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    Error Management In Audit Firms: Error Climate, Type, And...
    research summary posted November 17, 2014 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections, 11.0 Audit Quality and Quality Control, 11.06 Working Paper Review – Conduct, Biases and Predispositions 
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    Title:
    Error Management In Audit Firms: Error Climate, Type, And Originator
    Practical Implications:

    The findings of this study are important for audit firms when considering how audit offices implement the normally positive tone at the top of the firms that seem to favor practices and policies that support an open error management climate (EMC). First, our results suggest that successfully establishing an open EMC is beneficial for an audit firm in most (but not all) situations examined in terms of enhancing the firm’s ability to uncover internally errors that otherwise may remain undetected in audit working papers. Our findings imply, however, that these benefits can only be achieved when an open EMC is not only stated in formal firm policies but is actually implemented and consistently applied at the individual audit office level. Second, our findings imply that increasing auditors’ willingness to report their own conceptual errors (e.g., where an ineffective procedure is employed or incorrectly implemented) is particularly challenging and requires measures to support auditors in overcoming their concerns about presenting a good impression to their firm, given that an open EMC was not sufficient by itself to increase the reporting of conceptual errors. Finally, the generally high willingness to report own errors suggests that a key question is how to enhance the likelihood that auditors will indeed self-detect these errors.

    Further our findings suggest that audit regulators and inspectors need to be careful in their attempts to ensure that audit firm’s implement policies that support audit quality.  In particular, proposals that would link compensation, discipline and other within firm sanctions for audit quality reducing actions need to be considered carefully in light of the effects that such policies would have on the firm’s error management climate.  Careful delineation between repeat offenders being punished versus supporting an open learning environment for initial reporting of errors needs to be carefully considered and communicated or else the error management climate can quickly become a blame climate where errors are not reduced, just hidden better.

    For more information on this study, please contact any of the authors.

    Citation:

    Gold, A., U. Gronewold, and S. E. Salterio. 2014. Error management in audit firms: Error climate, type, and originator. The Accounting Review 89 (1): 303-330. 

    Keywords:
    error discovery, working paper review, error reporting, error management, climate, audit quality
    Purpose of the Study:

    Audit firms use their formal review process as a crucial mechanism to detect errors in audit working papers in order to ensure audit quality and avoid litigation or sanctions by oversight bodies (e.g., PCAOB) that might result if major audit errors remain undetected. While prior research has shown that this process is very effective, it is still a long way from being perfect, as a high portion of errors usually remains undetected as evidenced by continued inspection findings. This study suggests that an additional mechanism of uncovering audit errors, over and above the review process, is auditors’ self-discovery and internal reporting of such errors. Given staff auditors are likely to be tasked with activities that bring them frequently in contact with the working papers (whether electronic or paper based), enhancing their self-review and encouraging them to report any problems that they encounter may result in a greater ability of audit firms to detect errors in the working papers.

    This study investigates factors that may influence the willingness of staff auditors to report such discovered errors. Specifically, it is argued that the treatment of staff auditors who discover errors in the audit files by their superiors affects their willingness to report these errors. The way staff auditors are treated by their superiors is labeled as the audit office error management climate (EMC). EMC is the set of shared beliefs, norms, and common practices regarding the management of discovered errors and mistakes in an organization. The organizational literature distinguishes between two extremes of an EMC, a relatively more “open” one where error reports are used to enhance organizational learning and only repeated errors by individuals attract sanctions, versus a relatively more “blame” oriented climate that routinely sanctions the individual who commits an error. The following research questions are addressed in the study:

    • How does the individual audit office EMC affect the auditor reporting of discovered errors within the audit firm?
    • How does the effect of different audit office EMCs on the reporting of errors depend on
      • the type of error discovered (mechanical, e.g., arithmetic, vs. conceptual, e.g., omitting an important audit procedure) in the audit working papers, and
      • the error originator, that is, who committed the error, the discoverer him or herself or a peer? 
    Design/Method/ Approach:

    The experimental research evidence was collected in 2009. As part of series of experiment audit staff from several German audit firms took part in the research. The staff completed a simulated task involving the discovery of an error in the working papers after all detailed file reviews had been completed but before the auditor’s report was issued and the financial statements were released. Participants were asked to indicate how likely they were to report the discovered error to an appropriate responsible person for the audit engagement.

    Findings:
    • Generally, we find that an auditor’s willingness to report discovered errors is higher in an open error management climate (EMC) than in a blame EMC.
    • We also find that EMC mainly results in increases to the reporting of mechanical but not conceptual errors.
    • We further report EMC only increases peers’ errors reporting but this increase is up to the already high level of reporting for self-committed errors.
    Category:
    Audit Quality & Quality Control, Auditor Judgment
    Sub-category:
    Impact of potential post-audit review (e.g. PCAOB - internal firm inspections), Working Paper Review – Conduct - Biases & Predispositions