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    Audit Partner Evaluation of Compensating Controls: A Focus...
    research summary posted February 16, 2015 by Jennifer M Mueller-Phillips, tagged 07.0 Internal Control, 07.02 Assessing Material Weaknesses, 09.0 Auditor Judgment, 09.02 Documentation Specificity 
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    Title:
    Audit Partner Evaluation of Compensating Controls: A Focus on Design Effectiveness and Extent of Auditor Testing
    Practical Implications:

    The results of this study are important for audit firms to consider when audit partners are evaluating the level of precision in a compensating control. The evidence indicates that the partner’s knowledge of the existence of a material weakness unrelated to a compensating control being evaluated results in partners preferring a more precise compensating control and requiring more audit testing. Furthermore, this has implications for the efficiency of the audits as control-related decisions are potentially being influenced by inappropriate factors.

    For more information on this study, please contact Audrey Gramling, Ed O’Donnell, or Scott D. Vandervelde. 

    Citation:

    Gramling, A., E. O’Donnell, and S.D. Vandervelde. 2010. Audit Partner Evaluation of Compensating Controls: A Focus on Design Effectiveness and Extent of Auditor Testing. Auditing: A Journal of Practice & Theory 29 (2): 175-187.

    Keywords:
    audit partner judgments, compensating controls, halo effects, internal control over financial reporting, material weakness
    Purpose of the Study:

    The assessment of internal control over financial reporting is a mandatory requirement of auditors for large publicly traded companies. The assessment made by the auditors on the severity of any identified control deficiencies has a significant impact on external reporting. To assess the severity of a deficiency, auditors should consider the effect of any compensating controls. However, auditors’ prior knowledge has been a primary influence on their subsequent judgments during the assessment of this severity. Also knowledge of risk factors not directly related to the compensating control influences audit partner judgments’.

    This paper addresses the concern of the influence of this prior knowledge on the evaluation of compensating controls by investigating two factors:

    • Level of precision needed in a compensating control for it to be assessed as effectively designed
    • Extent of evidence needed for auditor testing of the operating effectiveness of the compensating control

                The authors motivate their expectations based on the psychology literature discussing halo effects. Halo effects occur when knowledge that has no diagnostic implications for a specific judgment still influences that judgment. In an audit setting, halo effects can result in auditors interpreting judgment-specific evidence to be consistent with global knowledge about the client, instead of evaluating that evidence based on its diagnostic implications relative to the judgment at hand.

    Design/Method/ Approach:

    The research evidence was collected in June 2007. The authors use a simulated task to examine whether information about overall risks influences audit partners’ judgments related to a compensating control that has been implemented within a specific client process. Participants have an average experience level of 20.91 years. The minimum number of years of experience is 10 and maximum number of years of experience is 35. Participating audit partners were asked to assume the role of an engagement partner on an integrated audit. 

    Findings:
    • Audit partners who knew of an unrelated material weakness required testing of a greater percentage of the revenue subject to the compensating control than partners who knew there were no other material weaknesses.
    • Differences in inherent risk did not significantly influence any of the dependent variables (assessment of the control design effectiveness, and the extent of evidence necessary for testing the operating effectiveness of that compensating control).
    Category:
    Auditor Judgment, Internal Control
    Sub-category:
    Assessing Material Weaknesses, Documentation Specificity