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    An Experimental Examination of Factors That Influence...
    research summary posted September 17, 2015 by Jennifer M Mueller-Phillips, tagged 07.0 Internal Control, 07.02 Assessing Material Weaknesses, 07.03 Reporting Material Weaknesses, 09.0 Auditor Judgment 
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    Title:
    An Experimental Examination of Factors That Influence Auditor Assessments of a Deficiency in Internal Control over Financial Reporting.
    Practical Implications:

    The results should be of interest to auditing standard setters who provide guidance on the evaluation of control deficiencies as part of an integrated audit. Further, regulators inspecting public company audits may want to further review settings where control deficiencies were not evaluated as material weaknesses and assess whether the presence/absence of a financial statement misstatement was appropriately considered. The findings provide a more complete understanding of how the factors that auditors encounter during the audit engagement influence their judgment about whether identified deficiencies in ICFR are such that there is a reasonable possibility that a material misstatement of the company’s financial statements will not be prevented or detected on a timely basis (i.e., material weakness).

    Citation:

    Gramling, A. A., E. F. O'Donnell, and S. D. Vandervelde. 2013. An Experimental Examination of Factors That Influence Auditor Assessments of a Deficiency in Internal Control over Financial Reporting. Accounting Horizons 27 (2): 249-269.

    Keywords:
    audit judgments, control deficiency, internal control over financial reporting, material weakness, operating effectiveness
    Purpose of the Study:

    Beginning in 2004, public company auditors who opine on client financial statements also express an opinion about whether the client’s internal control over financial reporting (ICFR) is effective at year-end. In forming the ICFR opinion, auditors evaluate the severity of each identified control deficiency to determine whether the deficiency is a material weakness. When auditors conclude there is a reasonable possibility that ICFR will fail to prevent or detect a material financial misstatement (i.e., a material weakness exists), they issue an adverse opinion on the effectiveness of ICFR. This study examines how different types of audit evidence accumulated during the audit influence auditor judgment of ICFR operating effectiveness and about whether an identified control deficiency is a material weakness in ICFR.

    The study is motivated by a recognition that many stakeholders, including financial statement users, company management, audit committee members, regulators, researchers, and other auditors, would benefit from an enhanced understanding of the factors an auditor considers when evaluating the effectiveness of ICFR and concluding whether identified control deficiencies represent material weaknesses.

    Design/Method/ Approach:

    The authors analyze responses from the submitted case materials of 138 participants, which include 44 partners, 47 senior managers, and 47 managers. On average, the participants had worked on 4.0 integrated audit engagements and had issued 1.1 adverse opinions on ICFR. For the integrated audit engagements on which the participants had worked, they reported an average of 4.1 potential material weaknesses that were ultimately deemed to be significant deficiencies. The evidence was gathered prior to June 2013.

    Findings:

    Based on experimental results from audit managers and partners, the authors provide evidence regarding whether the following factors are significant determinants of assessed operating effectiveness of an identified control deficiency: (1) whether the client has a material weakness unrelated to the deficiency being assessed (i.e., unrelated material weakness), and (2) whether there is a known misstatement associated with the identified control deficiency (i.e., failure of the specific control to prevent a misstatement). Further, they examine whether these two factors influence the likelihood of assessing a control deficiency as a material weakness. The authors find that the presence of either an unrelated material weakness or a known misstatement influences the assessed operating effectiveness of an internal control, in addition to the likelihood of a material weakness assessment. The presence of either an unrelated material weakness or a known misstatement warrants a decreased operating effectiveness assessment and an increased likelihood of a material weakness assessment. The combination of the two factors together does not further influence those assessments.

    Category:
    Auditor Judgment, Internal Control
    Sub-category:
    Assessing Material Weaknesses, Reporting Material Weaknesses