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    Monitoring by Auditors: The Case of Public Housing...
    research summary posted December 1, 2014 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, 08.06 Earnings Management – Detection and Response 
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    Title:
    Monitoring by Auditors: The Case of Public Housing Authorities
    Practical Implications:

    While prior research has investigated audit effects in for profit industries, this study investigates audit effects at nonprofit organizations. Nonprofits in general and PHAs in particular are largely served by smaller auditors frequently classified in prior research as lower quality. Further, nonprofits in general represent low litigation risks for the auditors and the threat of litigation and associated economic loss is generally considered one motive for an audit firm to perform a high quality audit. The evidence suggests that audits matter in the nonprofit industry. So even in a setting where research would suggest there would be low audit quality, when the auditor is smaller and the risk of litigation is low, auditors make significant adjustments to pre-audited data and help to constrain management bias toward meeting pre-established financial thresholds.

    For more information on this study, please contact Barbara Grein.

    Citation:

    Grein, B. M., and S. L. Tate. 2011. Monitoring by Auditors: The Case of Public Housing Authorities. The Accounting Review 86 (4):1289-1319.

    Keywords:
    auditor monitoring; audit adjustments; earnings management; management incentives; public housing authorities; nonprofit organizations; auditing procedures; risk
    Purpose of the Study:

    Audits are widely believed to be a means of improving financial reporting and mitigating management bias, although determining the actual effect of an audit is exceptionally difficult. In most cases, only the final results – audited financial statements and the audit report – are available. The authors take advantage of the unique setting of Public Housing Authorities (PHAs) where both pre-audit and post-audit data at the general ledger level are available. The study investigates

    • the number, dollar amount, and direction of audit adjustments to common financial statement line items and to financial ratios that were integral in the monitoring system established by the Department of Housing and Urban Development (HUD), PHA overseer;
    • whether audits result in significant adjustments to pre-audited data, both in terms of numbers of engagements with adjustments and the dollar amount of adjustments;
    • whether auditors’ adjustments act to reduce potential management bias when PHAs have greater incentives to meet financial targets that were part of the HUD monitoring system; and
    • whether auditors constrain overstatement bias differently than understatement bias.
    Design/Method/ Approach:

    The pre- and post-audit general ledger level data for nonprofit public housing authorities used in this study was obtained from HUD under the Freedom of Information Act. The study uses data from September 2001 through December 2007 as this was the period during which HUD enforced this specific monitoring system, Public Housing Assessment System.

    Findings:
    • The authors find that for key accounts and ratios (e.g., total expenses, tenant revenue, current ratio) the percentage of observations with audit adjustments ranges from a low of 15% to a high of 69%.
    • Further the study finds that audits result in material (economically significant) adjustments in PHA audit engagements.
    • Overall, audit adjustments are consistent with auditors attempting to reduce management bias in the financial statements.
    • In addition, the authors find that auditors appear to attend more to potential overstatements of quality scores than understatements.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management – Detection and Response, Earnings Management