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  • Jennifer M Mueller-Phillips
    Fraudulent Management Explanations and the Impact of...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence, 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Fraudulent Management Explanations and the Impact of Alternative Presentations of Client Business Evidence
    Practical Implications:

    The study provides evidence that the format of the audit evidence (using the business model evidence versus using the chronological evidence) impacts the level of fraud risk assessment.  This indicates that using the business model provides an advantage in evaluating and assessing the potential risk of fraud.  The advantages of using both forms of evidence may enable auditors to determine the nature, timing and extent of procedures to corroborate management’s explanations for fluctuations beyond the context of fraud.  Therefore, the findings of this study have broader implications, as it can be applied to other audit procedures to ensure that auditors are obtaining sufficient evidence throughout the audit as well as for an assessment of fraud risk.


    For more information on this study, please contact William F. Wright.
     

    Citation:

    Wright, W.F., and L. Berger. 2011. Fraudulent Management Explanations and the Impact of Alternative Presentations of Client Business Evidence.   Auditing:  A Journal of Practice and Theory 30 (2): 153-171.

    Keywords:
    Management explanation, management fraud, risk-based auditing, analytical procedures, information presentation
    Purpose of the Study:

    When planning an audit, auditors perform analytical procedures and inquiries of management regarding any significant fluctuations in the key financial information.  Auditors will assess these significant changes based on these procedures and use the information to assist in planning the nature, timing and extent of audit procedures.  In the context of fraud, the explanations for fluctuations will be based on evidence that either emphasizes the client’s business model or knowledge of the auditor’s chronological presentation of audit evidence.  The chronological presentation of evidence is based on given knowledge of the client’s business, prior year results compared current year information, and other items such as key ratios.  The business model explanation provides linkages between the client’s business strategy and objectives to support the fluctuations.  The use of the chronological information evaluates the comparison of the year over year financial condition and results as well as trend analysis.

    Since auditors use these as audit evidence, the study uses this evidence for generating expectations and for making risk assessments regarding fraud.  The authors hypothesize the following when management provides a fraudulent explanation: 

     

    • There will be a more accurate expectation of the non-fraudulent account balances using the business model versus the chronological method of performance.  If a fraudulent error explanation was not provided as an explanation of the fluctuation, there will not be a difference in the precision of expectations between the two presentation formats.
    • There will be a more effective fraud risk assessment for a significant fluctuation when using the business model versus the chronological method of performance.  If a fraudulent explanation was not provided as an explanation of the fluctuation, there will not be a difference in the fraud risk assessment.
       
    Design/Method/ Approach:

    The authors perform an experiment with 73 participants, 42 of which were auditors who had recently graduated from a Canadian university less than a year before. The remaining participants were graduate students.  The authors used a randomized 2x2 between-subjects design.  The factors that were evaluated included whether management’s explanation was or was not fraudulent as it related to the unexpected fluctuation in sales and the two client business evidence presentation methods:  business model or chronological.

    Findings:
    • As predicted, the study finds that when provided a fraudulent explanation, the users of the business model approach have higher assessment of fraud risk. The auditors realized the inconsistency in management’s explanation when using this approach.
    • When there was no seeded fraud, the business model and the chronological method of audit evidence did not yield any differences in judgment in the auditor’s fraud risk assessment.
       
    Category:
    Audit Quality & Quality Control, Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Adequacy of Evidence, Evaluation of Evidence, Fraud Risk Assessment
  • Jennifer M Mueller-Phillips
    Triangulation of audit evidence in fraud risk assessments
    research summary posted June 21, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence, 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Triangulation of audit evidence in fraud risk assessments
    Practical Implications:

    Given the level of regulatory scrutiny surrounding auditor judgment and skepticism of audit evidence, the results indicate that when assessing the risk of fraud, there is a lack of reliance on third party evidence, particularly when management provides a compelling story with its internal evidence.  The results of this study are important in enhancing awareness for auditors to use and corroborate both internal and external audit evidence for purposes of assessing and supporting the level of risk of the audit client.  In addition, in a broader context, the same could be said regarding the evaluation of evidence for purposes of procedures throughout the various stages of the audit process.

    Citation:

    Trotman, K.T., and W.F. Wright. 2012. Triangulation of audit evidence in fraud risk assessments. Accounting, Organization and Society 37: 41-53. 

    Keywords:
    Audit evidence, audit risk assessment, auditor judgment, adequacy of evidence, fraud risk
    Purpose of the Study:

    This study evaluates the impact that audit evidence has on an auditor’s fraud risk assessment using an evidence framework developed by Bell et al. (2005) called evidentiary triangulation.  The evidentiary triangulation framework is a way for auditors to evaluate complementary types of audit evidence and use the evidence to update any risk assessments.  Looking at how auditors use this notion of evidentiary triangulation is a key element in enabling audit quality improvement.

    The authors consider the following types of evidence within the study: evidence from management-controlled financial statement processes, evidence from management-controlled internal business processes, and evidence from third party external sources.   The use of evidence from a third-party external source is a key element in evaluating the concept of evidentiary triangulation with respect to fraud since it is not easily manipulated.     Using the framework, the authors specifically evaluate how auditors respond to different types of evidence when making fraud related judgments.  The authors test to determine if there are conditions that may exist whereby an auditor will alter their fraud risk assessment based on third party external evidence particularly when it contradicts the management-controlled evidence received by auditors. 

    Design/Method/ Approach:

    The authors perform a simulated case during a Big 4 audit firm’s training session with 102 participants with an average experience of approximately three years.   The authors perform a 2x2x2 subject design whereby evidence from a management-controlled financial statement process, a management-controlled internal business process, and an external source were manipulated to reflect either higher or lower fraud risk.  The dependent variable is the probability of a seeded fraud related to a higher than expected revenue from sales.  Using two different fraud concealment strategies (one where management provides a fraudulent explanation that is highly compatible to the business strategy and one that is not), the authors manipulate the management-controlled business evidence.  The participants are then asked to evaluate various pieces of information that are indicative of each of the manipulated concealment strategies and also external evidence from a customer that corroborates (or refutes) the information provided by management. 

    Findings:

    When evidence from the management-controlled financial statement process and management-controlled internal business evidence are inconsistent, auditors are more likely to request third party external evidence to corroborate management’s explanation.  The experiment shows that auditors will assess a higher risk of fraud when the third party external evidence contradicts the business objective that was provided by management only when there is conflicting internal evidence obtained from the management-controlled financial statement process and a management-controlled internal business process.  If the third party external evidence is consistent with management’s “story” (even though the “story” may be inconsistent with the internal evidence), the results indicate that it is less probable that auditors will assess a higher risk of fraud.

    Auditors do not rely on the third party external evidence when, on its own, both forms of the internal management-controlled evidence is deemed to be low fraud risk.  The results of the experiment indicate that auditors do not use the third party external evidence as a way to corroborate management’s internal evidence when management’s evidence seems trustworthy.

    Category:
    Risk & Risk Management - Including Fraud Risk, Auditor Judgment, Audit Quality & Quality Control
    Sub-category:
    Fraud Risk Assessment, Adequacy of Evidence, Evaluation of Evidence
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  • The Auditing Section
    Covariation Assessments with Costly Information Collection...
    research summary posted April 16, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.03 Adequacy of Evidence in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Covariation Assessments with Costly Information Collection in Audit Planning: An Experimental Study
    Practical Implications:

    The study has significant implications for situations where auditors must make decisions based on preliminary analyses (i.e. analytical procedures). From this analysis they either pass or extend testing on the accounts under review. In the absence of guidance on the importance of subjecting all accounts and transactions to testing, auditors may tend to over (under) test in response to greater (lesser) sensitivity of an account to error (based on the preliminary testing). The ineffectiveness and inefficiencies that may result are potentially greater when transactions to be tested are chosen judgmentally. 

    Citation:

    Ganguly, A.R. and J. S. Hammersley. 2009. Covariation Assessments with Costly Information Collection in Audit Planning: An Experimental Study. Auditing: A Journal of Practice and Theory 28(1):1-27.

    Keywords:
    auditing; audit planning; covariation; correlation; costly information.
    Purpose of the Study:

    Auditors often must estimate the potential that the presence of observable clues and could lead to or provide some insight into the actual presence of material misstatements in financial reporting. For example, while studying the internal control system during audit planning, the auditor may discover a weakness in internal control (clue). The auditor must then assess how this weakness may affect the risk of material misstatement and assign resources to testing accordingly. If the assessment is too high (or too low) the auditor will likely overemphasize (or underemphasize) the necessary substantive testing. 

    Prior auditing research has consistently demonstrated that people tend to place much more emphasis on presence, rather than absence, of clues. In this study, the authors study covariation and define it loosely as a measure of how much two variables change together (e.g. an internal control clue and an actual material misstatement). The purpose of this study is to explore how auditors assess the relationship between clues (specifically internal control clues) and resulting conditions (e.g. a material misstatement). In this setting the auditors have incentive to make accurate assessments; however, the cost of obtaining sufficient evidence to support the assessment is high.

    Design/Method/ Approach:

    The authors conducted two experiments during which students (surrogates for auditors) chose which costly information to obtain in order to assess the relationship between an observable clue and its associated condition. The experiments were conducted in the early 2000’s time period.

    Findings:
    • The authors find evidence suggesting that when people are simultaneously incentivized to be both effective and efficient, they collect insufficient information in specifically predictable patterns.
    • The authors find evidence suggesting that when participants were biased in their estimation assessments, the biases occurred more due to the type of information collected rather than improper processing of collected information.
    • The authors find evidence suggesting that collecting information randomly from all available populations can potentially      improve understanding of the relationship between clues and resulting conditions. However, it can lead to a stronger revision of initial beliefs based upon some perceived or real standard rather than collecting information only from judgmentally-selected populations.  
    • The authors find that when collecting information is costly and auditors are allowed to select populations from which to sample they are more likely to collect sufficient information if they have been instructed that sampling from all populations of interest is important.
    Category:
    Auditor Judgment
    Sub-category:
    Adequacy of Evidence
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  • The Auditing Section
    The Influence of Auditor Experience on the Persuasiveness of...
    research summary posted April 16, 2012 by The Auditing Section, tagged 07.0 Internal Control, 07.01 Scope of Testing, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence, 09.10 Prior Dispositions/Biases/Auditor state of mind in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Influence of Auditor Experience on the Persuasiveness of Information Provided by Management
    Practical Implications:

    The extent to which auditors’ judgments are persuaded by information from management represents asignificant issue for audit practice, especially when information from more objective sources is also available.  The evidence indicates that less experienced senior auditors rely on information from management that is aligned with management’s self-interest to a greater extent than more experienced audit seniors.  This reliance raises a concern that some senior auditors assess audit evidence more favorably than may be warranted because they inappropriately rely on information provided by management. A lack of appropriate skepticism has the potential to make audits ineffective and expose the firm to audit failures.  The study suggests the importance of carefully assigning audit tasks to auditors with an appropriate level of experience.

    Citation:

    Kaplan, S. E., E. F. O’Donnell, and B. M. Arel. 2008. The Influence of Auditor Experience on the Persuasiveness of Information Provided by Management. Auditing: A Journal of Practice & Theory 27 (1): 67-83.

    Keywords:
    Auditing, Auditor experience, Persuasiveness, Management’s assessments
    Purpose of the Study:

    Information provided by management is among the most pervasive sources of information that auditors receive during an audit engagement; however, evaluating information from management presents a dilemma for auditors.  On one hand, management should generally be knowledgeable and competent, which suggests they are a good source of information.  On the other hand, because management has self-interested incentives, they are not an objective source of information.  Thus, auditors should be particularly skeptical when evaluating information obtained from management.  Prior research finds that auditors may place too much reliance on information provided by management when that information is favorable to management (i.e., when the information may not be objective).  Understanding the factors that influence auditors’ consideration and skepticism of information provided by management is important. 

    The purpose of this paper is to examine whether auditor experience reduces auditors’ reliance on information provided by  management when that information is favorable to management.  The authors motivate their expectations based on the psychology literature of persuasion knowledge.  The authors expect that as auditors gain experience they develop more persuasion knowledge.  The authors also expect that with more persuasion knowledge, auditors will be more skeptical (or less persuaded) of management-provided information that is aligned with management’s self-interests.

    Design/Method/ Approach:

    The research evidence was collected in the mid-2000s time period.  The authors used a group of audit seniors with a wide range of experience from one Big 4 firm to complete a simulated task.  Auditors were provided with information about the reliability of internal controls.  They received assessment information from two sources: information from management and information gathered from other members of the engagement team.  The audit seniors were asked to assess the overall reliability of internal controls based on both management’s reliability assessment and the tests performed by the other members of the audit team.

    Findings:
    • The authors find that when management’s assessment information was aligned with management’s self-interests (when the information from management was more favorable than the information gathered from the other members of the engagement team), auditor experience at the senior level did have an effect on the audit seniors’ internal control reliability assessments.  Specifically, less experienced audit seniors were influenced more by management’s information than were more experienced audit seniors.  The authors claim that more experienced audit seniors had more persuasion knowledge than less experienced audit seniors; thus they were more skeptical of management’s information because it was aligned with management’s self-interests.  
    • The authors find that when management’s assessment information was not aligned with management’s self-interests (when the information from management was less favorable than the information gathered from the other members of the engagement team), auditor experience at the senior level did not have an effect on the audit seniors’ internal control reliability assessments.  Specifically, all audit seniors made similar internal control reliability assessments.
    Category:
    Internal Control, Auditor Judgment
    Sub-category:
    Scope of Testing, Adequacy of Evidence, Prior Dispositions/Biases/Auditor state of mind
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  • The Auditing Section
    Auditors’ Assessment and Incorporation of Expectation P...
    research summary posted April 16, 2012 by The Auditing Section, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Auditors’ Assessment and Incorporation of Expectation Precision in Evidential Analytical Procedures
    Practical Implications:

    The results of this study suggest that auditors’ precision assessments may not be well calibrated for relevant precision factors. Thus, auditors may benefit from additional guidance indicating the factors that should be considered for assessing the precision of analytical
    procedures.  Furthermore, audit firms might want to consider integrating some of the findings of this study into future training sessions and/or decision aids that would assist auditors in improving their precision calibration. An insensitivity to important precision factors may lead to over-reliance on analytical procedures, negatively affecting audit effectiveness. Because the allowance for loan losses is an estimate, the results of this study provide insight into factors that could influence the potential effectiveness of audits of estimates. Understanding how auditors evaluate analytical procedure precision for estimates is particularly critical in that analytical procedures may be the only source of assurance for testing these accounts.

    Citation:

    McDaniel, L.S. and L.E. Simmons. 2007. Auditors’ assessment and incorporation of expectation precision in evidential analytical
    procedures. Auditing: A Journal of Practice & Theory 26(1): 1-18.

    Keywords:
    Analytical procedures, precision, expectations, substantive test, audit evidence
    Purpose of the Study:

    The precision with which auditors form expectations during analytical procedures is important. The precision of an expectation is a measure of the closeness of the developed expectation to the actual amount and refers to the quality of the expectation, and thus, the quality of the analytical procedure. Professional standards clearly indicate that auditors should be able to form more precise expectations for accounts that are more predictable (income statement relationships generally are more predictable than balance sheet relationships) and when the information related to the account is more disaggregated (i.e., detailed). However, the Public Oversight Board’s (POB) Panel on Audit Effectiveness has found evidence that auditors rely on analytical procedures that do not provide the desired level of assurance, suggesting possible difficulty in assessing precision. To address this finding by the POB, this study investigates auditors’ abilities to assess expectation precision and incorporate their assessments into judgments related to substantive analytical procedures, as required by professional standards. A first step toward developing more effective guidance is obtaining a better understanding of why auditors sometimes fail to effectively apply analytical procedures. As such, the authors aim to answer the following two questions: 

    • To what extent do auditors’ precision assessments reflect the level of account predictability and the level of detail of the data used to form expectations? 
    • To what extent are auditors’ judgments consistent with their precision assessments? According to professional standards, the following judgments should be consistent with auditors’ precision assessments:

    (1)   The level of assurance expected by auditors to be provided by the analytical procedure.

    (2)   The range of the difference between the expected and recorded amount.

    (3)   The likelihood that the difference between the expected and recorded amount is due to misstatement versus non-isstatement causes.

    Design/Method/ Approach:

    The authors gathered their data experimentally at a firm training event for audit seniors and above (the training event occurred sometime during or prior to 2005). The participants were asked to review workpapers which included analytical procedures for two different accounts – the allowance for loan losses (a less predictable account) and interest income (a more predictable account). The expectations for the analytical procedures documented in the workpapers were either based on more or less detailed information. After reviewing the analytical procedures, auditors were asked to assess the precision and the level of assurance provided, provide an expectation range for the account balance, and judge the amount of difference between the expected and recorded amount due to misstatement.

    Findings:
    • Overall, auditors assess precision higher when the data forming the expectation are disaggregated (i.e., more detailed) versus aggregated (i.e., less detailed). 
    • Auditors also assess precision higher for the more predictable account (interest income) versus the less predictable account (the allowance for loan losses). 
    • Auditors’ precision assessments for the allowance for loan losses are not significantly different between the disaggregated and aggregated analytical procedures. This finding suggests that in assessing the precision of analytical procedures for less predictable accounts, auditors do not consider the effects of data aggregation. 
    • The results also show that for both accounts auditors judge the level of assurance obtained from the analytical procedures consistent with their precision assessments (i.e., higher assessed precision corresponds with a higher level of assurance).  
    • Counter to the authors’ expectations, auditors’ precision assessments were not related to their judgments of the range of differences between the expected and recorded amounts or the likelihood of misstatement.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Adequacy of Evidence
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  • The Auditing Section
    Auditors’ Assessment and Incorporation of Expectation P...
    research summary posted April 13, 2012 by The Auditing Section, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Auditors’ Assessment and Incorporation of Expectation Precision in Evidential Analytical Procedures
    Practical Implications:

    The results of this study suggest that auditors’ precision assessments may not be well calibrated for relevant precision factors. Thus, auditors may benefit from additional guidance indicating the factors that should be considered for assessing the precision of analytical
    procedures.  Furthermore, audit firms might want to consider integrating some of the findings of this study into future training sessions and/or decision aids that would assist auditors in improving their precision calibration. An insensitivity to important precision factors may lead to over-reliance on analytical procedures, negatively affecting audit effectiveness. Because the allowance for loan losses is an estimate, the results of this study provide insight into factors that could influence the potential effectiveness of audits of estimates. Understanding how auditors evaluate analytical procedure precision for estimates is particularly critical in that analytical procedures may be the only source of assurance for testing these accounts.

    Citation:

    McDaniel, L.S. and L.E. Simmons. 2007. Auditors’ assessment and incorporation of expectation precision in evidential analytical procedures. Auditing: A Journal of Practice & Theory 26(1): 1-18.

    Keywords:
    Analytical procedures, precision, expectations, substantive test, audit evidence
    Purpose of the Study:

    The precision with which auditors form expectations during analytical procedures is important. The precision of an expectation is a measure of the closeness of the developed expectation to the actual amount and refers to the quality of the expectation, and thus, the quality of the analytical procedure. Professional standards clearly indicate that auditors should be able to form more precise expectations for accounts that are more predictable (income statement relationships generally are more predictable than balance sheet relationships) and when the information related to the account is more disaggregated (i.e., detailed). However, the Public Oversight Board’s (POB) Panel on Audit Effectiveness has found evidence that auditors rely on analytical procedures that do not provide the desired level of assurance, suggesting possible difficulty in assessing precision. To address this finding by the POB, this study investigates auditors’ abilities to assess expectation precision and incorporate their assessments into judgments related to substantive analytical procedures, as required by professional standards. A first step toward developing more effective guidance is obtaining a better understanding of why auditors sometimes fail to effectively apply analytical procedures. As such, the authors aim to answer the following two questions: 

    • To what extent do auditors’ precision assessments reflect the level of account predictability and the level of detail of the data used to form expectations? 
    • To what extent are auditors’ judgments consistent with their precision assessments? According to professional standards, the following judgments should be consistent with auditors’ precision assessments:

    (1)   The level of assurance expected by auditors to be provided by the analytical procedure.

    (2)   The range of the difference between the expected and recorded amount.

    (3)   The likelihood that the difference between the expected and recorded amount is due to misstatement versus nonmisstatement causes.

    Design/Method/ Approach:

    The authors gathered their data experimentally at a firm training event for audit seniors and above (the training event occurred sometime during or prior to 2005). The participants were asked to review workpapers which included analytical procedures for two different accounts – the allowance for loan losses (a less predictable account) and interest income (a more predictable account). The expectations for the analytical procedures documented in the workpapers were either based on more or less detailed information. After reviewing the analytical procedures, auditors were asked to assess the precision and the level of assurance provided, provide an expectation range for the account balance, and judge the amount of difference between the expected and recorded amount due to misstatement.

    Findings:
    • Overall, auditors assess precision higher when the data forming the expectation are disaggregated (i.e., more detailed) versus
      aggregated (i.e., less detailed). 
    • Auditors also assess precision higher for the more predictable account (interest income) versus the less predictable account (the allowance for loan losses). 
    • Auditors’ precision assessments for the allowance for loan losses are not significantly different between the disaggregated and aggregated analytical procedures. This finding suggests that in assessing the precision of analytical procedures for less predictable accounts, auditors do not consider the effects of data aggregation. 
    • The results also show that for both accounts auditors judge the level of assurance obtained from the analytical procedures consistent with their precision assessments (i.e., higher assessed precision corresponds with a higher level of assurance). 
    • Counter to the authors’ expectations, auditors’ precision assessments were not related to their judgments of the range of differences between the expected and recorded amounts or the likelihood of misstatement.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Adequacy of Evidence
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  • The Auditing Section
    Why Do Auditor’s Over-Rely on Weak Analytical Procedures? T...
    research summary posted April 13, 2012 by The Auditing Section, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.01 Substantive Analytical Review – Effectiveness, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Why Do Auditor’s Over-Rely on Weak Analytical Procedures? The Role of Outcome and Precision
    Practical Implications:

    Analytical procedures are used frequently and increasingly are relied upon as substantive evidence. Based on this study, auditors are insensitive to the impreciseness of the analytical procedure when the results are favorable and may be a cause for over-reliance on weak evidence.  Performing a stronger, more precise analytical procedure caused participants in the favorable outcome situation to become more aware of the weakness of the initial procedure and re-evaluate their evidence strength rating. Further, evidence suggests that having auditors consider the possible weaknesses of an analytical procedure prior to performing the procedure will cause them to rate the strength of the evidence from a weak analytical procedure lower. Overall, this suggests a need to better train auditors in performing and interpreting analytical procedures.

    In a discussion of Glover et al.’s paper, McDaniel asks whether the findings may indicate that auditors in the unfavorable outcome (i.e. there is a material difference) are under-relying on the evidence rather than that auditors in the favorable outcome (no material difference) are over-relying on the evidence. Glover et al. respond that the over-relying of the evidence is of concern to regulators and the alternative does not explain all of the results.  McDaniel also notes that the case study was of a company in the financial industry but that the participants were not required to have any financial industry experience. Glover et al. note that the interest income item is the issue which is not specific to the industry or complicated.  McDaniel also notes concerns about a potential “anchoring” effect as the participants performed their analytical procedures based on prior year working paper results.  In response, Glover et al. discuss this feature of an audit. 

    Citation:

    Glover, S. M., D. F. Prawitt, and T. J. Wilks. 2005.  Why Do Auditor’s Over-Rely on Weak Analytical Procedures?  The Role of Outcome and Precision.  Auditing: A Journal of Practice & Theory 24 (Supplement):  197-220.  

    McDaniel, L. 2005.  DISCUSSION OF Why Do Auditor’s Over-Rely on Weak Analytical Procedures?  The Role of Outcome and Precision.  Auditing: A Journal of Practice & Theory 24 (Supplement):  221-228. 

    Glover, S. M., D. F. Prawlitt, and T. J. Wilks. 2005. REPLY TO DISCUSSION OF Why Do Auditor’s Over-Rely on Weak Analytical Procedures?  The Role of Outcome and Precision.  Auditing: A Journal of Practice & Theory 24 (Supplement):  229-232.

    Keywords:
    outcome; evidence quality; substantive analytical procedures; evidence assessment;
    Purpose of the Study:

    In 2000, a Public Oversight Board panel viewed audit work papers and determined that 20% of the time substantive analytical procedures were weak and provided insufficient evidence to support the conclusion. This study aims to look at one of the possible reasons why auditors’ over-rely on weak, unreliable analytical procedures.  The authors hypothesize that auditors do not consider their existing knowledge about the quality of the procedure when the outcome indicates that the balance is “fairly stated.”

    Design/Method/ Approach:

    The authors performed two experiments prior to 2005 where a material misstatement exists and a “weak, unreliable” (highly aggregated) analytical procedure is used.  In experiment 1, senior associates from one Big 4 accounting firm were asked to perform an interest revenue analytical procedure at the annual grand total level and compare the results to the client’s unaudited balance.  The balance is manipulated so that some participants’ results indicate there is no significant difference (i.e. favorable outcome) and the other participants’ results indicate that there is a significant difference (i.e. unfavorable outcome).  Participants evaluated the strength of the analytical procedure and concluded regarding a misstatement.  Additional disaggregated computations (interest revenue calculations broken down by type of loan and performed quarterly vs. annual basis) were then provided. Participants responded to the procedure strength of the aggregated analytical procedure.  In experiment 2, different senior associates from one Big 4 accounting firm were asked to document the weaknesses of the analytical procedure prior to performing the procedure.

    Findings:

    Experiment 1

    • Auditors attribute more evidential strength to the results of weak analytical procedures if the results indicate no material difference than the identical procedure where the results indicate a material difference.  In addition, auditors in the  avorable outcome are more likely to assign a lower risk of material misstatement and assess the balance as fairly stated, than those in the unfavorable outcome.
    •  After viewing the stronger, disaggregated analysis, auditors in the favorable outcome were more likely to revise their prior conclusion but auditors in the unfavorable outcome did not. Further, auditors in the favorable outcome were also more likely to downgrade their evidential strength assessment of the initial analytical procedure.
    • Altogether, the authors believe this indicates a potential for over-reliance on weak high level analytical procedures and that in situations where analytical procedures indicate no significant difference, auditors are less likely to realize their procedure may produce imprecise expectations and deem it to be a stronger procedure than it really is.

    Experiment 2

    • Auditors who were told to consider the potential weaknesses of the analytical procedure before performing the analysis were more likely to rate the strength of the evidence as lower than those who were not.
    • The prompt to consider potential weaknesses did not reduce the evidential strength assessment as much as requiring the additional analytical procedure in Experiment 1.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Adequacy of Evidence, Substantive Analytical Review – Effectiveness
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  • The Auditing Section
    An Investigation of Auditor Perceptions about Subsequent...
    research summary posted April 13, 2012 by The Auditing Section, tagged 01.0 Standard Setting, 01.07 Impact of SEC Actions, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    An Investigation of Auditor Perceptions about Subsequent Events and Factors That Influence This Audit Task
    Practical Implications:

    Auditors should recognize that an implicit tradeoff exists between the availability of subsequent event evidence and timelier reporting.  However, the net effect is not well understood because prior research has only focused on quantifying the benefits of timely reporting, not the costs associated with obtaining less subsequent event evidence.  The low evidence discovery rate reported by participants suggests that the current audit methodology might suffer from inefficiencies.  Further research should establish relative frequency information to help auditors generate hypotheses and guide audit planning.

     

    Citation:

    Janvrin, D. J. and C. G. Jeffrey. 2007. An Investigation of Auditor Perceptions about Subsequent Events and Factors That Influence This Audit Task.  Accounting Horizons 21 (3):  295-312

    Keywords:
    subsequent event; evidence evaluation; auditor judgment; timely reporting; accountants’ reporting.
    Purpose of the Study:

    Generally accepted auditing standards require auditors to consider subsequent events by examining transactions that occur after the balance sheet date.  In light of the Securities and Exchange Commission’s (SEC) decision to shorten the time between the balance sheet and report dates, this study seeks to better understand how auditors search for and discover subsequent event evidence in this new reporting environment.  Prior literature on this subject is sparse.  The Canadian Institute of Chartered Accountants (CICA) and the American Institute of Certified Public Accountants (AICPA) are concerned that audit quality will suffer because auditors now have less time to discover evidence of subsequent events.  For example, earnings management behavior is difficult to detect without persuasive evidence.  Specific study goals are as follows:

    •   Verify that auditors perceive subsequent event evidence to be important.
    •  Understand the process auditors employ to search for subsequent event evidence.  Standards suggest ten search procedures (e.g., reading interim financial statements prepared since the balance sheet date), but the degree to which auditors actually follow this guidance is not evident.
    •  Determine whether auditors uncover subsequent event evidence.  Measuring the perceived effectiveness of the ten recommended search procedures provides valuable feedback to the profession.
    •  Examine factors influencing this process.  Theory suggests the intensity of auditors’ search activities is influenced by balance sheet date judgment characteristics (i.e., transaction type, amount of supporting evidence, and consistency with prior expectations), characteristics of anticipated challenge evidence (i.e., consistency with prior expectations, and materiality) and environmental characteristics (i.e., length of search period, and time pressure).
    Design/Method/ Approach:

    A field-based experiential questionnaire was issued to U.S. auditors from each of the Big-4 firms and one national firm over a one-year period prior to November 2004. Participants had an average of 9.6 years of experience. Participants were asked to rate how often they search for and discover subsequent event evidence both in general, and using the ten procedures found in auditing standards.

    Findings:
    •  The authors find that auditors generally perceive subsequent event evidence as more important than the need for timely reporting, and that they use subsequent event evidence in the audit.
    •  The authors find that most auditors perform the majority of fieldwork after the balance sheet date, leaving potentially less time to gather subsequent event evidence.
    •  The authors find that auditors generally follow the ten suggested procedures.  However, the event discovery rate using any one procedure appears to be low.
    •  The authors find that auditors are more likely to search for and find subsequent event evidence when (1) minimal historical evidence exists, and (2) their balance sheet date judgments do not meet prior expectations.
    •  The authors find that auditors are more likely to search for evidence (1) when evaluating non-routine account balances, (2) that potentially impacts the financial statements as a whole rather than one account, and (3) when they have ample time to search.
    •  The authors find that auditors are more likely to find subsequent event evidence (1) that is consistent, rather than inconsistent, with their balance sheet date judgment, and (2) when the search period is longer.
    •  The authors find that time pressure does not impact whether auditors perceive that they find significant subsequent event evidence.
    Category:
    Standard Setting, Auditor Judgment
    Sub-category:
    Impact of SEC Actions, Adequacy of Evidence
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