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    Evidence of Organizational Learning and Organizational...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 11.0 Audit Quality and Quality Control 
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    Title:
    Evidence of Organizational Learning and Organizational Forgetting from Financial Statement Audits
    Practical Implications:

     Organizational learning and knowledge depreciation play a significant role in a firm’s audit strategy, pricing strategy, budgeting and forecasting. Failing to account for knowledge dissipation and differences in learning across personnel may lead to costly errors in the budgeting process. Furthermore, finding that there is little or no learning among lower-level staff provides empirical support for the concern of the effects of high turnover rates among lower-level staff in public accounting. This suggests that targeting retention at this level might reduce costs, including the costs of continuously having to train new personnel.

    Citation:

     Causholli, M. 2016. Evidence of Organizational Learning and Organizational Forgetting from Financial Statement Audits. Auditing: A Journal of Practice and Theory 35 (2): 53-72.

    Keywords:
    audit efficiency, organizational learning, and audit production
    Purpose of the Study:

    Organizational learning occurs when an organization gains knowledge from the repetition of producing a product or providing a service and uses this knowledge to operate more efficiently and at a lower cost. Organizational forgetting is when this knowledge is lost over time and results in losses in productivity and increases in the cost of production. A good amount of research exists on these topics as they relate to production, but the research on the correlation between these topics and professional services is underserved. Causholli investigates the nature of learning in the production of financial statement audits in this paper. This investigation comes at a good time due to the increasing debate surrounding whether mandatory audit firm rotation should be enforced. In 2013, the U.S. House of Representatives prohibited the PCAOB from mandating audit firm rotation, but in 2014 the European Parliament passed new regulation that requires audit firm rotation after a maximum of ten years. Because of these differing viewpoints, Causholli hopes to shed light on the discussion by showing how audit production costs vary with audit firm tenure.

    Design/Method/ Approach:

    Two equations were used to provide empirical specifications and test the hypotheses. Engagements were divided into three groups based on the number of years with a client, the short-tenure group, the medium-tenure group, and the long-tenure group. The audit production data are provided by a large international accounting firm and were collected as part of the annual internal quality reviews performed in late spring through early fall 2003.

    Findings:
    • The author’s findings show that an increase in audit experience leads to an initial reduction in total labor hours.
    • The author finds that when labor hours are disaggregated, learning effects are not homogenous across different ranks of labor; specifically, learning is significant among higher labor ranks (partners, managers, and in-charge) and is not significant for the lower ranks (staff).
    • The author finds some evidence of knowledge depreciation; specifically, an increase in experience beyond the learning period negatively affects productivity. This leads to an increase in production costs for partners and in-charge, but not for managers.
    • Overall, the author’s findings suggest that learning by doing as well as knowledge depreciation occur in a professional service industry.
    Category:
    Audit Quality & Quality Control, Independence & Ethics
    Sub-category:
    Audit Firm Rotation