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    Auditors’ Consideration of Material Income-Increasing v...
    research summary posted April 28, 2014 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, 08.06 Earnings Management – Detection and Response, 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence 
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    Title:
    Auditors’ Consideration of Material Income-Increasing versus Material Income-Decreasing Items during the Audit Process
    Practical Implications:

    The results of this study suggest that auditors spend a greater effort on analyzing income-increasing items compared to income-decreasing items. They also suggest that auditors compensate for greater risk associated with income-increasing items by requiring greater verification of such items. Because of the limitations placed on the results of this study due to the specific context of the experiment, future research should try and examine such differences in auditors’ decision-making processes.

    For more information on this study, please contact Naman K. Desai.
     

    Citation:

    Desai, N. K., and G. J. Gerard. 2013. Auditors’ Consideration of Material Income-Increasing versus Material Income-Decreasing Items during the Audit Process. Auditing 32 (2).

    Keywords:
    accruals; auditing; conservatism; memory; risk
    Purpose of the Study:

    The purpose of this study is to examine whether auditors’ consideration of material items, as evidenced by recognition memories, is influenced by the direction of material items. During the gathering of audit evidence, auditors come across evidence in support of material items that affect earnings in a positive or negative manner. Because earnings can be managed upward or downward depending on management’s objectives and incentives, auditors should be sensitive to both material increasing and deceasing items. Prior research indicates that auditors face greater litigation risk for non-detection of fraudulent income-increasing items compared to income-decreasing items. Therefore, the expectation is that auditors will spend greater cognitive effort evaluating material income-increasing items, resulting in superior memories for such items.

    Design/Method/ Approach:

    The experimental design is a 2 x 2 mixed design with data collected using a signal detection theory paradigm. The participants were randomly assigned to treatments. A total of 60 experienced auditors (all CPAs) participated in the experiment. The participants had an average of 9.83 years of auditing experience. The minimum experience was two years and the maximum was 19 years. The experiment was conducted on site during firm training sessions. 

    Findings:
    • Auditors’ memories for income-increasing items are significantly greater than that for income-decreasing items when auditors are not asked to form expectations about the future effects of the items.
    • This difference above is not observed when auditors are asked to form expectations about future effects of each item.
    • Auditors are less likely to refer back to the work papers to verify the accuracy of income-decreasing items compared to income-increasing items.
       
    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management – Detection and Response, Earnings Management, Evaluation of Evidence