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    How Do Auditors Address Control Deficiencies that Bias...
    research summary posted July 28, 2015 by Jennifer M Mueller-Phillips, tagged 07.0 Internal Control, 07.01 Scope of Testing, 07.02 Assessing Material Weaknesses, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.01 Substantive Analytical Review – Effectiveness 
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    Title:
    How Do Auditors Address Control Deficiencies that Bias Accounting Estimates?
    Practical Implications:

    For practice, the authors provide evidence about the relation between control deficiencies and substantive tests in the integrated audit. A significant minority of senior auditors attempt to identify bias in an accounting estimate with increased sampling from the biased estimation process, though they have been told that the estimation process is biased. The authors provide theory consistent empirical evidence that auditors often reach questionable, optimistic judgments about the capability of audit evidence to address control deficiencies. Auditors will often revert to what they know best, and it is difficult to get people to look beyond the familiar, regardless of experience level.

    Citation:

    Mauldin, E. G., & Wolfe, C. J. 2014. How Do Auditors Address Control Deficiencies that Bias Accounting Estimates? Contemporary Accounting Research 31 (3): 658-680.

    Keywords:
    accounting estimates, scarcity, control deficiencies, internal control
    Purpose of the Study:

    According to professional standards, auditors must integrate the internal control and financial statement audits. Revised risk assessment standards were issued, in part, to improve the integration of controls into the financial statement audit. However, PCAOB inspections find that auditors sometimes do not appropriately change the nature, timing, and/or extent of their substantive tests in response to clients’ internal controls. Auditors often have difficulty modifying substantive tests when responding to identified control deficiencies.

    To shed light on the underlying reasons for this difficulty, the authors of this design a contextually rich experimental case and examine how auditors map a control deficiency into modifications of substantive tests. The authors examine control deficiencies that cause errors of omission in an estimation process, resulting in an incomplete and biased estimation process. The focus is on whether auditors recognize the insufficiency of reviewing the biased estimation process and how they select alternative tests to replace or supplement such review.

    Design/Method/ Approach:

    Eighty-seven auditors attending one Big 4 firm’s national training for experienced audit seniors participated in the study. The authors employ a between-participants experimental design with two treatments. The authors describe the treatments in sequence within the experimental task. They then randomly assign participants to experimental treatments and ask them to complete a case study. The evidence was collected prior to September of 2014.

    Findings:
    • A significant minority of senior auditors (33 percent) attempt to identify bias in an accounting estimate with increased sampling from the biased estimation process. Further, they do this after being told that the estimation process is biased.
    • Seeing the falsely favorable substantive test results, on average, does not influence auditors’ tendency to increase sample size.
    • A supplemental sample of 14 managers produces a pattern of responses similar to the main results.
    • When the bias is from externally prepared documents, the authors find that about one-half the auditors (54 percent) choose the more efficient alternative test, adjusting the estimate using documents.
    • When the bias is from management judgment inputs, the authors find that most auditors (63 percent) choose to adjust the estimate using documents, even though this alternative is less effective than developing an auditor-generated estimate.
    • The observed results are not driven by lack of experience with percentage-of-completion accounting.
    • Together, the results suggest that auditors often make inefficient or ineffective alternative test choices depending on the source of omission caused by the control deficiency.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Internal Control
    Sub-category:
    Assessing Material Weaknesses, Scope of Testing, Substantive Analytical Review – Effectiveness