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    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 
    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. 

    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.  

    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.

    • 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.
    Auditing Procedures - Nature - Timing and Extent, Engagement Management, Risk & Risk Management - Including Fraud Risk
    Auditors’ Professional Skepticism, Earnings Management, Interactions with Client Management