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    Professional Skepticism: The Effects of a Partner’s I...
    research summary posted February 17, 2015 by Jennifer M Mueller-Phillips, last edited February 19, 2015, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment 
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    Title:
    Professional Skepticism: The Effects of a Partner’s Influence and the Level of Fraud Indicators on Auditors’ Fraud Judgments and Actions
    Practical Implications:

    Former Chief Accountant of the SEC enforcement division suggested that a lack of professional skepticism was among the primary causes of SEC actions against auditors. Further, the PCAOB suggested that auditors seem to lack professional skepticism in practice, resulting in significant deficiencies in important audit areas. SAS No. 99 requires auditors to evaluate the possibilities of fraud on all audits, suggesting that this evaluation will help auditors maintain professional skepticism. The standard suggests that for this evaluation to be effective, partners must set the proper tone at the top. The results of our study suggest that auditors led by a partner who emphasizes professional skepticism and effectiveness are both effective and efficient in their fraud investigations; however, those auditors led by a partner who emphasizes efficiency are not effective and are no more efficient. These results highlight the costs for partners who emphasize efficiency relative to effectiveness. Moreover, these results support standard setters’ suggestions that the partner must set the proper tone in order for the benefits of professional skepticism to be realized and to effectively investigate fraud. 

    Citation:

    Carpenter, T. and J. Reimers. 2013. Professional Skepticism: The Effects of a Partner’s Influence and the Level of Fraud Indicators on Auditors’ Fraud Judgments and Actions. Behavioral Research in Accounting 25 (2): 45-69.

    Keywords:
    professional skepticism, tone at the top, fraud risk assessments, audit procedures
    Purpose of the Study:

    The Public Company Accounting Oversight Board (PCAOB), in its recent auditor inspections, cited a lack of professional skepticism and selection of appropriate audit procedures as serious problems for auditors, and suggested that the tone set by audit partners is critical for auditors’ fraud investigations. We investigate selected components of Nelson’s (2009) model of professional skepticism: the effects of partner emphasis on professional skepticism and the effect of the level of fraud indicators on auditors’ identification of fraud risk factors, auditors’ fraud risk assessments, and their selection of audit procedures. Thus, we provide an initial test of predictions of the links established in his model, and our results suggest a possible extension to his model. This study provides evidence that a partner’s emphasis on professional skepticism is critical for both effective and efficient identification of relevant fraud risk factors and choice of relevant audit procedures. These results should be informative to both standard setters and academic researchers because they highlight the costs and benefits of an audit partner’s attitude toward professional skepticism on the evaluation of fraud. 

    Design/Method/ Approach:

    In an experiment with 80 audit managers from the Big 4 accounting firms, we manipulate between participants: 1) partner emphasis (high partner emphasis on professional skepticism or low partner emphasis on professional skepticism), and 2) the level of fraud indicators (strong or weak). We use a Securities and Exchange Commission (SEC) enforcement action case where the fraud was identified by the SEC and documented in an Accounting and Auditing Enforcement Release (AAER) and SEC claim. Using this benchmark, we are also able to identify as irrelevant those risk factors and procedures not identified by the SEC. We measure auditors’ identification of fraud risk factors, auditors’ fraud risk assessments, and their choice of fraud procedures related to identified risks. 

    Findings:
    • We find that the partner’s degree of emphasis on professional skepticism directly influences auditors’ fraud risk assessments. Specifically, we find that auditors in the high partner emphasis condition provide higher fraud risk assessments than do auditors in the low partner emphasis condition, both when fraud indicators are strong and when they are weak.
       
    • On the other hand, those auditors in the high partner emphasis and strong level of fraud indicators conditions provide the highest fraud risk assessments relative to other conditions. Further, these higher risk assessments did not translate into inefficiencies. Rather than identifying more total risk factors or selecting more total audit procedures, these auditors simply select more relevant fraud risk factors and more relevant audit procedures- risk factors and procedures that directly relate to the fraud indicators present in the SEC case- than auditors in the three other conditions.

    Those auditors influenced by a partner with high emphasis on professional skepticism also identify significantly fewer irrelevant fraud risk factors and select significantly fewer irrelevant fraud audit procedures than auditors in the other three conditions. Thus, their effectiveness is improved without sacrificing efficiency. However, we also find that when the partner places low emphasis on professional skepticism and is more focused on efficiency, there is no significant difference in the number of relevant fraud risk factors or relevant audit procedures selected for either the strong or weak level of fraud indicator conditions. This finding suggests that these auditors’ effectiveness has been weakened significantly.

    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment