To the auditors’ knowledge this study is the first to examine the joint effect of social pressure and estimate source. By examining the joint effect of these two factors, they identify the boundary conditions under which the effect of estimate source holds. The results of this study indicate that auditors perceive advice to be more acceptable when it is from a superior than when it is from a peer. Further, when advice is received from a peer, auditors in this study indicate that the advice is more likely to be weighed against other evidence than when the same advice is received from a supervisor.
Brink, A. G., F. Tang, and L. Yang. 2016. The Impact of Estimate Source and Social Pressure on Auditors’ Fair Value Estimate Choices. Behavioral Research in Accounting 28 (2): 29 – 40.
This paper empirically examines how estimate source interacts with social influence pressure to affect auditors’ judgments of fair value estimates. This research is motivated by growth in the use of fair value accounting practices in recent years and concern over the usefulness of reported fair values. Because of the subjectivity and judgment that is inherent in fair value estimation, evaluating fair value estimates poses a significant challenge to auditors and it is important to understand factors influencing auditors’ judgment in the selection and reporting of fair value estimates. While fair value accounting practices are of international concern, particular emphasis has been placed on whether emerging economies, such as China, are effectively implementing the fair value components of accounting standards.
The authors conduct an experiment with Chinese auditor participants to investigate how auditors’ choices regarding the investigation of a subjective fair value estimate are influenced by the source of a fair value estimate and social pressure.
This study has implications for public accounting firms engaging in GHG engagements. Team training that establishes an understanding of the knowledge and role of the team members from differing disciplines might help to alleviate over-reliance on peer-provided evidence. In the context of multidisciplinary assurance teams, establishing and adhering to audit firm quality control mechanisms relating to evidence collection, evaluation, and review are of particular importance. Accounting firms may also need to pay particular attention in fostering an assurance environment that encourages objective evidence processing.
Kim, S., W. J. Green, and K. M. Johnstone. 2016. Biased Evidence Processing by Multidisciplinary Greenhouse Gas Assurance Teams. Auditing: A Journal of Practice and Theory 35 (3): 119-139.
Due to the increased attention being paid to the environment as well as how humans are impacting the environment, there exists growing demand for a range of corporate social responsibility information. In order to be most efficient, assurors conduct greenhouse gas (GHG) assurance engagements using multidisciplinary teams containing varying technical expertise, with some possessing financial audit-related expertise and others possessing science or combined science/financial-related expertise. The purpose of this study is to investigate how auditors respond to the discipline-specific expertise of other team members in undertaking GHG assurance.
The authors test this by conducting an experiment in which traditional auditor participants respond to a simulated multidisciplinary team and examine whether the auditors bias their weighting of evidence based on if the senior assuror has a science background as opposed to a financial background.
This article explains the importance of redundancy to both design and assessment practices in aviation, but contests redundancy’s ability to accurately translate between them. It suggests that FAA reliability assessments serve a useful regulatory purpose by couching the qualitative work of engineers and regulators in an idiom of calculative objectivity, but cautions that this comes with potentially perverse consequences. For, like many audit-practices, reliability calculations are constitutive of their subjects, and their construal of redundancy shapes both airplanes and aviation praxis.
Downer, J. 2011. On audits and airplanes: Redundancy and reliability-assessment in high technologies. Accounting, Organizations & Society 36 (4/5): 269-283.
Reliability assessments of the most publicly significant high technologies– from nuclear power-plants to civil jetliners – invoke calculative practices that are both opaque to the public gaze and largely neglected by sociologists of accounting. This paper is an effort to begin the long process of redressing the latter. A panoply of oversight bodies are responsible for performing reliability assessments of high technologies. Invariably, these are state regulators, such as the Nuclear Regulatory Commission (NRC) and Federal Aviation Administration (FAA) in the US. Among other functions, they measure and verify the reliability of complex and potentially dangerous technologies. This function is important, not only because the technologies involved are consequential, but also because the reliability they require is not readily knowable.
This paper argues that reliability assessments of complex technologies can usefully be construed as ‘audits’ and understood in relation to the literature on audit-practices. It looks at a specific calculative tool – redundancy – and explores its role in the assessments of new airframes by the Federal Aviation Administration (FAA).
This article is a commentary.
It is important to recognize that the counting practices of high technology, like those of other audit domains, are worthy of sociological consideration and amenable to sociological deconstruction. Like all institutional audit practices, they are socially constructed and materially constitutive: shaping technological systems and colonizing engineering practices. They may even be more constitutive in engineering than in other domains. Modernity widely subscribes to a pervasive but misleading ideal that construes technologies as more ‘objectively knowable’ than most audit objects, and this imbues engineering calculations with uncommon influence.
In the specific case of FAA reliability assessments, the ideal of objectivity leans heavily on redundancy because of its usefulness in enacting quantitative proof. It allows auditors to translate the vicissitudes of engineering practice into the formal language of regulatory assessment. Yet this function depends on a false equivalence between redundancy as ‘engineering tool’ and redundancy as ‘audit paradigm’, where the latter is misconstrued as accurately reflecting the former. And, given the socially and materially constitutive nature of formal reliability assessments, this disjuncture has complex ramifications with significant social consequences. Calculative practices like redundancy are not important because they accurately represent the technological world but because they claim to, and because such claims become institutionalized in ways that shape technological designs, influence technological practices, and frame important technological choices.
Based on the interviews and problems identified, the authors conjecture that potentially suboptimal auditing methods are being used to evaluate complex estimates which are an important and growing part of the financial statements. This may be negatively impacting audit quality. More specifically, auditors over-rely on management estimates because they lack the knowledge and incentives to behave otherwise. This possibility has direct consequences for auditor professional skepticism because increasing professional skepticism may be less effective unless auditors are also given the requisite knowledge to properly use it. These problems are reinforced by auditing standards and regulators which generally outline/criticize the current auditing methods without suggesting new or better ones.
Griffith, E., J. Hammersley, and K. Kadous. 2015. Audits of Complex Estimates as Verification of Management Numbers: How Institutional Pressures Shape Practice. Contemporary Accounting Research 32 (3): 833-863.
Complex estimates are increasingly important to financial statements and of growing concern to both regulators and investors. While auditors have well-established procedures for auditing more objective account balances (i.e., valued at historical cost), little is known about the process auditors use to evaluate more subjective, complex estimates. This article conducts interviews with experienced audit personnel to determine how auditors evaluate such estimates, determines the problems with such approaches, and uses “institutional theory” to theorize the reason such problems exist and persist. The authors consider the influence of both audit firms themselves and regulators (i.e., information from PCAOB inspection reports) on auditors’ complex estimate audit procedures.
The authors conducted semi-structured phone interviews with experienced audit personnel. Participants are from 6 large accounting firms with at least manager level experience. Interviews were conducted between October and November 2010. The authors analyzed the audit process steps discussed by participants for complex estimates and coded these steps according to the PCAOB auditing standards related to accounting estimates (AU 342 and 328). For steps that could not be appropriately classified into ones discussed by the auditing standards, the authors developed additional classifications.
While auditing standards allow for different approaches to evaluating complex estimates (e.g., testing management process, preparing independent estimate, etc.), the authors find that auditors usually just test management’s process (i.e., verifying inputs such as historical cost, understanding who and how estimate is generated, testing controls surrounding process, and testing sensitivity of assumptions used).
Based on institutional theory, the authors theorize two key reasons that auditors mainly use management process verification when auditing complex estimates instead of other (potentially more creative and skeptical) approaches. The reasons are:
Incorporating Big Data into an audit poses several challenges. This article establishes how Big Data analytics satisfy requirements of audit evidence, namely that it is sufficient, reliable, and relevant. The authors bring up practical challenges (such as transferring information, privacy protection, and integration with traditional audit evidence) and provide suggestions for addressing them in incorporating Big Data into audit evidence. They also suggest that Big Data can complement tradition audit evidence at every level of audit evidence: financial statement, individual account, and audit objective.
Yoon, K., L. Hoogduin, and L. Zhang. 2015. Big data as complementary audit evidence. Accounting Horizons 29 (2): 431-438.
This paper frames Big Data in the context of audit evidence, specifically looking at the requirements for something to be considered audit evidence, to provide an argument for the usefulness of Big Data to auditors. The authors address the sufficiency, reliability, and relevance of Big Data analytics; they then outline potential challenges to using Big Data for adequate audit evidence.
The authors summarize existing literature on audit evidence as it applies to Big Data. They perform no original analyses, but rather discuss the characteristics of Big Data analytics as they relate to regulations and research findings.
The authors address:
The heightened epistemic motivation induced by principles-based accounting standards then ultimately increases auditors’ demands for audit evidence. Thus, the results suggest the important influence of accounting standards on auditors’ motivations and consequent program planning decisions. The findings provide valuable information to regulators in their evaluation of how or whether to move forward with potential IFRS adoption or convergence of U.S. GAAP with IFRS. In a principles environment, audit firms must take measures to guard against this potential bias, e.g., review of proposed audit programs and results of tests.
Peytcheva, M., Wright, A. M., & Majoor, B. 2014. The Impact of Principles-Based versus Rules-Based Accounting Standards on Auditors' Motivations and Evidence Demands. Behavioral Research In Accounting 26 (2): 51-72.
There has been considerable discussion about the effects of principles-based versus rules-based accounting standards on financial reporting quality, particularly given the debate concerning the adoption of, or convergence with, International Financial Reporting Standards (IFRS) in the United States. Auditing research has investigated the effects of different accounting standards on auditors’ decisions to constrain aggressive reporting by clients. Missing from this literature is evidence on how the type of accounting standard influences auditors’ cognitive motivations and demand for audit evidence. This study addresses this gap in the literature, which is important since the financial statements are the joint product of management’s and the auditor’s actions.
This is the first study to examine the effects of the type of accounting standard on auditors’ cognitive motivations and information search patterns. The authors address an important, and missing, piece of the puzzle: are there fundamental differences in the psychological processes employed by auditors who face principles versus rules accounting guidance? If there are differences, are auditors’ motivations under principles-based accounting standards driven by simple self-interest as opposed to a desire to understand the economic substance of the transaction at hand?
The theoretical model is tested using an experiment with 104 auditors from the U.S. and 48 auditors from The Netherlands. The experiment manipulates the type of accounting standard between participants at two levels: rules-based or principles-based. The evidence was gathered prior to January 2014.
Findings from this experiment suggest that principles-based versus rules-based standards lead to significant differences in the judgment processes of professional auditors. In turn, greater process accountability induces higher epistemic motivation in auditors—a desire to obtain a rich and thorough understanding of the problem at hand. High levels of epistemic motivation stimulated by principles-based accounting standards then induce a greater demand for both total desired evidence and diagnostic audit evidence. These findings suggest that, while bright-line rules and thresholds can limit cognitive effort, accounting standards based on broad principles are likely to evoke systematic and thorough information processing, thereby leading auditors to strive for a rich and accurate understanding of the issues under consideration.
The results also indicate that, although auditors exposed to IFRS over a prolonged period (e.g., Dutch auditors) may experience lower process accountability and epistemic motivation when working with principles-based standards than U.S. auditors, principles-based accounting standards still induce greater epistemic motivation than rules-based accounting standards in these auditors, suggesting a greater desire to obtain a rich understanding of the matter at hand.
This research furthers the understanding of auditors’ judgment performance in four important ways. We show that
For more information on this study, please contact David Plumlee.
Plumlee, R. D., B. Rixom, and A. Rosman. 2015. Training auditors to perform analytical procedures using metacognitive skills. The Accounting Review 90 (1): 351-369.
Auditors encounter many ill-structured tasks. Due, in part, to their greater technical knowledge, partners and managers perform these tasks better than less experienced auditors. Partners and managers also have in their memories a diverse set of problem solutions gained from their experience that they can retrieve as needed to organize and solve ill-structured problems. Less experienced auditors do not have access to these additional experiences and may benefit from a more structured approach to thinking while solving ill-structured tasks. We believe that training less experienced auditors in in metacognition—consciously thinking about one’s thought process—will help close the performance gap. We chose to train less experienced auditors to use a sequential thought process comprised of two metacognitive skills: divergent thinking, where they generate explanations for unusual evidence, followed by convergent thinking, where they evaluate explanations generated and eliminate those judged infeasible. Training less experienced auditors in the proper use of these skills was expected to provide them with the problem-structuring knowledge that managers and partners acquire through their frequent encounters with ill-structured situations.
Auditors with approximately two years of experience were randomly assigned to receive training in either divergent and convergent thinking skills, only divergent, or neither (a control). The training included four separate self-paced online sessions over two weeks. At the end of each session, we measured participants’ comprehension of the training and their ability to apply the specific skills addressed in that session. The fourth session synthesized the previous sessions and included a comprehensive analytical review case to measure whether the training resulted in better performance.
We found that
The increasing use of uncertain fair value measurements and other estimates in financial statements place an increasingly difficult burden on auditors, who are required to provide a high level of positive assurance that financial statements—including those containing items subject to enormous inherent estimation uncertainty such as those described above—are fairly stated in all material respects. The authors state that auditors are doing their best within the requirements imposed by standard setters and regulators, but also suggest that it is time for those who set and regulate standards to consider ways to more clearly convey where extreme estimation uncertainty exists within financial statements, and to reconsider auditors’ ability to provide positive, high level audit assurance on these inherently uncertain estimates.
For more information on this study, please contact Steven M. Glover.
Christensen, B. E., S. M. Glover, and D. A. Wood. 2012. Extreme Estimation Uncertainty in Fair Value Estimates: Implications for Audit Assurance. AUDITING: A Journal of Practice & Theory 31 (1):127-146.
The prevalence of fair value and other estimates in financial statements, as well as their inherent estimation uncertainty, has increased dramatically in recent years. Auditors are placed in a difficult position, as no amount of auditing can remove the underlying estimation uncertainty in reported values that are determined by management-derived estimation models that are hypersensitive to small changes in inputs. Despite the increase in uncertainty, the content of the audit report and the information conveyed on the face of the financial statements have changed relatively little. The study discusses how recent events have seemingly resulted in higher expectations and tighter constraints, thus placing a potentially unrealistic burden on auditors, essentially requiring them to provide a product that may be beyond their reach. Finally, the study questions whether auditing and financial reporting standards provide for effective conveyance of the uncertainty contained in financial statements.
The study uses estimates reported by Wells Fargo and General Motors to illustrate how changes in estimation model inputs impact fair value point estimates. The authors compare estimation uncertainty in the point estimates, as reported by management, to audit materiality for the financial statements taken as a whole. The level of estimation uncertainty highlights potential challenges that auditors face in providing assurance on account balance estimates with uncertainty ranges that often are many times larger than materiality for the financial statements taken as a whole.
Analysis of disclosures from Wells Fargo and GM show that:
The Wells Fargo and GM cases highlighted in the study demonstrate the extreme estimation uncertainty in some significant accounting estimates. Hypersensitivity to small changes in unobservable inputs, the large number of such inputs, the large number of estimates in the financial statements of complex entities that involve such inputs, and the level of management discretion involved in accounting estimates all add to the burden placed on auditors in providing assurance surrounding these estimates.
The results have implications about situations in which others evaluate the auditor’s work after the fact, such as the audit review process or the examination of audit evidence by regulators, jurors, or judges. In such situations, decision makers need to evaluate the strength of previously gathered audit evidence, and to judge the extent to which the evidence supports a previously reached conclusion. Regarding the assessed sufficiency of audit evidence, the results suggest that evaluators of the auditor’s work could require larger sample sizes under sequential sampling than under fixed sampling, to support the same level of confidence in the auditor’s opinion. Although sequential sampling might in fact increase audit efficiency, the findings suggest that this benefit could be negated by subsequent unfavorable assessment of audit evidence from a sequential sampling plan.
For more information on this study, please contact Marietta Peytcheva.
Gillett, P. R., and M. Peytcheva. 2011. Differential evaluation of audit evidence from fixed versus sequential sampling. Behavioral Research in Accounting 23 (1): 65-85.
The authors examine whether the assessed value of audit evidence depends on whether it was collected using fixed or sequential sampling. Opposing views are held by the two main schools of statistical theory: Bayesian statisticians maintain the value of audit evidence is the same, regardless of the sampling plan, whereas frequentist statisticians argue the sampling plan should affect evidence evaluation. This study tests empirically how using fixed versus sequential sampling plans influences the subsequent evaluation of audit evidence.
In two experiments, audit students and practicing auditors assess the strength of audit evidence obtained using different sampling plans. The experimental task involves testing of internal controls as part of the audit of the revenue cycle. The research evidence is collected in 2005—2008.
Audit evidence obtained from a fixed sampling plan is invariably assessed as stronger, by both audit students and practicing auditors. This finding is consistent with frequentist statistical theory, but not with Bayesian theory. Participants in the first experiment who considered the fixed sampling plan (the plan more widely used in audit practice) were prone to consider additional factors (such as whether or not they had gathered the evidence themselves) in their assessment of the strength of observed audit evidence. Participants exposed to the sequential plan, however, did not respond to these additional factors but assigned generally lower strength to evidence obtained from a sequential plan. Qualitative data on the reasoning behind auditors’ observed preferences suggest that auditors perceive fixed sampling plans as unbiased. Sequential plans, in contrast, are perceived to leave room for bias. The main concern auditors report regarding the sequential sampling plan is that this plan presents samplers with an opportunity to influence the test results by increasing or altering sample size until the desired results are observed.
Given the extent of audit evidence collected by young staff auditors, the findings of this study have direct implications for workpaper and audit quality. The mismatch of age, experience, and knowledge between staff-level auditors and client management can result in a potentially intimidating situation for the staff-level auditor, and impact decisions made in collecting information and conducting testwork. These results provide new evidence regarding the impact of auditor-client interactions on audit quality. This suggests that firms may want to consider how to manage these social mismatches of their staff.
For more information on this study, please contact G. Bradley Bennett.
Bennett, G. B., and R. C. Hatfield. 2013. The Effect of the Social Mismatch between Staff Auditors and Client Management on the Collection of Audit Evidence. The Accounting Review 88 (1): 31–50.
This study analyzes social interactions between staff-level auditors and client management to determine how differences in perceptions may influence decisions regarding the collection of audit evidence. During fieldwork, staff-level auditors have extensive interaction with client management, and evidence suggests these auditors are often socially “mismatched” with client management, in terms of their experience, age, and accounting knowledge. Concerns exist over these staff-level auditors’ desires to avoid the interactions and how it may affect the amount of audit evidence collected. The authors of this study attempt to determine the overall effects of these relationships.
Surveys were conducted to gather evidence about audit staff interactions with client management. The results of these studies were used to develop and experiment. Graduate auditing students with approximately 2.5 months average internship experience over one busy season were considered an appropriate and practical proxy for staff-level auditors with minimal experience. Participants in the experiment included 138 Master’s of Accountancy students, 52 percent female and 48 percent male, from a large state university in the Southeast. Participants in the experiment were put into a simulated work environment and asked to review accounts receivable confirmations in which additional information was needed from the client’s controller. Results of the experiment were used to determine the participant’s perception of the audit client and their ability to collect sufficient audit evidence.