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  • Jennifer M Mueller-Phillips
    Internal Audit Sourcing Arrangements and Reliance by...
    research summary posted September 26, 2013 by Jennifer M Mueller-Phillips, tagged 07.0 Internal Control, 07.01 Scope of Testing, 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:
    Internal Audit Sourcing Arrangements and Reliance by External Auditors
    Practical Implications:

    The authors note a couple of implications for practitioners resulting from this study.  First, given the fact that external auditors assess internal audit quality and rely upon the work similarly for outsourced and cosourced internal audit functions, it may be worthwhile for companies to consider engaging some level of independent outside service provider to work along with their in-house internal auditors for high risk areas. 
        Second, having the same 3rd party internal audit service provider also provide tax services results in less reliance upon the work performed by internal audit, even though those services are approved by the audit committee and performed by different individuals.  Therefore, external audit increases their audit effort, thereby implying that external audit must see this additional service provision to be detrimental to the internal audit service provider’s objectivity. 
     
    For more information on this study, please contact Naman K. Desai.
     

    Citation:

    Desai, N. K., G. J. Gerard, and A. Tripathy. 2011. Internal Audit Sourcing Arrangements and Reliance by External Auditors. Auditing: A Journal of Practice & Theory 30 (1):149-171.

    Keywords:
    cosourcing; external auditor reliance; internal audit; sourcing
    Purpose of the Study:

      The purpose of this study is to investigate potential internal audit (IA) sourcing arrangements (in-house, outsource, and cosource) and to determine how that impacts an external auditor’s evaluation of the IA function’s competency, objectivity, and technical skills. The extent to which the audit team will rely upon work performed by the internal auditors can also be determined this way.  This study also looks at whether tax services provided by the IA service provider impacts the extent of reliance for outsourced or cosourced IA.
    This study is important because the Institute of Internal Auditors makes no preference between any of these sourcing arrangements.  Prior research has shown that outsourcing the IA function results in higher ratings of objectivity and more reliance upon their work when inherent risk is high (but no differences when inherent risk is low).  However, no studies test how cosourcing arrangements are evaluated.  This question is important to answer since a cosourced arrangement is a blend of in-house and outsourced internal auditors, which indicates that results could go either way. 
     

    Design/Method/ Approach:

    The authors conducted an experiment including experienced CPAs from Big 4 and regional firms prior to October 2007.  The design results in only 5 groups – in-house, outsource, or cosource without mention of tax services and outsource or cosource with the service firm also providing tax services.  External auditors were asked to provide ratings related to internal audit’s quality, reliance on internal audit work, audit risk, planned external audit effort, and likelihood that IA would give in to management regarding potential findings.

    Findings:
    • The authors find that in high risk areas, external auditors’ rate outsourced and cosourced internal auditors as having higher levels of quality than in-house internal audit.
    • They similarly find that external audit is more likely to rely upon the internal audit work performed if it is performed by outsourced or cosourced IA.
    • Further, the authors find no differences in quality or reliance ratings between outsourced and cosourced IA. 
    • However, when outsourced or cosourced internal audit service providers also provide tax services (which are performed by individuals other than those who perform the internal audit work) external auditors perceive the quality of the internal audit work to be lower.  As a consequence, they rely less upon the internal auditor’s work and instead increase their own external audit efforts. 
       
    Category:
    Auditing Procedures - Nature - Timing and Extent, Governance, Internal Control
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Reliance on Internal Auditors, Scope of Testing
  • Jennifer M Mueller-Phillips
    How a Systems Perspective Improves Knowledge Acquisition and...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.01 Substantive Analytical Review – Effectiveness, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    How a Systems Perspective Improves Knowledge Acquisition and Performance in Analytical Procedures
    Practical Implications:

    This experiment provides evidence that training in a systems perspective could help auditors analyze complex relationships between accounting data. This could be used to set appropriate analytics expectations and, more importantly, provide a credible way to determine whether management’s representations are well-grounded or not.  This method also appears to require less mental effort to implement, since it moves the complicated relationship structure out of memory and onto a model.  Given the added complexity of many estimates in today’s companies, systematic methods of processing information like a systems perspective may help to simplify the analysis of the estimates.

    For more information on this study, please contact Billy Brewster.
     

    Citation:

    Brewster, B. E.  2011.  How a systems perspective improves knowledge acquisition and performance in analytical procedures.  The Accounting Review 86 (3), 915-943.

    Keywords:
    analytical procedures; knowledge organization; learning; mental models
    Purpose of the Study:

    Understanding complicated relationships with multiple links between information is difficult, as people have limited memory to keep all the relationships straight.  This problem is evident in setting analytics expectations, as there are many reasons why accounting numbers change from year to year (and the reasons are often related to each other in varying, nonlinear ways).  In order to avoid a “reductionist” perspective where pieces of information are considered in isolation and linearly, auditors may be able to construct a better mental model of the situation by using a “systems perspective”.  This involves considering how all the parts of a system are related as well as their behavior from how they interact.  Using a systems perspective (compared to a reductionist perspective) is predicted to be more accurate, more efficient, better able to detect management representations that are inconsistent with the evidence, and better able to integrate new information into their expectations accurately.

    Design/Method/ Approach:

    In an experiment conducted prior to 2008, undergraduate accounting students (juniors/seniors) are given training in evaluating stocks and flows (systems perspective) or business risks (reductionist perspective).  They then learn about an audit client and its industry which has a particularly complicated relationship between multiple factors over time and the resulting product price.  Using the technique they were taught, they then graph the product price over time.  The students are then provided management’s estimate of the price and evaluate its credibility.  Finally, the participants learn new information about the industry and are asked to factor it into their price evaluation.

    Findings:
    • When compared to a computer simulation of how the product price should change over time, participants who used a systems perspective were closer to the simulation than those using a reductionist perspective
    • Those using a systems perspective did not need to exert as much mental effort to perform their evaluations
    • Using a systems perspective made it more likely to identify inconsistent management representations of the product price
    • When encountering new information, a systems perspective allows participants to incorporate the information more appropriately than a reductionist perspective
       
    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Substantive Analytical Review – Effectiveness, Sustainability ServicesTraining & General Experience
  • Jennifer M Mueller-Phillips
    Gathering Evidence through Enquiry: A Process Improvement...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 11.0 Audit Quality and Quality Control, 11.03 Management/Staff Interaction in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Gathering Evidence through Enquiry: A Process Improvement Focus
    Practical Implications:

    Given the results, the study provides evidence that there may need to be some additional guidance or tools used by auditors to stimulate the planning of client inquiries in order enhance the reliability of audit evidence obtained from client inquiry.  Auditors may benefit from having some high-level guidelines and framework to prepare and plan for meetings where they will be inquiring of management.  There would be benefits to providing a loose framework of items to consider before making an inquiry of management. This could increase the reliability of the inquiries as a form of evidence.  If the information obtained through inquiry is more reliable, the judgments and decisions that an auditor makes based on the inquiries may achieve a higher level of audit quality.

    For more information on this study, please contact Guoping Liu.
     

    Citation:

    Liu, Guoping. 2012. Gathering Evidence through Enquiry:  A Process Improvement Focus.   Behavior Research in Accounting 24 (2): 153-175.

    Keywords:
    Audit enquiry, cognitive planning, decision aids, experiment
    Purpose of the Study:

    As the accounting guidance continues to implement standards that require client management to make even more estimates in their financial statements, auditors have to rely on inquiries of client management as means of obtaining of audit evidence.  The critical aspect of this notion is how to make information obtained from management inquiries a more reliable form of audit evidence.  In order to make the evidence more reliable, it is important to determine what improvements in the inquiry process need to be made. 

    Audit inquiries are a key aspect of seeking information regarding the company’s financial and non-financial information.  Inquiries could include obtaining information regarding significant fluctuations in financial information, changes in the business, assumptions made in estimates, the rationale behind complex business transaction as well as other aspects about a client.

    The authors develop two types of decision aids and examine how these aids impact the inquiry process in which auditors engage with management.  The author believes that these decision aids may help improve how auditors plan for inquiries of client management as opposed to explicitly indicating how the inquiry process should occur.   The two types of decision aids are:

     

    • Theory-based decision aid:    This is based on psychology-based theory that someone who plans for the inquiry procedure by creating a mental simulation of its conversation with management will be better prepared to successfully completes the inquiry process.  Cognitive planning could ultimately improve the task performance (but not by prescribing specific behavior) by providing only simple task instructions to assist in planning for an inquiry. 
    • Practice-based decision aid:  This is based on the CICA 360 model that focuses on providing a basis for developing a practice-aid for the planning of client management inquiry,  This model focuses on the reliability of the evidence obtained through the inquiry including the reliability of the interviewee, the effectiveness of the interviewer, the quality of the information, the credibility of the findings noted, and how the information is integrated and synthesized by the auditor into the audit evidence.  The author develops a list of matters to consider in preparing for the client management inquiry.  Using a practice-based planning tool, the auditors will improve how auditors plan for the inquiries as compared to performing a checklist of required steps in carrying the inquiry task.


     

    Design/Method/ Approach:

    The participants consisted of 150 Master-level students (from two Canadian universities) who have approximately 6-24 months of audit experience.  The experiment was a 1x3 between-subject research design.  The participants were divided into one of three groups:  base, cognitive planning and practice aid groups.  The base group was provided the background information and then given the instruction to describe how they would perform the inquiry of management.  The cognitive planning group was given more instruction than the base group and was instructed to consider the information the auditor would like to obtain, how to obtain such information during the inquiry, and sequence of steps to carry out the inquiry.  The group is then asked to describe how they would perform the inquiry of management.  The practice group was given the practice-aid that listed the matters to consider in planning the inquiry in detail

    Findings:
    • Comparing the results of the cognitive planning group to the base group, the author finds that the cognitive planning group planned to pose more questions of a larger and more diverse group of the client.  This group also planned to extend their audit procedures beyond inquiry to corroborate the information obtained from management during the inquiry. 
    • When comparing the results of the cognitive planning group to the practice aid group, the results are similar with regard to their planned questions and number of interviewees; however, there was less focus on corroboration outside of inquiring of management
       
    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Management/Staff Interaction
  • Jennifer M Mueller-Phillips
    The Effects of Employer and Client Identification on...
    research summary last edited September 12, 2013 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Effects of Employer and Client Identification on Internal and External Auditors' Evaluation of Control Deficiencies
    Practical Implications:

    The Primary implication of this study is that reliance on the work of internal auditors may improve audit quality. AS5 recommends reliance on the work of internal auditors for lower-risk areas because it is presumed to improve efficiency. This paper, however, suggests that quality will be improved as well. Therefore, auditors may want to evaluate policies regarding regarding using the work of internal auditors and do so more heavily in the future.
     

    For more information on this study, please contact C.M. Stefaniak.

    Citation:

    Stefaniak, C., R. Houston, and R. Cornell. 2012. The Effects of Employer and Client Identification on Internal and External Auditors' Evaluations of Internal Control Deficiencies. Auditing: A Journal of Practice and Theory. (31)1:39 –56.

    Keywords:
    Auditor judgment, organizational identification, internal auditor, external auditor
    Purpose of the Study:

    Auditing Standard No. 5 (AS5) encourages external auditors to rely on internal auditors to increase the efficiency of lower-risk internal control evaluations. This study uses experimental data to determine whether internal auditors or external auditors are more lenient and by extension, which auditors perform higher quality audits.

    Design/Method/ Approach:

    In the post-Sarbanes Oxley period, the authors conducted an experiment with 40 internal auditors and 48 external auditors. Participants were given a hypothetical scenario, and were asked to evaluate the internal controls of the hypothetical firm.

    Findings:

    The main differences between internal and external auditors are as follows:

    • Internal auditors perceive a greater level employer identification when compared to external auditors
    • Internal auditors are less lenient than external auditors
       
    Category:
    Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Reliance on Internal Auditors
  • Jennifer M Mueller-Phillips
    The Impact of Initial Information Ambiguity on the Accuracy...
    research summary posted September 10, 2013 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.01 Substantive Analytical Review – Effectiveness in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Impact of Initial Information Ambiguity on the Accuracy of Analytical Review Judgments
    Practical Implications:

    The practical implication of this research for auditors is that it is best to avoid making initial hypotheses until after they obtain a comprehensive perspective of the data. Auditors should instead treat early stages of the decision process as a fact-finding exercise.

    Citation:

    Luippold, B.L. and T.E. Kida. 2012.  The Impact of Initial Information Ambiguity on the Accuracy of Analytical Review Judgments.  Auditing: A Journal of Practice and Theory. (31) 2:113–129.

    Keywords:
    analytical review, hypothesis testing, initial information ambiguity, auditing
    Purpose of the Study:

    This study seeks to determine the extent to which initial information ambiguity affects analytical review judgments. That is, this paper examines whether the impact of initial information ambiguity persist even after the ambiguity is gone.

    Design/Method/ Approach:

    Around 2010 94 participants, who were mainly staff level auditors, participated in an experiment with a seeded error wherein they were required to perform preliminary analytical procedures. The participants were separated by condition into different levels of information ambiguity to perform preliminary analytical procedures and all were then given the full data to make a final judgment.

    Findings:

    The main finding of this paper is that initial information ambiguity affects an auditor's ability to detect financial statement errors at the end of the analytical review process. Specifically, if auditors develop initial hypotheses using ambiguous information sets, they are less likely to identify errors causing fluctuations in financial data even after they search through all of the client's relevant information

    Category:
    Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Substantive Analytical Review – Effectiveness
  • The Auditing Section
    The Importance of Account Relations when Responding to...
    research summary last edited May 25, 2012 by The Auditing Section, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.01 Substantive Analytical Review – Effectiveness in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Importance of Account Relations when Responding to Interim Audit Testing Results
    Practical Implications:

    The results of the study are important, as they demonstrate that relations among different financial statement accounts should be considered when examining how auditors respond to changes in risk of misstatements.  Specifically, auditors do appear to respond to increases in the risk of material misstatement of one account by also increasing planned audit hours in related accounts.  The results also highlight the fact that auditors’ responses to changes in audit risk are insensitive to fee pressure; specifically, the increase in budgeted audit hours when encountering a serious misstatement is similar whether fee pressure is low or high.  Moreover, the author suggests that the concept of relatedness of accounts explored in this paper could be extended to tests of internal controls – for example, information about the effectiveness of one internal control could be informative about strength or importance of related internal controls

    Citation:

    Vandervelde, S. 2006. The Importance of Account Relations when Responding to Interim Audit Testing Results. Contemporary Accounting Research. 23(3): 789 – 821.

    Keywords:
    Account relations; audit planning; interim evidence; profit pressure; auditing procedures - nature, timing, and extent
    Purpose of the Study:

    Both U.S. and international auditing standards mandate auditors to adapt audit procedures as the risk of the audit engagement changes.  As many financial statement accounts are interrelated (e.g., accounts payable and inventory), it is important for auditors to consider the relations between accounts when engaging in audit planning procedures and adjusting audit procedures for changes in risk.  This study tests auditors’ responses to risk changes discovered during interim testing (potential fraud, error, or no problem).  The study also explores the following two potential reasons why prior research has generally concluded that auditors are not very responsive to risk changes:

    • Profit pressures may cause auditors to avoid increasing audit testing, in order to keep the engagement audit fees at the level initially agreed upon.  To address this potential explanation in the experiment, the author examines whether auditors’ still increase planned audit hours in the presence of more severe misstatements even when audit profit pressure is high.
    • An auditor’s response to risk changes may not be detected when accounts are analyzed in isolation rather than considering the relations between accounts (that are inherent in the double-entry format of recording transactions). For example, an auditor may address an increase in risk of accounts payable by performing additional testing of inventory receipts. To address this potential explanation in the experiment, the author examines how auditors’ responses to risk increases in an account differ, depending on whether the accounts are related vs. unrelated. 
    Design/Method/ Approach:

    The research evidence was collected prior to 2004. The author uses a group of audit senior associates from both Big 4 and non-Big 4 audit firms to complete a simulated audit budgeting task from a website. Participants are first asked to read background information on the audit client, including the prior year audit budget and realized audit hours.  Then, participants are asked to prepare an
    initial budget for audit hours allocated to five financial statement accounts.  Next, participants view the results from interim testing procedures (where the potential fraud, error, or no problem arises) and are then asked to indicate the amount of audit hours they would budget for the year-end audit work, representing their response to the change (or no change) in risk. 

    Findings:
    • Auditors’ planned audit hours for an account increase as the interim audit procedure results indicate that the account has more serious problems (i.e., potential fraud is the most serious, error is moderately serious, and no problem is least serious).
    • As the severity of a potential account misstatement increases, the associated increase in budgeted audit hours is greater when relatedness between accounts is high than when relatedness is low. 
    • The increase in budgeted audit hours in response to the interim testing results indicating a serious misstatement is the same under both low and high fee pressure, indicating that auditors’ response to increased risk is insensitive to high fee pressure.
    Category:
    Risk & Risk Management - Including Fraud Risk, Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Assessing Risk of Material Misstatement, Substantive Analytical Review – Effectiveness
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  • The Auditing Section
    The Effect of Audit Inquiries on the Ability to Detect...
    research summary last edited May 25, 2012 by The Auditing Section, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 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:
    The Effect of Audit Inquiries on the Ability to Detect Financial Misrepresentations
    Practical Implications:

    The results of this study show that inquiry, including repeating questions and providing deception training do not increase the accuracy of those observing interviews.  However, the participants were less likely to believe interviewees when they observed the open ended question inquiry than when they observed the yes/no questions only. Therefore, there is some evidence that by observing an inquiry, professional skepticism is increased.       

    The authors recognize that their results may not generalize to experienced auditors, who may have general or specialized knowledge and abilities that enable them to detect deception better than undergraduate accounting students and recommend further research on experienced auditors.  

    Citation:

    Lee, C. C. and Welker, R. B. 2007. The effect of audit inquiries on the ability to detect financial misrepresentations. Behavioral Research in Accounting 19 (1): 161-178.

    Keywords:
    fraudulent financial reporting, audit inquiry, deception detection, deception training
    Purpose of the Study:

    There has been a recent emphasis placed on inquiries for fraud risk assessments. The present study assesses how well deception can be detected during audit inquiries.  Due to the nature of an audit inquiry, the authors predict that the inquiries will create an environment where deception is more difficult to carry out and is therefore easier to catch. Using two experiments, the authors examine whether a student observing an interview (as opposed to performing the interview) is effective at detecting deception and whether training increases the ability to detect deception. 

    Design/Method/ Approach:

    The authors performed two experiments using undergraduate accounting students.  The experiment involved a simulated interview where an interviewer (former auditor and CPA) asked an interviewee (MBA student) questions and observers (accounting students) reviewed a video of the interviews and determined whether the interviewee was telling the truth or lying.  Observers were exposed to one of three sections of the interview: just the representations of the interviewee (just yes or no questions), the representations and the inquiry (yes/no and open ended questions), or the entire interview (including repeated questions). 

    A second experiment was conducted which was consistent with the first experiment. A new set of undergraduate accounting students were observers of the same interviews used in experiment one. However, half of the observers received training and half did not. 

    Findings:
    • Students are not any better at detecting deception by observing an interview than random chance.
    • Those who observed the inquiry (open ended questions) are no better at detecting deception than those who just observed the representations (yes/no questions).
    • Those who observed the entire interview with repeated questions are no better at detecting deception than those who observed the inquiry without repeated questions.
    • Those who received training were not any better at detecting deception than those who did not receive training.
    Category:
    Risk & Risk Management - Including Fraud Risk, Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Fraud Risk Assessment, Auditors’ Professional Skepticism
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  • The Auditing Section
    Internal Audit Quality and Earnings Management
    research summary last edited May 25, 2012 by The Auditing Section, tagged 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:
    Internal Audit Quality and Earnings Management
    Practical Implications:

    This study develops an empirical measure of internal audit quality, and provides evidence supporting companies’ use and  development of an IAF as part of improvements to its overall governance environment.  Regulators and other parties interested in corporate governance may find it helpful to more explicitly consider the role of internal auditor in the evaluation of the firm. 

    Citation:

    Prawitt, D., J. Smith, D. A. Wood 2009. Internal Audit Quality and Earnings Management. The Accounting Review 84 (4): 1255-1280.

    Keywords:
    corporate governance; internal audit function; internal audit quality; earnings management; abnormal accruals; analyst forecasts
    Purpose of the Study:

    Standards promulgated by the AICPA and PCAOB recognize the impact that a high-quality internal audit function (IAF) can have on reducing control risk, and by extension, audit risk.  As such, regulators permit and encourage external auditors to rely on the work of others if that work is deemed to be performed by “competent and objective persons” (PCAOB 2007).  Similarly, the Institute of Internal Auditors (IIA) recognizes the IAF as one of the four cornerstones of corporate governance, along with the audit committee, executive management, and the external auditor.  However, while several prior studies establish a negative association between the quality of firm’s corporate governance mechanisms and management’s tendency and ability to manipulate reported financial results, there is little evidence that relies on archival data concerning the impact of a quality IAF on firms’ earnings manipulation activities.

    The purpose of this study is to examine archival data to determine whether differences in the quality of firms’ IAF impact firms’ earnings management activities.

    Design/Method/ Approach:

    The authors rely on the IIA maintained GAIN database (a proprietary database), that is composed of survey responses from chief audit executives associated with IIA member organizations.  Member organizations responding to the survey include publicly traded and private companies, educational and governmental institutions, as well as individual divisions within companies.  The study covers the fiscal years of 2000-2005. 

    The authors create an index based on six factors that SAS No. 65 suggests external auditors should consider when evaluating whether to rely on the work of the internal auditors, and therefore differentiate IAF quality.  Those factors include the IAF’s professional experience, professional certifications, training, objectivity, relevance of their work to the financial reporting function, and the IAF’s relevance to the organization based on how much resources the corporation invests in the IAF group.  To capture management’s earnings management activities, the authors rely on measures of abnormal accruals and whether the firm just misses or beats analysts’ forecasts.

    Findings:
    • Overall, the results suggest that higher quality IAFs reduce management’s ability to manipulate earnings.
    • Specifically, higher quality IAFs appear to be associated with smaller negative abnormal accruals.
    • Companies with higher quality IAFs appear more likely to just miss analysts’ earnings forecasts, a measure of less earnings management.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Governance
    Sub-category:
    Reliance on Internal Auditors, Internal auditor role and involvement in controls and reporting
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  • The Auditing Section
    Internal Audit Reporting Lines, Fraud Risk Decomposition,...
    research summary last edited May 25, 2012 by The Auditing Section, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 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:
    Internal Audit Reporting Lines, Fraud Risk Decomposition, and Assessments of Fraud Risk
    Practical Implications:

    The results of this study are important for audit firms to consider when determining the extent of reliance on internal auditor’s fraud risk assessments.  Internal auditor judgments may be influenced by pressures to decrease risk assessments when reporting to the audit committee.  Thus, the recent suggested improvements for improving audit practice and risk assessment processes by reporting to the audit committee may have adverse and unexpected consequences.  Additionally, internal auditor judgments may be influenced by an over-reliance on attitude cues, even when decomposing fraud risk assessments.  Thus, decomposition may amplify the problem that prompted its use.

    Citation:

    Norman, C.S., A.M. Rose, and J.M. Rose. 2010. Internal audit reporting lines, fraud risk decomposition, and assessments of fraud risk. Accounting, Organizations and Society 35: 546-557.

    Keywords:
    internal audit, fraud risk assessment, audit committee
    Purpose of the Study:

    The internal auditor function is one of the four cornerstones of corporate governance along with senior management, the board, and external auditors.  External auditors frequently rely on the work of internal auditors, including firm risk assessments per AS5, An Audit of Internal Control over Financial Reporting that is Integrated with an Audit of Financial Statements.  Internal auditors may report to management or to the audit committee.  Many investors and regulators have suggested that internal auditors should report directly to the audit committee to minimize the threats to independence and objectivity that may potentially occur when internal auditors report to management.  However, if the audit committee is given power over the internal audit function, this may create potential new threats to internal auditor independence not previously considered.  For example, many audit committees now have the authority to hire or fire the Chief Audit Executive.  This paper addresses the effects of internal audit reporting lines on the fraud risk assessment judgments of internal auditors.  Below are two objectives that the authors address in their study: 

    • Examine the extent that internal auditors may be subconsciously motivated to avoid reporting higher levels of fraud risk to the audit committee, relative to when the risks are reported to management.
    • Examine whether decomposition of fraud risk into the components of the fraud triangle (management attitude, incentives, and opportunities) improves the internal auditor’s sensitivity to opportunity and incentive cues.
    Design/Method/ Approach:

    The authors collected their evidence from highly experienced internal auditors (mean experience of 15.3 years) via survey instruments. The authors then collected additional evidence using an experiment where participants were asked to complete a simulated task. Experiment participants were experienced internal auditors with mean experience of 9.6 years.  Survey participants were asked five questions about risk assessment discussions, reporting lines, and reactions.  In the simulated task participants were asked to assess the level of fraud risk in a hypothetical firm.  Participants were assigned to either a higher or lower level of fraud risk and to a reporting line of either audit committee or management.  The research was conducted in the mid- to late-2000s time period.

    Findings:
    • The authors find that internal auditors perceive greater personal threats when reporting high levels of fraud risk to the audit committee than when reporting to management.  Internal auditors fear overreaction from the audit committee, potentially leading to increased workload and management reprisals.   
    • The perception of greater perceived threats leads internal auditors to reduce assessed levels of fraud risk when reporting to the audit committee relative to reporting to management.  This finding is contrary to expectations and reveals additional unexpected threats created by having internal audit report to the audit committee.
    • Internal auditors increase attention to management attitude when risk assessments are decomposed, without a corresponding increase to incentive or opportunity cues.  Thus, unlike external auditors, fraud decomposition does not appear to mitigate perceived problems associated with insensitivity to incentive and opportunity cues.    
    Category:
    Risk & Risk Management - Including Fraud Risk, Auditing Procedures - Nature - Timing and Extent, Governance
    Sub-category:
    Fraud Risk Assessment, Reliance on Internal Auditors, Internal auditor role and involvement in controls and reporting
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  • The Auditing Section
    Exploring Trust and the Auditor-Client Relationship: Factors...
    research summary last edited May 25, 2012 by The Auditing Section, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind, 10.0 Engagement Management, 10.04 Interactions with Client Management in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Exploring Trust and the Auditor-Client Relationship: Factors Influencing the Auditor’s Trust of a Client Representative
    Practical Implications:

    The findings provide evidence that auditors do hold a level of trust in client representatives and that the level of trust is associated with commonplace behaviors of client representative that attract trust.  The results of this study are important to make auditors and auditing standards setters aware of factors that may lead to greater auditor trust of client management and perhaps consider whether there may be a potential for excessive trust to overwhelm the auditor’s professional skepticism. Note that the study was unable to determine whether the levels of trust that the auditors had for the client were such that auditor judgment would be compromised.

    Citation:

    Rennie, M. D., L. S. Kopp, and W. M. Lemon. 2010. Exploring Trust and the Auditor-Client Relationship: Factors Influencing the Auditor’s Trust of a Client Representative. Auditing: A Journal of Practice and Theory 29 (1): 279-293

    Keywords:
    Trust, Professional Skepticism, Auditor-Client Relationship
    Purpose of the Study:

    A financial statement audit cannot be conducted in the absence of the auditor’s trust of client management.  The auditor needs information provide by management and the cooperation of management to carry out the audit.  Thus, the auditor has no option but to bestow some degree of trust upon client management.  Yet, if trust is too strong, professional skepticism could be impaired.  Below are the objectives of this descriptive, exploratory study: 

    • To shed light on auditors’ trust of client management using the context of an auditor-client disagreement.
    • To learn about client behaviors (e.g. openness of communication and demonstration of concern) that may influence the auditor’s trust of a client.
    • To learn about aspects of the auditor-client relationship (length of association and frequency of past disagreements) that may influence the auditor’s trust of a client.
    • To gather auditors’ opinions about the importance of trust and about managing the balance between trust and professional skepticism.
    Design/Method/ Approach:

    The authors collected their evidence via a survey questionnaire prior to June 2007. Participants surveyed include 71 experienced auditors (48 partners, 2 principals, 20 senior managers, and 3 managers) from Canadian international accounting firms. Participants were asked to briefly describe a disagreement they had previously had with a client and were asked specific questions about that disagreement.

    Findings:
    • A disagreement experience with the client is relevant to the auditor’s trust of that client.
    • A client’s openness of communication during the course of a disagreement is positively associated with the auditors’ trust of that client representative.
    • A client’s demonstration of concern toward the auditor appears to be trust-relevant.
    • The frequency of disagreements with the client is negatively associated with the auditor’s trust of the client.
    • The length of the auditor-client relationship is positively associated with the auditor’s trust.
    • An auditor’s satisfaction with the outcome of the disagreement is positively associated with the auditor’s trust. 
    • The auditor’s predisposition to trust is not associated with the auditor’s trust of the client.
    • Auditors believe it is important to trust their clients but they also attempt to ensure that trust does not impede professional skepticism.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment, Engagement Management
    Sub-category:
    Auditors’ Professional Skepticism, Prior Dispositions/Biases/Auditor state of mind, Interactions with Client Management
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