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    Client Engagement Risks and the Auditor Search Period.
    research summary posted October 19, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.02 Client Risk Assessment 
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    Title:
    Client Engagement Risks and the Auditor Search Period.
    Practical Implications:

    This paper contributes to the auditing literature in three ways. First, it sheds light on whether or not perceived engagement risks affect the ASP, a previously unaddressed question. Second, it provides greater insight into the client acceptance decision. This decision has become increasingly important because of auditor litigation, insurance costs, reputational damage, and regulatory review of the auditing profession in the post-SOX era. Third, it contributes to the understanding of whether the provision of nonaudit services alters auditor decision making by documenting that the potential to provide nonaudit services does not necessarily alter the attractiveness of a prospective client or shorten the search period.
     

    Citation:

    Khalil, S. K., J. R. Cohen, and K. B. Schwartz. 2011. Client Engagement Risks and the Auditor Search Period. Accounting Horizons 25 (4): 685-702.

    Keywords:
    audit risk, auditor search period, client acceptance
    Purpose of the Study:

    The past decade has witnessed an increased interest in the auditor’s client acceptance decision and in the way audit firms evaluate potential clients. The interest arises, in part, from litigation against auditors, competitive market forces, and recent advances in information technology that have affected and redefined the attestation process. Audit firms assess the risks associated with a prospective client (also known as engagement risks or client acceptance risks), the profitability and billing rate, and the risk/return relationship before submitting a formal engagement proposal and entering into fee negotiations.

    The authors investigate whether risk lengthens the acceptance phase for audit firms and results in a longer auditor search period for their clients. The authors posit that the auditor search period (ASP) following auditor resignations is significantly longer for riskier clients because of the additional time needed to collect and analyze information and to obtain required approvals within the audit firm. They focus on auditor resignations since the ASP, which is essentially unobservable, can be more accurately approximated for auditor resignations than auditor dismissals. Firms whose auditors resign may know about the resignation decision at or just before the resignation date. As such, the audit search process formally starts at or a short time before the auditor resignation date reported on a registrant’s Form 8-K filing. In contrast, firms planning to dismiss their auditor are aware of the dismissal decision long before the dismissal date. Hence, the auditor search period may start long before the dismissal date reported on the Form 8-K filings.

    Design/Method/ Approach:

    The authors test the hypotheses using a sample of auditor resignations obtained from the Audit Analytics database. The final sample includes 216 auditor resignations in firms (1) listed on major U.S. stock exchanges (NYSE, AMEX, NASDAQ), (2) with a ticker available, and (3) reporting at least one auditor resignation over the period 20032008.

    Findings:

    Findings support the client business risk hypothesis by documenting a longer ASP for firms that are in financial distress. Results also support the audit risk hypothesis, given that the ASP is longer for firms that report internal control weaknesses issues. Findings further support the auditor business risk hypothesis by showing a shorter ASP for firms hiring an industry specialist audit firm.

    Category:
    Client Acceptance and Continuance
    Sub-category:
    Client Risk Assessment