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  • The Auditing Section
    The Global Audit Profession and the International Financial...
    research summary posted May 4, 2012 by The Auditing Section, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 01.06 Impact of PCAOB in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Global Audit Profession and the International Financial Architecture: Understanding Regulatory Relationships at a Time of Financial Crisis
    Practical Implications:

    This paper provides insight into the effect of the global financial crisis on auditors and the relationships between large international accounting firms, regulators, and standard setters. The paper summarizes a variety of reports and policy proposals related to the global financial crisis, including the number of times auditors are mentioned in each of the reports. The paper discusses issues related to bank audits, including discussion of fair value issues and going concern reports.

    Citation:

    Humphrey, C., A. Loft and M. Woods. 2009. The Global Audit Profession and the International Financial Architecture: Understanding Regulatory Relationships at a Time of Financial Crisis. Accounting, Organizations and Society 34 (6-7): 810-825.

    Keywords:
    International auditing, standard setting, auditing interpretations, global audit regulation, audit committees, accountant independence, global financial crisis, and international federation of accountants
    Purpose of the Study:

    The global financial crisis of 2008 resulted in multiple bank failings, some with little to no warning from auditors. However, auditors have largely stayed out of the discussions of what went wrong to cause the global financial crisis. This paper takes a look at the potential effects the global financial crisis could have on the auditing profession. Specifically, the paper notes: 

    • The importance of viewing auditing from a global context Regulatory response to the global financial crisis and how new regulations affect auditing
    • The potential future of bank auditing 

    This paper also explores the relationships between the international audit firms, regulators, and standard setters.

    Design/Method/ Approach:

    This paper provides the authors’ commentary on the global financial crisis and discusses some reports and policy proposals that resulted from the financial crisis.

    Findings:
    • The paper notes that although auditors have not been questioned extensively regarding their role in the global financial crisis, some new policy initiatives and reports have mentioned the auditing profession.
    • The paper suggests that in solving the global financial crisis, it is important for auditors, regulators, standard setters, and others to work together.
    • The paper notes that it is important to consider the audit profession on a global basis.
    • The authors challenge the industry to make the knowledge related to international audit practice, regulatory networks and the forces driving the same more accessible.
    Category:
    Standard Setting
    Sub-category:
    Changes in Audit Standards, Impact of PCAOB
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  • Jennifer M Mueller-Phillips
    The Impact of Audit Evidence Documentation on Jurors’ N...
    research summary posted January 19, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 09.0 Auditor Judgment, 09.02 Documentation Specificity in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Impact of Audit Evidence Documentation on Jurors’ Negligence Verdicts and Damage Awards.
    Practical Implications:

    This study suggests that audit workpaper documentation decisions can significantly influence juror negligence verdicts and damage awards in cases where the auditor faces litigation. This is a particularly important finding for audit firms as this is an aspect of the litigation process that the auditor can directly control prior to facing litigation by considering how jurors might perceive this information when designing documentation procedures.

    Citation:

    Backof, A. G. 2015. The Impact of Audit Evidence Documentation on Jurors’ Negligence Verdicts and Damage Awards. The Accounting Review 90 (6): 2177-2204.

    Keywords:
    audit documentation, auditor liability, culpable control model, damage awards
    Purpose of the Study:

    During litigation proceedings, audit workpaper documentation represents a key piece of evidence supporting the quality of audit work because these documents are not only presented to jurors and scrutinized by experts during the trial, but are also available for juror review during deliberations. Because of its prominence during trials, the method and information contained in audit workpaper documentation has the potential to influence juror negligence verdicts and damage awards. This study examines how variation in audit documentation decisions related to the linkage of specific audit procedures performed to risks of misstatement for individual-level accounts, along with the inclusion of facts inconsistent with the auditor’s professional judgment influenced subsequent juror decisions. In particular, the study addresses the following research objectives:

    • Whether the inclusion of the auditor’s consideration of alternative accounting treatments in workpaper documentation influences juror perceptions of the foreseeability of the misstatement.
    • Whether the inclusion of documentation which directly links account-level risks of misstatement to specific audit procedures performed increases the juror’s evaluations of auditor intentions to conduct a quality risk-based audit.  
    • Whether differences in workpaper documentation influence juror evaluations of auditor negligence and subsequent damage assessments.
    Design/Method/ Approach:

    The research evidence was collected utilizing a group of participants whose characteristics mimicked that of an average jury pool. Participants listened to a 28-minute audio recording of a negligence lawsuit, and then received a written transcript of the trial along with copies of the audit workpapers entered into evidence during the trial. Participants were instructed to assume the role of a juror in order to evaluate whether the audit firm was negligent and to determine an appropriate level of damages to assess the audit firm.

    Findings:
    • Jurors assess the likelihood of auditor negligence as higher when the auditor includes in their workpaper documentation facts inconsistent with their professional judgments. This is the case because jurors assess the misstatement as more foreseeable when this information is available in the workpaper documentation.  
    • When the workpaper documentation includes direct links between identified account-specific risks of misstatement and specific audit procedures performed, jurors do not view auditor’s intentions to conduct a quality risk-based audit as higher. Subsequently, jurors do not view the auditor’s likelihood of negligence to be lower when this information is included in workpaper documentation.
    • Workpaper documentation which includes direct links between identified account-specific risks of misstatement and specific audit procedures performed does not significantly influence the amount of damages awarded by jurors when facts inconsistent with the auditor’s professional judgments are not additionally included in the documentation. However, when this additional information is present, jurors award lower damages when the documentation does include direct links between identified account-specific risks of misstatement and specific audit procedures performed.
    Category:
    Auditor Judgment, Standard Setting
    Sub-category:
    Changes in Audit Standards, Documentation Specificity
  • Jennifer M Mueller-Phillips
    The Impact of PCAOB Auditing Standard No. 5 on Audit Fees...
    research summary posted October 3, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 07.0 Internal Control, 07.05 Impact of 404 on Fees and Financial Reporting Quality in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Impact of PCAOB Auditing Standard No. 5 on Audit Fees and Audit Quality
    Practical Implications:

    This study provides an analysis of the effect of PCAOB Auditing Standard No. 5 (AS5) on internal control audit efficiency. The authors interpret their results as indicating that AS5 improved internal control audit efficiency by reducing audit fees without harming audit quality. The results of this study provide insight into the consequences of PCAOB standard setting, which is of interest to standard setters and businesses subject to their rules.


    For more information on this study, please contact Dechun Wang.
     

    Citation:

    Wang, D. and J. Zhou. 2012. The Impact of PCAOB Auditing Standard No. 5 on Audit Fees and Audit Quality. Accounting Horizons 26 (3): 493-511.

    Keywords:
    PCAOB Auditing Standard No. 5, audit fee, audit quality, internal control.
    Purpose of the Study:

    Due to strong complaints to the SEC and PCAOB about high audit costs associated with PCAOB Auditing Standard No. 2 (AS2) which governed internal controls audits, the PCAOB amended AS2 and proposed Auditing Standard No. 5 (AS5) in 2007. AS5 was aimed at reducing unnecessary costs and providing a more efficient audit of internal controls. It provides auditors a “top-down, risk-based” approach which allows them to tailor the audit to client size, complexity and specific critical risk areas. Furthermore, it provides auditors more flexibility in relying on the work of management and internal auditors.
        This study’s aim is to understand whether the PCAOB has accomplished its goal of making internal audits more efficient. The authors make a point to say that this requires not only audit fee reduction but also no drop in audit quality. The authors make and test the following hypotheses:

    H1: Audit fees are significantly lower after the adoption of AS5 for accelerated filers, but not non-accelerated filers (Note: AS5 does not apply to non-accelerated filers because the requirement of an audit of internal controls for these firms was initially deferred and eventually exempted by the Dodd-Frank Act of 2010)

    H2: Ceterus Paribus, audit quality does not change after the adoption of AS5
     

    Design/Method/ Approach:

    The authors utilize data on public companies around the 2007 implementation of AS5. They classify accelerated filers that had FYEs between November 15, 2007 (the AS5 implementation date) and November 14, 2008 as AS5 firms. They compare changes in audit fees for these firms to changes in audit fees in the previous year. They then compare changes in audit fees for AS5 firms to changes in audit fees for firms not subject to AS5 during the same period (non-accelerated filers). Finally they compare audit quality for AS5 firms in the year after AS5 implementation to the year immediately preceding AS5 implementation.

    Findings:
    • The authors provide evidence of a decrease in audit fees for the AS5 sample while audit fees increased for the pre-AS5 sample and the contemporaneous non-accelerated filing sample. 
    • The authors do not find a significant change in audit quality for the AS5 sample. This failure to find a significant result is robust to different measures of audit quality (Abnormal accruals, meeting or beating earnings forecasts and the probability of issuing an internal control weakness opinion).

    Taken together, the authors claim that these results are indicative of AS5 providing more efficient audits of internal controls. They argue that this result is confirmation that AS5 has accomplished the PCAOB’s objective of providing the same benefits of Sarbanes Oxley at a more reasonable cost to companies.

    Category:
    Internal Control, Standard Setting
    Sub-category:
    Changes in Audit Standards, Impact of 404 on Fees and Financial Reporting Quality
  • Jennifer M Mueller-Phillips
    The Joint Effects of Multiple Legal System Characteristics...
    research summary posted June 22, 2017 by Jennifer M Mueller-Phillips, tagged 01.02 Changes in Audit Standards, 15.04 Audit Firm Rotation in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Joint Effects of Multiple Legal System Characteristics on Auditing Standards and Auditing Behavior
    Practical Implications:

    Whether or not the ISA should be adopted by the United States is a greatly contested topic. This study is helpful for regulators and standard-setting boards in the United States about the potential effects of the adoption of ISA and mandatory audit rotation for the United States. This information is also applicable for other countries when making these decisions as well.

    Citation:

    Simunic, Dan A., M. Ye, and P. Zhang. 2017. “The Joint Effects of Multiple Legal System Characteristics on Auditing Standards and Auditor Behavior”. Contemporary Accounting Research 34.1 (2017): 7.

    Purpose of the Study:

    This paper examines the impacts of legal characteristics and auditing standards on audit behavior. Then based on this information the authors determine what the optimal auditing standards would be under different legal regimes. The two legal characteristics examined are vagueness in interpreting audit standards by courts and the expected damage award size in lawsuits against auditors for a failed audit. In recent years there has been a large number of countries adopting the International Standards on Auditing (ISA). Specifically, this study addresses whether or not ISA can be applied efficiently for all countries, and whether or not it adds value to the country that adopts the standards. 

    Design/Method/ Approach:

    The authors begin the analysis by determining the audit quality based on auditing standards and the legal system by using a single-period auditing model with risk-neutral players. After that the optimal auditing standards which maximize audit quality for a specific legal system were determined. The effect of auditor rotation on audit quality was found by adding contingent fees into the model.

    Findings:

    Overall, the authors find that audit quality is affected by both auditing standards and characteristics of legal systems. The optimal audit standards for a particular country also change depending on the legal system.

    Specifically, the authors find:

    • In situations where the expected damages are low, the audit standards are not able to increase audit quality. This is also true for a vague interpretation of audit standards by the courts. Simply adopting a set of rules, such as the ISA, does not determine audit quality.
    • Mandatory auditor rotation can improve audit quality and is more beneficial in countries that have tough and vague auditing standards.

    In regards to ISA the authors find:

    • In places that already have similar standards and legal systems, such as Canada, ISA can be effectively implemented.
    • However, in countries that have a weak legal system, such as China, it is not likely the adoption of ISA will affect audit quality.
    • It is hypothesized by the authors that due to the litigious legal environment of the United States the adoption of ISA would decrease audit quality. 
    Category:
    International Matters, Standard Setting
    Sub-category:
    Changes in Audit Standards
    Home:

    http://commons.aaahq.org/groups/e5075f0eec/summary

  • Jennifer M Mueller-Phillips
    The Use of Business Risk Audit Perspectives by Non-Big 4...
    research summary posted March 10, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Use of Business Risk Audit Perspectives by Non-Big 4 Audit Firms
    Practical Implications:

    The first implication is a call for proportionality and flexibility to adopt an audit approach that meets the client-audit firm context. SMP auditors told us that they struggle with achieving proportionality by not performing some audit procedures such as entity-level analytical procedures for smaller clients, because they feel obliged to perform these procedures to comply with documentation requirements of the auditing standards or of regulators and oversight bodies. Such experiences may result in inefficient, ‘‘check-the-box’’ audits in order to satisfy perceived documentation requirements for review purposes.

    The second implication is that standard setters should be aware that the type and/or scope of the assurance engagement might also vary by jurisdiction. For example, in a jurisdiction with a close book-tax alignment, the clients’ and users’ expectations about the type and scope of assurance may interact with the prescribed standards in shaping audit practice.

    For more information on this study, please contact Niels van Nieuw Amerongen.

    Citation:

    Van Buuren, J., C. Koch, N. v. Nieuw Amerongen, and A. M. Wright. 2014. The Use of Business Risk Audit Perspectives by Non-Big 4 Audit Firms. Auditing: A Journal of Practice and Theory 33 (3): 105-128

    Keywords:
    business risk auditing, small and medium-sized audit practices (SMPs), auditing standards, audit methodology
    Purpose of the Study:

    The purpose of this study is to examine the extent of use of business risk perspectives by Small and Medium-sized audit Practices (SMP) and to investigate the conditions and factors affecting the application of such practices. We neither focus on the degree of compliance with standards nor on the audit quality differences among audit firms. Rather, we want to document variation in practices and, in particular, the relative reliance on Business Risk Audit (BRA) forms of evidence, since current auditing standards allow great flexibility in the choice of audit approaches on an audit engagement.

    Investigating SMPs is expected to provide new insights because SMP auditors face an audit environment that is very challenging in the use of business risk perspectives. For instance, SME clients often do not have formalized entity-level controls for assessing (client) business risks. Also, clients of such firms vary considerably in size and complexity, which may affect the cost-effectiveness of various forms of BRA evidence. We examine whether business risk assessments are proportionally applied. That is, we investigate whether the extent of consideration of business risks is dependent upon cost-effectiveness in the client setting. For instance, for large clients, the complexity of the engagement likely requires a focus on business risks and entity-level evidence, while for small clients, it may be more cost-effective to primarily rely on substantive tests at the assertion-, account or cycle level. In this respect, we consider a continuum of audit approaches, ranging from a substantive-based audit approach to a full-scope business risk audit, to explain differences in the use of business risk perspectives in SMP’s audit planning.

    Design/Method/ Approach:

    To examine these issues, we use a semi-structured interview approach involving 38 highly experienced auditors in Germany and in The Netherlands. This approach allows us to gather rich, detailed data of auditors’ experiences in the field.

    Findings:

    The findings indicate limited application of business risk perspectives by SMPs. Although SMPs regularly assess business risks, they are divided in their experiences and perceptions about the usefulness of business risk perspectives and rarely apply the knowledge of business risks for analytical procedures. We also find that many SMP auditors find it challenging to rely on entity-level controls that are often informal in SMEs or that are established by an owner-manager. Our results suggest that SMP auditors more often choose a systems-based or primarily substantive audit approach, as compared to the broad BRA approach. The findings indicate that the use of business risk perspectives is driven by consideration of the tradeoff between audit effectiveness and efficiency. Auditors with larger and more complex clients apply business risk perspectives more extensively. Further, auditors identify other factors that may affect the use of a business risk audit approach, such as tax-book alignment, enforcement by audit supervisory authorities, prior working exposure to BRA through experience with Big 4 audit firms, audit client tenure, and investments in training and databases.

    Category:
    Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Assessing Risk of Material Misstatement, Changes in Audit Standards
  • Jennifer M Mueller-Phillips
    Who Did the Audit? Audit Quality and Disclosures of Other...
    research summary posted October 19, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 11.0 Audit Quality and Quality Control in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Who Did the Audit? Audit Quality and Disclosures of Other Audit Participants in PCAOB Filings.
    Practical Implications:

    The study results are important to regulators and audit practitioners as they show the differential audit quality for participating auditors used in issuer audits. The results show that audit quality declines when audit engagements use participating auditors that are not experienced in auditing SEC issuers. This indicates that public disclosure of the principal and participating auditors in the audit report can provide useful information to evaluate audit quality.  

    Citation:

    Dee, C.C., A. Lulseged, and T. Zhang. 2015. Who Did the Audit? Audit Quality and Disclosures of Other Audit Participants in PCAOB Filings. The Accounting Review 90 (5): 1939-1967.

    Keywords:
    PCAOB, audit quality, earnings quality, other audit participants
    Purpose of the Study:

    The Public Company Accounting Oversight Board (PCAOB) introduced in 2011 and re-proposed in 2013, an auditing standard that would require audit reports of SEC issuers to disclose participants in the audit other than the principal auditor. The PCAOB introduced the proposal to provide investors with full disclosure of the participants in the audit process, including affiliated firms of international audit firm networks. The underlying assumption of the proposed standard is that participating auditor involvement may negatively effect audit quality.   However, using a participating auditor may not effect audit quality due to the market pressure on the principal auditor to maintain high audit quality. The authors investigate whether the proposed standard would provide market participants with additional information to evaluate audit quality.

    The paper addresses whether there is a difference in audit quality between issuer audits with and without participating auditors. Using publicly available PCAOB filings, the authors identify an issuer sample that uses a participating auditor and a control sample that does not. The use of PCAOB filings allows the authors to identify participating auditors with limited experience in serving as a principal auditor for an issuer audit. The authors believe these auditors have a higher likelihood of low audit quality. If audit quality is not reduced using this auditor population, there is lower likelihood that audit quality reductions would occur in an expanded auditor sample. However, if audit quality is reduced, it would provide evidence that the proposed standard would benefit market participants in assessing audit quality.   

    Design/Method/ Approach:

    The authors employ an archival research methodology in this study and obtain PCAOB Form 2 filings from 2010-2012 to identify the sample. The study includes an experimental sample (use a participating auditor) and a control sample (does not use a participating auditor). To assess differences in audit quality, the authors use four proxies: cumulative abnormal returns, earnings response coefficients, discretionary accruals, and audit fees.

    Findings:
    • The authors find that cumulative abnormal returns are significantly negative in the one, two, and three days after the public disclosure of a participating auditor for the experimental sample. For the control sample, the cumulative abnormal returns are not significantly different from zero. This finding shows that the initial disclosure of the participating auditor is informative to the market.
    • In the earnings response coefficient analysis, the market valuation of earnings surprises decreases in the quarters subsequent to the public disclosure of the participating auditor. 
    • When evaluating discretionary accruals, the authors find that performance-adjusted discretionary accruals are higher for the experimental sample issuers when compared to the control sample. 
    • Using audit fees as a measure of audit quality, the results did not show a reduction in audit fees for the experimental sample issuers compared to the control sample.
    • Overall, the results show that the public disclosure of SEC issuer engagements with participating auditors provides the market with information that is beneficial in assessing audit quality.  
       
    Category:
    Audit Quality & Quality Control, Standard Setting
    Sub-category:
    Changes in Audit Standards
  • Jennifer M Mueller-Phillips
    “Twisting words”? A study of the construction and rec...
    research summary posted July 27, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    “Twisting words”? A study of the construction and reconstruction of reliability in financial reporting standard-setting.
    Practical Implications:

    First, the authors present a long-term case study of the development of the idea of reliability in accounting literature and standard-setting which adds to histories of conceptual thinking in financial reporting. Hence, by following the decision-making of the standard setting bodies regarding the qualitative characteristics of their framework, this paper contributes to the scarce empirical literature on actual processes of standard-setting in accounting.

    Citation:

    Erb, C., & Pelger, C. (2015). “Twisting words”? A study of the construction and reconstruction of reliability in financial reporting standard-setting. Accounting, Organizations & Society 40: 13-40.

    Keywords:
    standard setting, reliability, representational faithfulness
    Purpose of the Study:

    Qualitative characteristics serve to operationalize the objective of financial reporting and aim at shaping accounting discourses of standard-setters and their constituents. In the recent revision of their conceptual frameworks, the IASB and FASB decided to replace reliability”, arguably one of the most important properties of accounting, with ‘”representational faithfulness”. Although the boards considered the move to representational faithfulness to be a change in terms rather than in substance, simply reflecting a better terminology of the boards’ understanding, the boards’ constituents were heavily opposed to this alteration. The aim of the present paper is to shed light on the boards’ decision through a historical analysis of how reliability appeared in standard-setting and by tracing its abandonment in detail. In this paper the authors show that the construction and reconstruction of reliability followed from the standard-setters’ aim to extend the boundaries of appropriate financial reporting by changing conceptual language.

    Design/Method/ Approach:

    For this historical study, the authors examined official pronouncements, studies and other publications by professional institutions (AICPA) and research committees (AAA) in the US. They also carried out a thorough manual search of accounting journals for articles and other contributions concerning qualitative characteristics. The latter task was independently performed by both authors. The journals examined were Journal of Accountancy [19601985], Journal of Accounting Research [19631980] and The Accounting Review [19601980], the leading professional and academic accounting journals during that time. In total, the authors identified 36 relevant articles, seven monographs, two contributions from a collected edition and one statement from an institution formally in charge of standard-setting.

    Findings:

    Reliability was constructed in stand setters’ previous frameworks as a compromise between the traditional (evolutionary) practitioner idea embodied in the concept of verifiability and more recent academic notions of faithful representation. As constituents continuously ignored the faithful representation part of reliability and repeatedly used their understanding along the lines of verifiability to dismiss fair value accounting, the standard-setters reconstructed reliability to establish a single focus on faithful representation. However, the standard-setters’ attempt to alter traditional practical understandings by using ever higher levels of abstraction led to very different views among constituents and board members about what “faithful representation” means and what it implies. Hence, the standard-setters ‘construction and reconstruction of “reliability” against traditional understandings of verifiability by employing ever higher (more academic) levels of abstraction appears to be a permanently failing project.

    More specifically, the authors reveal that some board and staff members pressed the change towards faithful representation to eliminate a major hindrance to the expansion of fair value accounting. These actors’ ultimate success was due to confusion amongst and indifference by other board members as well as the strong position of the staff in pushing the change. The intensive public consultation carried out by the boards paradoxically served to decouple the standard-setters’ world from everyday accounting practice.

    Category:
    Standard Setting
    Sub-category:
    Changes in Audit Standards