity to discuss review notes and ask/answer questions in person).  Recent accounting research finds that review mode can affect the judgments of auditors preparing workpapers.  In this study, Agoglia et al. investigate the extent to which review mode (electronic or face-to-face) affects the quality of documentation in the workpapers and the mechanism behind this relationship.  In addition, the authors investigate whether reviewers are able to discern and compensate for these documentation quality issues.

    Design/Method/ Approach:

    Agoglia et al. collect their evidence via an experiment in which auditors act as mock preparers or reviewers of workpapers.  Participants prepare preliminary going-concern evaluation workpapers for a hypothetical client.  Specifically, they are required to document evidence for a preliminary going concern conclusion.  Preparers are randomly assigned to one of two conditions: face-to-face review or electronic review.  Preparers in each condition are informed that their work will be reviewed face-to-face or electronically, depending on the condition.  

    Reviewers are randomly assigned to preparers and informed that they will review the workpapers either face-to-face or electronically, depending on the preparer’s condition.  The reviewers are required to leave notes and assess quality, reliability, and completeness of the working papers, as well as any additional work still required to be done.  The reviewers’ judgments are then compared with those of experts (audit partners) who receive the same materials as the preparers.  The experimental data was collected in the early 2000’s.

    Findings:
    • The judgments of the face-to-face workpaper reviewers are, on average, essentially the same as those of the experts (audit partners), indicating they are of relatively high quality.  Conversely, the judgments of the electronic workpaper reviewers are significantly different, on average, than those of the experts (i.e., of lower quality).
    • The experts consider the evidence documentation provided by the electronic review group to be of lower quality than the documentation provided by the face-to-face preparers.  However, reviewers do not appear to recognize this issue.  Specifically, the authors find that the documentation quality assessment gap (reviewer minus expert mean assessment of documentation quality) is significant for the electronic review group, while it is insignificant for the face-to-face group – indicating that while experts and reviewers have similarly high perceptions of documentation quality of the face-to-face preparers, reviewers perceive workpapers of electronic review preparers to be of higher quality than do experts. The authors show that the documentation quality assessment gap negatively affects electronic reviewers’ judgment quality. In other words, it is electronic reviewers’ inability to assess the lower quality of the workpaper documentation that is the mechanism behind their lower reviewer judgment quality.            
    • Electronic reviewers rely on the preparer’s workpapers and would require additional work to the same  extent as the face-to-face reviewers.  Further, electronic reviewers take about the same time to review and give about the same number of review notes as the face-to-face reviewers.  This finding is best viewed in light of the finding in prior research showing that reviewers believe electronic reviews are less effective.  However, electronic reviewers do not appear to be compensating for the lower quality of workpapers prepared in anticipation of electronic review.
    Category:
    Auditor Judgment, Audit Quality & Quality Control
    Sub-category:
    Auditor judgment in the workpaper review process, Supervision & Review – Effectiveness, Working Paper Review – Conduct - Biases & Predispositions
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  • The Auditing Section
    The Effects of Client and Preparer Risk Factors on Workpaper...
    research summary posted May 9, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.11 Auditor judgment in the workpaper review process, 11.0 Audit Quality and Quality Control, 11.06 Working Paper Review – Conduct, Biases and Predispositions 
    Title:
    The Effects of Client and Preparer Risk Factors on Workpaper Review Effectiveness
    Practical Implications:

    The results suggest that although preparer risk is not a driver of review effort, it nevertheless can affect accuracy when client risk is high. The results of this study are useful for understanding how client risk and preparer risk interact to influence workpaper review effort and accuracy. Overall, it appears that reviewers expect highly competent preparers to identify and correct errors. Accordingly, reviewers tend to rely on the work of a competent preparer and allow low preparer risk to compensate for high client risk. The authors note that although this is an efficient strategy, it can adversely affect the reviewer’s effectiveness by reducing the accuracy with which they identify errors.

    Citation:

    Asare, S. K., C. M. Haynes and J. G. Jenkins. 2007. The Effects of Client and Preparer Risk Factors on Workpaper Review Effectiveness. Behavioral Research in Accounting 19 (1): 1-17.

    Keywords:
    workpaper review, client engagement risk, workpaper preparer risk, review effort, review accuracy
    Purpose of the Study:

    When reviewing workpapers, auditors must accept some degree of risk. This risk is composed of (1) client risk and (2) preparer risk. Client risk refers to the risk that the information provided by the client is materially misstated and preparer risk refers to the risk that the workpaper preparer failed to identify, investigate and/or resolve existing material misstatements. The purpose of this study is to examine how combined client risk and preparer risk affect the effort and accuracy of the workpaper reviewer.

    Design/Method/ Approach:

    Fifty-three experienced auditors reviewed an actual set of audit workpapers which were originally prepared and reviewed by a Big 4 accounting firm. The workpapers related to the sales and collection cycle and contained one uncorrected revenue recognition error and ten seeded mechanical errors.

    Participants were asked to assume the role of in-charge auditor and instructed to review the workpapers. They were also provided with information about whether client risk was high (e.g., “Management’s accounting policies and estimates are aggressive”) or low (e.g., “Management’s accounting policies and estimates are conservative”) and information about whether preparer risk was high (e.g., “Jane’s ranking among staff accountants in your office is in the 50th percentile”) or low (e.g., Jane’s ranking among staff accountants in your office is in the top 5 percent”).

    After reviewing the workpapers, participants were asked whether they agreed or disagreed with the preparer’s conclusions. Their effort was measured by the amount of time they spent reviewing the workpapers and their accuracy was measured by the number of errors that they correctly identified.

    Findings:
    • The authors find that reviewers expended more effort during their review when reviewing workpapers of a high-risk client, relative to a low risk client. However, the preparer risk did not make a difference in the amount of effort exerted.
    • The authors also find that reviewers were more accurate in their review (i.e. correctly identified more errors) when both client risk and preparer risk were high. However, the preparer risk did not make a difference in accuracy when the client risk was low.
    Category:
    Auditor Judgment, Audit Quality & Quality Control
    Sub-category:
    Auditor judgment in the workpaper review process, Working Paper Review – Conduct - Biases & Predispositions
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