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  • Jennifer M Mueller-Phillips
    Are Fraud Specialists Relatively More Effective than...
    research summary posted July 22, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 10.0 Engagement Management, 10.01 Budgeting and Audit Time Management in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Are Fraud Specialists Relatively More Effective than Auditors at Modifying Audit Programs in the Presence of Fraud Risk?
    Practical Implications:

    Although both auditors and fraud specialists added non-standard procedures to the audit program, auditors cut the budgets for some standard procedures, making room in the overall audit budget for non-standard additional procedures. In contrast, fraud specialists added standard procedures, but they were not more effective than those selected by auditors, and also provided less budget room for those procedures. The involvement of fraud specialists in planning an audit engagement where fraud risk is present is likely to lead to additional audit effort and cost, possibly without commensurate benefit. However, considering the potential consequences to the auditor of undiscovered fraud, it may be cost-effective to include additional non-standard procedures in an audit program if they improve the probability of discovering a fraud.

    Citation:

    Boritz, J. E., Kochetova-Kozloski, N., & Robinson, L. 2015. Are Fraud Specialists Relatively More Effective than Auditors at Modifying Audit Programs in the Presence of Fraud Risk? Accounting Review 90 (3): 881-915.

    Keywords:
    audit planning, audit procedures, fraud, specialists
    Purpose of the Study:

    Since the passage of Statement on Auditing Standards (SAS) 99 and the Sarbanes-Oxley Act of 2002, policy-makers and regulators have promulgated additional guidance aimed at improving auditors’ performance in assessing and responding to fraud risks of audit clients. Auditors are expected to address fraud risk through the design of their audit methods and programs and by involving specialists. The authors study whether fraud specialists are relatively more effective than auditors in designing an audit program that will address elevated fraud risk. The goal is to examine whether the expertise of fraud specialists can directly contribute to planning the nature and extent of audit procedures, and whether the mix of procedures that such specialists recommend is likely to be more effective and efficient than the procedures proposed by auditors in a setting where ex ante fraud risk is rated at above a low level. By directly examining fraud specialists’ recommendations for an audit plan under conditions of an elevated fraud risk, the authors seek to clarify whether there are benefits in requesting fraud specialists to participate in audit program design.

    Design/Method/ Approach:

    Participants completed an audit case based on an actual company that had issued fraudulent financial statements. Thirty-two fraud specialists and sixteen auditors completed the case  On average, the fraud specialists were 41 years old, had 12 years of specialized fraud-related experience, and six years of auditing experience. The auditors were, on average, 36 years old, had 13.25 years of auditing experience, but no specialized fraud experience. The evidence was gathered prior to November 2010.

    Findings:
    • In a situation with elevated fraud risk, fraud specialists did not select more procedures from a standard audit program than financial statement auditors; nor were the selected procedures more effective than those selected by auditors. This suggests that the benefits of involving fraud specialists in audit planning do not lie in their ability to identify more effective standard audit procedures.
    • When the risk of fraud is other than low, the fraud specialists proposed more additional procedures than did auditors, and the specialist-proposed additional procedures were marginally more effective, but significantly less efficient, than the additional procedures proposed by auditors. This suggests that involving fraud specialists in audit planning can carry benefits for engagements where fraud risk is not low by helping to identify a larger set of effective procedures than even very experienced auditors are able to do.
    • Fraud specialists increased time budgets to reflect the additional effort that they proposed via extensive non-standard procedures. However, although they proposed significantly more additional procedures than did auditors, their proposed time budget increases for those procedures were significantly lower than adjustments proposed by the auditors. 
    Category:
    Audit Team Composition, Engagement Management, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Budgeting & Audit Time Management, Fraud Risk Assessment, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • Jennifer M Mueller-Phillips
    Attracting Applicants for In-House and Outsourced Internal...
    research summary posted April 18, 2016 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.04 Staff Hiring, Turnover and Morale, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Attracting Applicants for In-House and Outsourced Internal Audit Positions: Views from External Auditors.
    Practical Implications:

    This study offers insights into why internal auditing is experiencing a shortage of qualified job candidates and offers a potential solution to the problem. The authors find that external auditors have negative perceptions about internal auditing, and these negative perceptions are associated with a (1) decreased desire to apply for internal auditing positions, (2) lower likelihood of recommending an in-house internal auditing career to high-performing students, and (3) higher likelihood of recommending an in-house internal auditing career to mediocre students. Internal auditors can try solving this problem by improving perceptions about internal auditing via a media campaign that raises awareness about the true internal audit career path.

    Citation:

    Bartlett, G.D., J. Kremin, K.K. Saunders, and D.A. Wood. 2016. Attracting Applicants for In-House and Outsourced Internal Audit Positions: Views from External Auditors. Accounting Horizons 30 (1): 143-156.

    Keywords:
    internal audit, hiring decisions, outsourcing, external auditors
    Purpose of the Study:

    The internal audit function can help organizations strengthen their risk management and corporate governance, yet the demand for qualified candidates to fill internal audit job openings exceeds the supply of interested applicants. Consequently, the internal audit function may find itself short-staffed and/or staffed with lower quality candidates, which may limit its ability to add value to the organization. In order to correct this problem, it is important to fully understand its scope and its root cause(s). Prior research attempting to gain this understanding has focused on investigating how accounting students’ beliefs about internal audit impact their interest to pursue an internal audit career. The authors of this paper extend this research by:

    • Investigating how external auditors’ beliefs about internal audit impact (1) their interest to pursue an internal audit career and (2) their recommendations to students about pursuing an internal audit career,  
    • Investigating differences in external auditor’s perceptions of in-sourced versus out-sourced internal audit, and
    • Asking external auditors to suggest what needs to be done to improve their perceptions of internal audit.
    Design/Method/ Approach:

    The authors use data from three sources. First, the authors performed an experiment using experienced external auditorsmostly seniors or associateswho were asked whether they would apply for a job described as either an accounting, in-house internal audit, or outsourced internal audit position. Second, the authors performed another experiment using experienced external auditorsmostly managers or directorswho were asked whether they would recommend that a high-performing (mediocre performer) student pursue an external audit, in-house internal audit, or outsourced internal audit career. Third, the authors surveyed high-ranking former/current external auditors who never worked in internal audit about what would make internal auditing a more appealing career for them.

    Findings:
    • When the same job opening is labeled as either accounting, in-house internal auditing, or outsourced internal auditing, the accounting label is likely to attract two times as many external auditor applicants as the other two labels.
    • External auditors are equally willing to apply for in-house internal auditing or outsourced internal auditing positions.
    • External auditors have more negative perceptions of in-house internal auditors than outsourced internal auditors.
    • External auditors have negative perceptions of the internal auditing profession. They believe that (1) others have negative stereotypes about the profession, (2) business professionals do not respect internal auditors, and (3) internal auditors do boring work.
    • Those less interested in applying for internal audit jobs have negative perceptions of internal auditing.
    • The average external auditor willing (unwilling) to apply for an internal audit position would want to receive at least 124% (149%) of his current salary before being willing to switch from his current external audit job to an internal audit job.  
    • External auditors will be most likely to recommend that top-performing students work in external audit and mediocre students work in in-house internal audit.
    • External auditors will equally recommend that top-performing students and mediocre students should consider outsourced internal audit as a second best career path.
    • External auditors have more negative perceptions of outsourced internal auditing than external auditing on most dimensions, except in regards to work-life balance. They believe that work-life balance is better for outsourced internal auditors.
    • Current and former external auditors believe that internal auditing could become more appealing if internal auditors do more interesting work, receive more respect, perform value-added tasks, receive better compensation, and have better promotion opportunities. Because internal auditors appear to already be following these suggestions, internal auditors may benefit from giving others a better understanding of internal audit careers.
    Category:
    Audit Team Composition, Auditing Procedures - Nature - Timing and Extent, Governance
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Reliance on Internal Auditors, Staff Hiring - Turnover & Morale
  • Jennifer M Mueller-Phillips
    Audit and Tax Career Paths in Public Accounting: An Analysis...
    research summary posted February 24, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.04 Staff Hiring, Turnover and Morale in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit and Tax Career Paths in Public Accounting: An Analysis of Student and Professional Perceptions
    Practical Implications:

    Competition for talent that requires students to make a professional career-track choice at an increasingly early stage in their development can lead to harmful “job market unraveling” that has been observed in other professional fields (e.g., law, medicine).  To the extent aspiring public accountants can make well-informed career track decisions, individuals and public accounting firms should benefit from improved person-job fit.  In this study, we provide systematic survey evidence about tax versus audit career alternatives which should be helpful to future accounting professionals.  We also note that ‘career track choice prior to internship’ appears to be an increasingly prevalent aspect of the public accounting labor market that would benefit from additional research.

    For more information on this study, please contact Derek W. Dalton.

    Citation:

    Dalton, D. W., S. Buchheit and J.J. McMillan. 2014. Audit and Tax Career Paths in Public Accounting: An Analysis of Student and Professional Perceptions.  Accounting Horizons 28 (2): 213-231

    Keywords:
    Theory of Planned Behavior; person-job fit; career choice; audit versus tax
    Purpose of the Study:

    Accounting students increasingly select their public accounting career path, either the audit or tax ‘track’, during university study.  Frequently, a career track decision is made prior to a public accounting internship.  We wanted to learn (1) how students make this important career decision and (2) whether the factors important to students’ audit vs. tax career choice seemed reasonable based on the perceptions of practicing accounting professionals.  In short, we wanted to learn whether students’ employment expectations matched professionals’ perceptions of job reality.

    Design/Method/ Approach:

    We gathered initial perceptions using a survey involving Masters of Accounting students during the fall of 2011.  Results helped us develop a relatively comprehensive survey for 171 upper-level accounting students at two large public universities during spring semester 2012.  The upper-level students largely had not yet made a ‘career track’ decision.  During the summer of 2012, we provided a similar survey to 310 public accounting professionals who had, on average, 10 years of work experience.  Respondents were evenly split as to professional track and were distributed across a wide distribution of employers (e.g., Big 4, national, regional, and local firms).

    Findings:

    Student career path choice is associated with students’ perceptions of job characteristics such as

    • Professional travel requirements,
    • Expected amount of client interaction, and
    • Long-term career opportunities in industry

    In large part, student perceptions agreed with those of practicing professionals; however, career misconceptions were noted.  Contrary to evidence from practicing professionals, students believed that:

    • Tax is less ambiguous than audit,
    • Tax is more difficult than audit, and
    • Auditors are more extroverted than tax professionals.
    Category:
    Audit Team Composition
    Sub-category:
    Staff Hiring - Turnover & Morale
  • Jennifer M Mueller-Phillips
    Audit Firms’ Client Acceptance Decisions: Does P...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit Firms’ Client Acceptance Decisions: Does Partner-Level Industry Expertise Matter?
    Practical Implications:

     This paper contributes to the literature on auditor industry expertise in many ways. First, it extends previous studies on this topic to examine whether industry specialists demonstrate different risk preferences in client acceptance decisions. The finding that partner-level industry specialists are more likely to accept less risky clients may partly explain why industry specialists have better quality clients.

    Citation:

    Hsieh, Y., and Lin C. 2016. Audit Firms’ Client Acceptance Decisions: Does Partner-Level Industry Expertise Matter? Auditing: A Journal of Practice and Theory 35 (2): 97-120.

    Keywords:
    partner-level industry specialization, client acceptance decision, and Big N auditors
    Purpose of the Study:

    Recently, audit firms have paid more attention to client acceptance decisions due to increased litigation risk. As a result more and more studies have investigated what goes into making this important decision. However, most prior studies examine whether auditors evaluate client risk characteristics when making client portfolio management decisions and whether auditors change their portfolio management strategies in response to changed in response to changes in litigation liability. Few studies have examined the impact of auditor characteristics other than accounting firm size. Auditors with different attributes could have different risk considerations in making client portfolio management decisions. In fact, previous studies have suggested that auditors use industry experience as a risk management strategy to mitigate risk on client portfolio management decisions because industry specialists provide high-quality audits and thus decrease litigation risk and reflect a good client-auditor match. Audit firms make large investments in specialized industries, so specialist auditors have an incentive to shed risky clients to avoid litigation risk and protect their reputation; hence, whether audit firms use industry expertise as a risk management strategy to mitigate the effect of risk is an empirical issue. The authors of this paper hope to explore whether industry specialization affects the association between risk considerations and client acceptance decisions. 

    Design/Method/ Approach:

    The sample is restricted to Taiwanese listed companies audited by Big N audit firms from 1999 to 2010. The final sample contains 9,337 observations. A Client Acceptance Decision Model was created to examine the effect of auditor industry expertise on firms’ risk consideration when making client acceptance decisions. 

    Findings:
    • The authors find that auditors are less likely to accept clients with audit risk higher than that of existing clients.
    • The authors find that firm-level industry expertise has no significant effect on the association between risk consideration and client acceptance decisions.
    • The authors find that partner-level industry specialists alone are less likely to accept clients with higher financial risk or higher audit risk, which supports the hypothesis that partner-level industry specialization affects the association between risk factors and client acceptance decisions. No evidence is found that firm-level industry expertise alone affects risk considerations in client acceptance decisions. 
    Category:
    Audit Team Composition, Client Acceptance and Continuance
    Sub-category:
    Industry Expertise – Firm and Individual
  • The Auditing Section
    Audit Partner Tenure and Audit Quality
    research summary posted May 7, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 05.0 Audit Team Composition, 05.03 Partner Rotation, 15.0 International Matters, 15.03 Audit Partner Rotation in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit Partner Tenure and Audit Quality
    Practical Implications:

    The results of this study are limited to the debate concerning individual audit partner rotation and do not support the argument for, or negate the prior studies that examine, audit firm rotation.  Combining the results of this study with the prior studies suggests that audit firms develop, over time, client and industry-specific knowledge that increases their ability to provide quality audits, and if quality control procedures within the firm are adequate (such as might be expected at a Big 6 firm), then rotating audit partners periodically helps maintain the auditor’s independence and objectivity while minimizing the loss of client-specific knowledge and rtise.

    Citation:

    Carey, P. and R. Simnett 2006. Audit Partner Tenure and Audit Quality. The Accounting Review 81 (3): 653-676.

    Keywords:
    audit partner tenure; audit quality; qualifications; earnings management
    Purpose of the Study:

    For many years, regulators have expressed concern regarding auditors’ extended associations with particular audit clients (i.e., long auditor tenure) and its potential impact on auditors’ independence and objectivity.  In the U.S., the AICPA Practice Section mandated in the 1970’s that audit partners rotate off their client after a seven year period.  The Sarbanes-Oxley Act of 2002 decreased this period to five years for public company engagements.  Outside the U.S., countries following international accounting standards and the Code of Ethics implemented by the International Federation of Accountants, as well as the United Kingdom and Australia, adopted similar standards by the early 2000’s due to the perceived “familiarity threat” associated with long auditor tenure.  Two of the arguments for mandatory rotation are that long auditor tenure 1) results in personal relationships with the client that could impair, consciously or subconsciously, the auditor’s independence, and 2) weakens the auditor’s ability to critically evaluate the client’s assertions.  However, to date, there is little empirical evidence to support these
    arguments.

    Due to data limitations, previous studies examining auditor tenure tend to focus on tenure of the audit firm as a whole.  Contrary to regulators’ perceptions, those studies tend to find that audit quality actually deteriorates in the early years after a change in the client’s audit firm, which is attributed to the “learning curve” effect, and that higher audit quality is associated with longer audit firm tenure, which is consistent with the audit firm developing more knowledge and familiarity with the client and industry as time progresses.  Based on their actions, regulators appear convinced that the potential benefits associated with auditor rotation are greater than the potential risks.  Therefore, the purpose of this study is to further examine whether long auditor tenure contributes to decreased audit quality in a setting where individual audit partners can be identified for particular audit clients.

    Design/Method/ Approach:

    The authors rely on data for Australian-domiciled companies publicly traded on the Australian Stock Exchange in 1995.  The authors accumulate auditor tenure information through 1997.

    The authors proxy for audit quality using three different measures: 1) the auditor’s propensity to issue a going-concern opinion; 2) the client’s reporting of abnormal working capital accruals; and 3) the extent to which key earnings targets are just beaten or missed.  Using the results of prior studies and the arguments and policies provided by regulators, the authors examine the association between audit quality and three measures of auditor tenure: less than two years, three to seven years, and greater than seven years.

    Findings:
    • For going-concern opinions, the authors find that longer audit partner tenures do decrease the individual auditors’ propensity to issue such an opinion.  Sensitivity analyses for this test suggest that these results are driven by non-Big 6 audit firm partners.
    • The results of this study find no association between abnormal working capital accruals and longer audit partner tenure. 
      These findings are in contrast to a prior study that examines the Taiwanese market and does find some support for an increased association between abnormal accruals (i.e., lower earnings quality) and longer auditor tenures,
    • The results show limited evidence of fewer clients just missing earnings benchmarks (i.e., more clients beating earnings benchmarks) in cases where the audit partner has longer tenure at the client.
    Category:
    Independence & Ethics, Audit Team Composition, International Matters
    Sub-category:
    Audit Firm Rotation, Partner Rotation, Audit Partner Rotation, Audit Firm Rotation
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  • Jennifer M Mueller-Phillips
    Audit Partner Tenure and Cost of Equity Capital
    research summary posted May 28, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 05.0 Audit Team Composition, 05.03 Partner Rotation in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit Partner Tenure and Cost of Equity Capital
    Practical Implications:

    Prior research suggests that the length of auditor-client relationship affects audit quality, and, therefore, the integrity and information risk associated with a clients’ financial reporting. This study attempts to examine the effects of audit engagement partner tenure and rotation on investors’ perceptions. The results of this study raise important questions for future research. It is not known to what extent investors or analysts are aware of the audit partner’s identity or pay attention to audit partner tenure. If investors or analysts do not consider partner tenure, future research may identify omitted variables that have the same nonlinear relationship with the ex ante cost of capital that we observe for non-Big 4 audit partner tenure.  

    Citation:

    Azizkhani, M., G. S. Monroe, and G. Shailer. 2013. Audit Partner Tenure and Cost of Equity Capital. Auditing 32 (1).

    Keywords:
    audit partner rotation; audit partner tenure; cost of capital; financial reporting credibility
    Purpose of the Study:

    Recent proposals by the PCAOB suggest that audit firms should be required to identify the name of the engagement partner in the audit report. The proposals suggest that this provides useful information to investors by allowing investors to identify audit partner tenure and rotation. Professional accounting bodies and regulators have long been concerned that long auditor-client relationships impair audit quality. The PCAOB, however, has noted that other commenters do not believe disclosure of partner identity will provide meaningful information to investors. This study investigates the usefulness of disclosing partner identity by exploring whether audit partner tenure and partner rotation are informative to investors, as indicated by the ex ante cost of equity capital.

    Design/Method/ Approach:

    The authors tested the relationship between client-specific ex ante cost of equity capital and audit partner tenure using two models. The client-specific ex ante cost of equity capital was estimated using the price-earnings ratio divided by the short-term earnings growth rate. Auditor tenure was tested using raw, long transform, and quadratic terms. The authors also used two-stage regressions to address the potential for Big 4 selection bias. The sample was selected for all Australian-domiciled companies listed on the Australian Stock Exchange during the 1995-2005 time period. 

    Findings:
    • Partner tenure has a nonlinear relation with the ex ante cost of equity capital for non-Big 4 audit engagements prior to the introduction of partner rotation requirements.
    • Imputed gains from partner tenure appear similar to the imputed gains of having a Big 4 auditor.
    • Partner rotation is associated with increased ex ante cost of equity capital.  
    Category:
    Audit Team Composition, Standard Setting
    Sub-category:
    Changes in Audit Standards, Partner Rotation
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  • Jennifer M Mueller-Phillips
    Audit quality and the market value of cash holdings: the...
    research summary posted July 30, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit quality and the market value of cash holdings: the case of office-level auditor industry specialization.
    Practical Implications:

    While theoretical literature has extensively examined the link between audit quality and firm value, very little empirical evidence has been provided as to the potential channels in which high-quality audits enhance firm value. This study extends and complements the existing line of research by providing useful insights into the role of audit quality in constraining managerial diversion or misuse of corporate cash resources. The results of this study are useful in assessing the effects of audit quality on firm value, specifically the market value of cash holdings.

    Citation:

    Kim, J. B., J. J. Lee, and J. C. Park. 2015. Audit Quality and the Market Value of Cash Holdings: The Case of Office-Level Auditor Industry Specialization. AUDITING: A Journal of Practice & Theory 34 (2): 27-57.

    Keywords:
    audit quality, auditor industry specialization, capital expenditures, cash holdings, cash management efficiency
    Purpose of the Study:

    In the past, research has been conducted in regards to the impact of managerial cash expenditures on the market value of cash holdings within corporations. Specifically, the misuse of corporate cash resources by management has been shown to result in investors discounting the value of cash holdings. This study investigates the monitoring role of high-quality auditors defined as office-level industry specialists in the stock market valuation of cash assets. The authors pose the idea that high-quality audits facilitate external discipline, thereby preventing potential misuse of cash holding and the associated destruction of cash values.  The study aims to provide large-sample, systematic evidence on whether higher-quality audits contribute to an increase in the market value of cash holdings.

    Design/Method/ Approach:

    Once problematic data were excluded, the sample consisted of 14,688 Big 4 client-year observations for publicly traded U.S. companies over the sample period of 20032011. The relation between audit quality and the market value of cash holdings was investigated by applying a regression model developed in previous research. The authors controlled for certain factors that have been previously shown to affect the market value of cash, including audit financial reporting quality and corporate governance.

    Findings:

    Overall, the results of the study support the idea that higher-quality audits contribute to an increase in the market value of cash holdings. Specifically:

    • The market value of cash is significantly higher for firms audited by local practice offices with both national and city-specific industry specialization.
    • The marginal value of cash is 34 cents higher for the client of a joint industry specialist at both the national and city levels than for the client of a non-specialist.
    • The positive association between joint-industry specialization and the value of cash holdings is more significant than those of national-only or city-only industry specialization.
    • When the auditor has joint-industry specialization, cash holdings are more closely associated with capital investment, and the market value of capital expenditures is significantly higher.
    • The market value of cash holdings increases significantly following the change of auditors to joint-industry specialists.
    Category:
    Audit Quality & Quality Control, Audit Team Composition
    Sub-category:
    Industry Expertise – Firm and Individual, Industry Experience
  • Jennifer M Mueller-Phillips
    Audit Report Lags after Voluntary and Involuntary Auditor...
    research summary posted June 22, 2013 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 05.0 Audit Team Composition, 05.03 Partner Rotation in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit Report Lags after Voluntary and Involuntary Auditor Changes
    Practical Implications:

    Regulators have long debated mandating auditor rotation. This study quantifies some of the costs of auditor rotation, specifically its impact on audit report lag. The findings lend support to opponents of mandatory rotation, since the first year after rotation requires more audit effort. The study also highlights one benefit that partner-firm familiarity can have (in decreasing audit report lag).

    Citation:

    Tanyi P., K. Raghunandan, and A. Barua. 2010. Audit Report Lags after Voluntary and Involuntary Auditor Changes. Accounting Horizons 24 (4): 671-688.

    Keywords:
    Auditor tenure; auditor rotation; audit partner rotation
    Purpose of the Study:

    Because of recent debate about the costs of auditor rotation, the authors examine how mandatory and voluntary auditor rotation affects audit report lag, or the number of days between the fiscal year end and the audit report date.Prior research examines only voluntary auditor rotation, which might have different effects than the mandatory rotation advocated by regulators.

    Design/Method/ Approach:

    Authors use the demise of Arthur Andersen and firms’ subsequent auditor changes as a setting in which to learn about mandatory auditor rotation.

    Authors compare audit report lags for firms with fiscal yearend of December 31, 2002. Audit report lag is the only publicly observable, quantifiable measure of auditor effort.

    Andersen firms switch from Andersen to another audit firm in fiscal 2002, and control firms (voluntary rotation) switch from a Big5 audit firm in fiscal 2002.

    Authors also examine audit report lags in fiscal 2000.

    Authors also partition Andersen firms into firms that follow their Andersen partner into a new audit firm and those that do not.

    Findings:

    Andersen firms that do not follow their partners into a new audit firm have longer audit report lags than clients of other Big 5 auditors who switched to a new auditor in 2002. The audit report lag increases by 6.5 days (from 58.02 days to 62.57 days).

    Andersen firms that follow their audit partners into a new audit firm have shorter audit report lags (by 4.56 days or 7.8 percent) than Andersen firms that did not follow their audit partners.

    Compared with firms that do not change audit clients, firms with voluntary auditor changes experience only marginally longer audit report lags. Firms with mandatory auditor changes have significantly longer audit report lags.

     

    For more information on this study, please contact K. Raghunandan.

    Category:
    Independence & Ethics, Audit Team Composition
    Sub-category:
    Audit Partner Rotation, Audit Firm Rotation
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  • Jennifer M Mueller-Phillips
    Auditing Fair Value Measurements: A Synthesis of Relevant...
    research summary posted March 31, 2016 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Auditing Fair Value Measurements: A Synthesis of Relevant Research.
    Practical Implications:

    The authors believe that when armed with knowledge of how management may intentionally or unintentionally introduce error into their FVMs, auditors will be better able to take steps to adjust for this error. Currently, professional skepticism is the best way to combat this problem. Researchers and policy makers within firms need to grapple with the possibility that existing audit team structure and incentives may not be compatible with audits that require more and more specialized valuation knowledge.

    Citation:

    Martin, R. D., J. S. Rich, and T. J. Wilks. 2006. Auditing Fair Value Measurements: A Synthesis of Relevant Research. Accounting Horizons 20 (3): 287-303.

    Purpose of the Study:

    In order to contribute to the PCAOB project on auditing fair value measurements (FVMs), the authors synthesize and discuss the implications of academic research that should be relevant to auditors, standard-setters, and academics who increasingly deal with the complexities of auditing FVMs. The authors structure their synthesis of prior research along two dimensions:

    1. An emphasis on the auditor’s need to understand how FVMs are prepared, including an awareness of the potential pitfalls and biases inherent in preparing FVMs, and
    2. The audit steps and procedures necessary to verify and attest to FVMs, including an awareness of the potential biases inherent in auditing FVMs.
    Design/Method/ Approach:

    Structuring the synthesis along the aforementioned dimensions, the authors first focus on the generation of FVMs because they believe auditors cannot exercise due care in the audits of FVMs without a thorough understanding of the underlying valuation techniques and inputs used in assessing FVMs. They focus second on research related to verification and attestation procedures for FVMs, even though very little research directly examines the auditing of FVMs.

    Findings:
    • FVMs frequently incorporate forward-looking information reflected in market place exchanges as well as judgments about the applicability of those market inputs to company-specific conditions.
    • Future events and conditions cannot be predicted with certainty, so an element of judgment is always involved.
    • Specialists are often required to audit FVMs.
    • The structures of audits teams may inhibit the utilization of knowledge of such specialists in today’s audit firms. 
    • A number of errors and biases likely affect prepares’ valuation judgments, and auditors should be aware of those.
    • Auditors may rely on internal controls over FVM estimation process.
    • Auditors must be able to identify key assumptions and inputs in the FVM process.
    Category:
    Audit Team Composition, Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Auditors’ Professional Skepticism, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • Jennifer M Mueller-Phillips
    Auditor Industry Specialization and Evidence of Cost...
    research summary posted October 21, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Auditor Industry Specialization and Evidence of Cost Efficiencies in Homogenous Industries.
    Practical Implications:

    The results of this study are important to audit firm clients, audit firms, and audit regulators as they evaluate the benefits and costs of industry specialization. For auditors and their clients, the evidence indicates that specialist auditors in homogenous industries, even when complex accounting is involved, achieve economies of scale that are passed on to clients. Clients in homogenous industries appear to benefit from a lower cost audit without a decrease in audit quality. Moreover, audit firms may benefit from increased client retention in these industries because of their expertise and competitive price. And, though audit regulators have expressed concern about concentration in the audit market, the results indicate that concentration can improve audit firms’ economies of scale in homogenous and complex industries without reducing audit quality. As audit clients, audit firms, and audit regulators consider industry specialization, this paper provides support for auditor specialization in homogenous industries.

    Citation:

    Bills, K. L., D. C. Jeter, and S. E. Stein. 2015. Auditor industry specialization and evidence of cost efficiencies in homogenous industries. The Accounting Review 90 (5): 1721-1754.

    Keywords:
    auditor industry specialization, audit fees, economies of scale, homogenous industries, complex industries
    Purpose of the Study:

    Audit firms specialize in certain industries hoping to enhance audit quality and achieve lower costs through knowledge transfer across clients. There has been mixed evidence to date regarding audit pricing for firms in specialized industries; most studies indicate that auditors charge a premium on their services, while others indicate that auditors discount their services due to achieved economies of scale. This paper examines the audit pricing effects of auditor industry specialization based on specific industry characteristics. Specifically, the authors:

    • Investigate whether the specialist auditor’s pricing behavior varies based on industry characteristics, like an industry’s similarity (homogeneity) of operations and complex accounting requirements.
    • Investigate whether the pricing decisions by the specialist auditor in industries where auditors achieve economies of scale depend on client bargaining power.
    Design/Method/ Approach:

    The authors collected audit firm market share data, operating expense data for each industry, information about AICPA audit and accounting guides, as well as data necessary to calculate control variables on companies with data available in the Audit Analytics database and Compustat. The information collected on these companies was for years 2004-2009.

    Findings:
    • The authors find that industry specialist auditors serving client firms in non-homogenous industries charge a fee premium. However, audit fees are incrementally lower for client firms in homogenous industries and client firms in homogenous and complex industries. This indicates that specialist auditors achieve cost efficiencies that are passed to clients who operate in homogenous industries. Additionally, when the client firm displays a relatively high degree of bargaining power, specialist auditors exhibit significantly lower fees.
    • The authors find that non-specialist auditors can also realize cost savings in homogenous industries, but charge higher fees to client firms in complex industries. Specialist auditors charge incrementally higher fees than non-specialists to client firms in complex, but not homogenous, industries. 
    • The authors find that audit quality provided by industry-specialist auditors in homogenous, or homogenous and complex, industries are not significantly different from other industries. These results support that specialist auditors generate production efficiencies without sacrificing audit quality. 
       
    Category:
    Audit Team Composition, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Industry Expertise – Firm and Individual