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    Risk Monitoring and Control in Audit Firms: A Research...
    research summary posted April 16, 2012 by The Auditing Section, last edited May 25, 2012, tagged 02.0 Client Acceptance and Continuance, 02.02 Client Risk Assessment, 11.0 Audit Quality and Quality Control, 11.02 Engagement Quality Review – Processes and Effectiveness, 11.11 Impact of Firm and External Inspection Programs 
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    Title:
    Risk Monitoring and Control in Audit Firms: A Research Synthesis
    Practical Implications:

    While research on “quality-threatening behaviors” by auditors is difficult to perform due to confidentiality constraints, the available findings suggest that audit firms can make a difference in their incidence and severity through careful attention to policies and procedures for assessing, monitoring and controlling risk of violation of professional standards. While there is likely to be greater resistance to higher quality control standards among smaller firms, research shows that audit quality concerns are greater for smaller firms and that larger firms are currently passing smaller and riskier clients to them. The authors suggest that small accounting firms can adopt strategies, like creating alliances or becoming niche providers of certain audit services, to allow them to meet this challenge.

    Citation:

    Bedard, J.C., D.R. Deis, M.B. Curtis, and J.G. Jenkins. 2008. Risk monitoring and control in audit firms: A research synthesis. Auditing: A Journal of Practice & Theory 27 (1): 187-218.

    Keywords:
    Audit firm quality control, risk monitoring, auditing standards, independence risk, whistle-blowing, decision aids
    Purpose of the Study:

    Audit firm quality control is defined as an audit firm’s assessment and control of the risk that auditing standards, professional values or the public interest might be violated. The PCAOB has recently expressed interest in understanding the current status of research related to audit firm quality control as it considers revising the current standards in this area. This paper summarizes the research literature related to audit firm quality control with the following two objectives: (1) to provide information on the current state of knowledge with regard to the ways in which audit firms monitor and control firm-level risk; and (2) to highlight implications for development of new standards and for future research.

    Design/Method/ Approach:

    This paper reviews the literature related to audit firm quality control. Evidence was collected prior to 2006 with much of the data gathered prior to SOX and the founding of the PCAOB.

    Findings:

    Risk Management before the Engagement:

    • Recent research suggests that larger firms are shedding smaller, riskier clients to smaller audit firms as a result of the Andersen demise and Section 404 work. Further, smaller clients often choose smaller firms on the basis of more affordable fees. These findings suggest that client portfolio risk has recently increased among smaller firms.
    • Studies find that audit firms appear to be willing to take on riskier clients if the billing rate allows increased testing and/or assignment of more highly qualified engagement personnel (e.g., specialists). However, smaller audit firms may be less able to price engagement bids to cover increased exposure from riskier clients. 

    Monitoring and Control of Auditor Independence Risk:

    • Audit Firm and Partner Rotation: The archival studies report mixed results on the effect of firm and partner rotation on auditor independence. However, behavioral research provides evidence in support of firm or partner rotation. Behavioral studies generally find that auditors’ tend to make decisions in favor of management’s position and that proposed adjustments are typically smaller when rotation is not required.
    • Employing Former Auditors: Research suggests that the practice of companies employing former auditors is widespread. There is also some evidence of independence impairment and a loss of professional skepticism associated with this practice.
    • Auditor-Provided Nonaudit Services: While results are somewhat mixed, the balance of research does not appear to support the conclusion that auditor independence is compromised by the provision of nonaudit services. 

    Risk Management during the Engagement

    • Electronic Decision Aids: Research shows continuing growth and development of electronic decision aids in audit firms. Potential benefits of auditing decision aids include increased compliance with auditing standards and audit methodology, increased audit efficiency, consistency in audit approaches across clients, easier documentation, and increased control of junior staff.
    • Consultation Units: Accounting firms can control risk by developing specialized internal groups to assist local offices in making decisions. Creating a database of research increases efficiency and improves the consistency of accounting treatments recommended to clients. However, research suggests that the use of consultation units is inconsistent across the profession and declines significantly with firm size.
    • Whistle-Blower Mechanisms: Research suggests that the presence of whistle-blower mechanisms increases the likelihood that reports of wrong-doing will be made. The effectiveness of these programs is enhanced when (1) confidentiality is ensured; (2) employees thoroughly understand the mechanism; and (3) when firms both encourage such reporting and discourage retribution for reporting unethical acts. 

    Internal and External Inspections and Review

    • Internal Engagement Quality Control Reviews: Research indicates that engagement quality control reviews reduce audit risk by improving audit risk assessments and inducing partners to plan higher levels of audit testing.
    • Peer Reviews: Participation in a quality peer review process represents a commitment to quality by the audit firm. In fact, research provides evidence that audit firms participating in a peer review process conduct higher quality audits, and continued participation leads to continued improvements in audit quality over time.
    • Regulatory Quality Control Reviews and Inspections: Overall, a positive link has been found between quality control reviews and audit quality.
    Category:
    Client Acceptance and Continuance, Audit Quality & Quality Control
    Sub-category:
    Client Risk Assessment, Engagement Quality Review – Processes & Effectiveness, Impact of Firm & External Inspection Programs
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