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    Documentation Requirements and Quantified versus Qualitative...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 09.0 Auditor Judgment, 09.02 Documentation Specificity, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections 
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    Title:
    Documentation Requirements and Quantified versus Qualitative Audit Risk Assessments
    Practical Implications:

    This study should be of interest to both regulators and audit firms.  In the future, standard setters should consider how natural human behavior may result in unintended consequences.  By considering psychology, standard setters may be able to write the standards in a way to minimize those potential consequences or at least be aware of the risks. 
        This study should also be of interest to audit firms because current auditing standards are neutral with respect to whether audit documentation of risk assessments are performed quantitatively or qualitatively.  This implies that either option is adequate and treats the potential costs as minor.  As risk assessments that are more lenient in nature tend to lead to fewer audit procedures and less substantive evidence, the costs may be more than inconsequential. 

    For more information on this study, please contact M. David Piercey.
     

    Citation:

    Piercey, M. D. 2011. Documentation Requirements and Quantified versus Qualitative Audit Risk Assessments. Auditing: A Journal of Practice & Theory 30 (4):223-248.

    Keywords:
    quantitative versus qualitative audit risk assessments; elastic re-definition; documentation requirements
    Purpose of the Study:

    The purpose of this study is to examine whether there are any potential unintended consequences that result from Auditing Standard No. 3 (AS3) – Audit Documentation, which requires auditors to document most judgments.  The intent of AS3 is to improve documentation so that it is easier to inspect the firms’ working papers and understand what was done and why.  The expectation is that due to the increased potential scrutiny from reviewers (e.g., PCAOB review or litigation) the added documentation will cause auditors to improve their judgments and increase their levels of objectivity and professional skepticism.   
    This study looks at auditor risk assessments, which, according to the standard, can be documented quantitatively (i.e., using numerical assessments) or qualitatively (i.e., using worded assessments).  The author is concerned that if an auditor has a preference to arrive at a conclusion that is client-preferred and more lenient, the added documentation requirements will cause auditors to be even more lenient than if they were not required to meet these new documentation requirements.  This would be contrary to what one would expect given the potential risk of the firm opening itself up to liability in the event of review or litigation.
     

    Design/Method/ Approach:

    The author conducted an experiment including auditors of all ranks from 2 large accounting firms and senior accounting students prior to May 2011.  The experiment manipulated two factors (documentation requirements and response mode).  Participants were asked perform a risk assessment of material misstatement in one of three ways (one of which is quantitative and two are qualitative).  Then participants were told whether or not their assessment was going to be documented (or not) in the working papers and thus be subject to potential PCAOB review.  

    Findings:
    • The author finds that when auditors are required to document risk assessments and assess risk in qualitative terms, they are more apt to be even more lenient when they have pressures to provide a client-preferred assessment.  The qualitative terms seem to allow auditors to rationalize the more lenient judgments.
    • When using quantitative assessments, the author does not find similar results.  There is no difference in these judgments regardless of whether auditors are required to document their judgments in working papers or not.
    • These findings are not unique to auditors.  Humans, in general, assess risk differently when they are doing so with words instead of numbers. 
       
    Category:
    Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Documentation Specificity, Impact of potential post-audit review (e.g. PCAOB - internal firm inspections)