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  • Jennifer M Mueller-Phillips
    The Global Financial Crisis: U.S. Bankruptcies and...
    research summary posted October 22, 2014 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Global Financial Crisis: U.S. Bankruptcies and Going-Concern Audit Opinions
    Practical Implications:

    As the PCAOB, SEC and other regulators assess auditors’ reporting decisions in the wake of the GFC, the results of our study provide evidence that the propensity to issue a GCO to a financially stressed and subsequently bankrupt client increased during the GFC. Our results suggest that critics of the auditors’ role during the GFC may have overstated a perceived problem based on relatively few bankruptcies without a prior GCO. At the same time, our results indicate that this increased scrutiny was similar for Big 4 and non-Big 4 auditors, but that it was largely restricted to smaller clients. Auditor going-concern modification decisions remain a complex process that is not fully understood or easily captured.

     

    For more information on this study, please contact Marshall Geiger via email at mgeiger@richmond.edu.

    Citation:

    Geiger, M.A., K. Raghunandan, and W. Riccardi. (2014). The global financial crisis: U.S. bankruptcies and going-concern audit opinions. Accounting Horizons 28 (1): 59-75.

    Keywords:
    going concern; bankruptcy; audit opinion; financial crisis
    Purpose of the Study:

    The reporting responsibility of auditors with respect to financially troubled clients received renewed attention from standard setters and regulators in light of the “Global Financial Crisis” (GFC). Both auditing regulators and the business press had complained that auditors did not provide adequate warning in their reports prior to many companies’ bankruptcy filings during the GFC. Accordingly, the purpose of this study is to examine whether auditors’ propensity to issue going-concern audit opinions (GCO) decreased after the onset of the global financial crisis. We also examine whether the observed effects differ for the largest audit firms (i.e., the “Big 4”). In additional analyses, we further examine whether our detected results differ with client size.

    Design/Method/ Approach:

    The study is based on a sample of financially stressed U.S. companies that entered into bankruptcy between 2004 and 2010. Sample firms’ bankruptcies are coded as being during the GFC if the associated audit opinion is dated after September 1, 2008. 

    Findings:

    Our empirical findings are summarized as follows:

    • Overall, we find that the auditors’ propensity to issue going-concern modified opinions increased after the onset of the GFC. This suggests that, collectively, auditors in the U.S. were more likely to provide a signal of clients’ impending bankruptcy during the GFC.
    • We find no difference in this effect for auditors of different size (i.e., Big 4 versus non-Big 4). That is, both Big 4 and non-Big 4 auditors significantly increased the probability of issuing a going-concern modified audit opinion to subsequently bankrupt clients after the start of the GFC.
    • Of particular interest, we find that for both Big 4 and non-Big 4 auditors, the observed increase in the likelihood of issuing a going-concern modified audit opinion is restricted to smaller clients.
    • There does not appear to be any change in auditors’ weighting of our financial stress variables between the pre- and post-GFC periods. 
    Category:
    Accountants' Reporting, Auditor Judgment
    Sub-category:
    Going Concern Decisions, Going Concern Decisions
  • Jennifer M Mueller-Phillips
    Audit Reporting for Going-Concern Uncertainty: A Research...
    research summary posted October 20, 2014 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit Reporting for Going-Concern Uncertainty: A Research Synthesis
    Practical Implications:

    This study provides a summary of the literature examining the auditor’s GCO decisions. Determinants of GCOs include client factors (e.g. size, level of financial stress, financial reporting quality, corporate governance), auditor factors (e.g. audit firm size), auditor-client relationships (e.g. auditor switching and the issue of opinion shopping) and environmental factors (e.g. changes in regulations, auditing standards and audit market structure). Important findings are that auditors will change the likelihood of issuing GCOs in response to changes in the environment (whether due to changes in regulation or changes in the economy) and that the majority of companies that receive GCOs do not subsequently file for bankruptcy.

    For more information on this study, please contact Elizabeth Carson.

    Citation:

    Carson, E., N. L. Fargher, M. A. Geiger, C. S. Lennox, K. Raghunandan, and M. Willekens. 2013. Audit reporting for going-concern uncertainty: A research synthesis. Auditing: A Journal of Practice & Theory 32 (Supp): 353-384.

    Keywords:
    going-concern; audit reporting; bankruptcy
    Purpose of the Study:

    The global financial crisis in 2007 has resulted in an increased incidence of company failures. This led to renewed interest from regulators, standard setters and investors in the auditor’s assessment and reporting on a company’s ability to continue as a going concern. In order to facilitate the understanding of the role and effectiveness of independent audit, this study conducts a comprehensive review to synthesize and discuss the extant academic literature on auditors’ decisions to issue a modified opinion based on going concern uncertainty (hereafter, GCO).

    Design/Method/ Approach:

    This study synthesizes major findings from audit research since the 1970s. Most of the research reviewed is archival; however, a few studies using experimental designs are also cited. A framework is developed to structure the categorization of the extant GCO literature. Three main themes are identified: (1) Determinants of GCOs, (2) Accuracy of GCOs, and (3) Consequences of GCOs. This study also provides a discussion on issues related to research methodology and identifies areas for further research.

    Findings:

    Under the category of “Determinant of GCOs”, the synthesis shows that:

    • Auditors are more likely to issue GCOs after December 2001, which is in response to the accounting and auditing scandals in early 2000s (e.g. collapse of Enron). Also, smaller companies more likely to receive GCOs.
    • In the ten-year period between 2000 and 2010, 60.10% of bankruptcy filings are preceded by GCOs.
    • Determinants of GCOs include: (1) client factors (e.g. size, level of financial stress, financial reporting quality, corporate governance), (2) auditor factors (e.g. audit firm size), (3) auditor-client relationships (e.g. auditor switching and the issue of opinion shopping) and (4) environmental factors (e.g. changes in regulations, auditing standards and audit market structure).

    Under the category of “Accuracy of GCOs”, the synthesis shows that:

    • Since the adoption of SAS No.59, 40-50% of bankruptcy firms did not receive a prior GCO.
    • 80-90% of companies receiving a GCO do not file for bankruptcy in the subsequent year.

    Under the category of “Consequences of GCOs”, the synthesis shows that:

    • Issuance of GCOs is associated with negative excess returns, and the reaction is more negative when problems with obtaining financing are cited.
    • In the U.S., the issuance of GCO can be a “self-fulfilling prophecy” and cause the financial demise of company that would have survived if it had not received a GCO.

    With regards to issues in research methods, this study cautions the use of small samples in analysis and the interpretation of interaction variables in the statistical models. The study also finds general limitations in extant research due to the varying sample selection criteria for identifying financial stressed firms and the exclusion of private companies from samples examined.

    This study suggests further research could (1) examine the relations between auditor independence and GCO decisions, (2) investigate auditor’s GCO decisions and the related issues for financial institutions, non-profit organisations and government entities, (3) replicate research on GCO accuracy in different time periods with different samples, (4) examine the information usefulness of GCOs to a wide set of market participants, and (5) properly distinguish between the roles of management, audit committee and auditor in the disclosure and discussion of going-concern. 

    Category:
    Accountants' Reporting, Auditor Judgment
    Sub-category:
    Going Concern Decisions, Going Concern Decisions
  • Jennifer M Mueller-Phillips
    Auditor Fees and Auditor Independence: Evidence from Going...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 09.0 Auditor Judgment, 09.04 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Auditor Fees and Auditor Independence: Evidence from Going Concern Reporting Decisions
    Practical Implications:

    The finding of this study suggest that concerns over the relation between auditor fees and the possible impairment of auditor independence, as reflected in going concern modification decisions, are supported in the more recent years for highly distressed clients. The relationship between auditor fees and impairment of auditor independence with respect to auditor decision-making has long been a concern of many regulators in the accounting industry. This research may inform both audit firms and standard setters with respect to specific types of engagements and the judgments or behaviors most likely to be affected.

    For more information on this study, please contact Allen D. Blay.
     

    Citation:

    Blay, A. D., and M. A. Geiger. 2013. Auditor Fees and Auditor Independence: Evidence from Going Concern Reporting Decisions. Contemporary Accounting Research 30 (2).

    Keywords:
    auditor fees; auditor independence; going concern; regression analysis
    Purpose of the Study:

    The possible adverse effect of auditors providing services to clients who pay them directly has historically been a concern of the public accounting profession. Without independence there is no need for external auditors attesting to the purported accuracy and completeness of company financial statements. The association between fees received by audit firms directly from clients and the possible impairment of auditor independence, particularly with respect to going concern decisions, continues to be of considerable interest to regulators and others. This study assesses the potential impairment of auditor independence in the context of going concern reporting.

    Design/Method/ Approach:

    The authors derive their findings examining the association between both current and future audit service and nonaudit service fees received by U.S. auditors and the type of opinion rendered to a financially distressed client. To achieve their sample, the authors used the Audit Analytics database and first identified firms that received a going concern modified (GCM) audit opinion in the years 2004-2006. They also identified firms that had both negative income and cash flows from operations in the same year but did not receive a GCM opinion. Finally, the authors tested their hypotheses by using a research model to determine the probability of issuing a GCM audit opinion to a financially distressed client. 

    Findings:

    A negative correlation exists between future fees paid to auditors and auditor going concern opinion decisions.
    Higher levels of current nonaudit service fees paid to auditors reduces the frequency of going concern opinion modifications in the more recent 2004-2006 time period when using a more stringent control sample of financially distressed firms.
    Findings related to going concern decisions and nonaudit service fees in the United States are sensitive to both the time period examined and the selection of appropriate control samples of distressed non-GCM firms.
    A negative association exists between current nonaudit service fees and total subsequent fees paid to auditors.
     

    Category:
    Auditor Judgment, Client Acceptance and Continuance, Independence & Ethics
    Sub-category:
    Audit Fee Decisions, Going Concern Decisions, Impact of Fees on Decisions by Auditors & Management
  • Jennifer M Mueller-Phillips
    How Do Auditors Behave During Periods of Market Euphoria?...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.04 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    How Do Auditors Behave During Periods of Market Euphoria? The Case of Internet IPOs
    Practical Implications:

    Due to the potential for future market bubbles, the findings of this study may be of interest to audit regulators and standard setters. These finding suggest mixed conclusions regarding the Big 5’s behavior during periods of market euphoria. The presence of going concern opinions varies inversely with variables that represent client viability and auditor self-interest. Evidence that points to a decrease in the predictive value of Big 5 opinions signed during the Internet IPO bubble may also have consequences for investors.
     
    For more information on this study, please contact Andrew J. Leone.
     

    Citation:

    Leone, A. J., S. Rice, J. P. Weber, and M. Willenborg. 2013. How Do Auditors Behave During Periods of Market Euphoria? The Case of Internet IPOs. Contemporary Accounting Research 30 (1).

    Keywords:
    auditors’ opinions; going concerns; initial public offerings; online information services
    Purpose of the Study:

    The study of periods of market euphoria is a long-standing topic of interest to economists. Theorists specify conditions under which market participants and institutions cause bubbles to form. This study looks at how auditors behave during these periods of euphoric market conditions, specifically around the time of the wave of Internet companies’ IPOs in the late 1990s and early 2000s. The goal was to discover how audit decisions change with fluctuations in the external marketplace. The authors address whether auditors are maintaining their responsibility to act in the public’s best interest during these unique market conditions, and how going concern decisions of these Internet IPO companies might vary based on these conditions.

    Design/Method/ Approach:

    The authors obtained a sample of 756 Internet IPO filings from 1996 to 2000 using an online database, as well as a sample of non- Internet IPO registrants. Using descriptive statistics, the authors tested these samples for determinants that could lead auditors to shift their going concern decision criteria during euphoric market conditions.

    Findings:
    • The presence of going concern opinions varies with variables that proxy for both economic reasons and for less independence and skepticism by the Big 5.
    • Some evidence points to associations between costs to investors and a decrease in Big 5 going concern opinions during the bubble.
    • Big 5 firms were not a major cause of the Internet IPO bubble, but large audit firms did little to slow it from inflating.
       
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment, Client Acceptance and Continuance
    Sub-category:
    Auditors’ Professional Skepticism, Business Risk Assessment (e.g. industry - IPO - complexity), Going Concern Decisions
  • Jennifer M Mueller-Phillips
    The Auditor’s Going- Concern Opinion as a Communication of R...
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Auditor’s Going- Concern Opinion as a Communication of Risk
    Practical Implications:

    The results of this study have very important implications to auditors of publicly traded firms whose audit reports are available to the general public. Auditors should always keep in mind that their opinion has great importance to the market’s perception of their client. The effects that issuing a going-concern modified audit opinion can have on the market perception of a firm’s value, as evidenced by the different market perceptions for similarly financially distressed firms when one had a going-concern modified report and one did not, are grave enough to warrant significant consideration by auditor’s deciding whether or not the going-concern modified opinion is necessary.

    For more information on this study, please contact Allen D. Blay.
     

    Citation:

    Blay, A.D., M.A. Geiger, and D.S. North. 2011. The auditor’s going- concern opinion as a communication of risk. Auditing: A Journal of Practice and Theory 30 (2): 77-102.

    Keywords:
    auditor’s opinion; going- concern; value-relevance; financial distress.
    Purpose of the Study:

    The auditor’s report is the only lawful way for auditors to communicate with the general public concerning business matters of a particular client. The information conveyed in the audit report is usually limited to an opinion of the accuracy and completeness of the client’s financial information and the related disclosures. However, SAS 59 requires the auditor to add modified language to the standard audit report when it is deemed necessary. An occurrence that makes modified wording necessary is the auditor’s belief that substantial doubt exists that the client will continue to be viable over the next reporting year. This situation illustrates the only way that an auditor can indicate his or her perceived risk regarding the continuity of a client’s business. This study provides evidence regarding the effects of an auditor’s communication of business risk through the issuance of a going- concern modified audit report for the first time for a particular client on the valuation mechanisms used by the securities market to adjust share price. The authors studied how a going- concern modified audit report affected the market’s perception of financially distressed firms in order to assess the relevance of specific nonfinancial information communicated by the external auditors in the audit report.

    Design/Method/ Approach:

    The data for this study was collected from Compustat and 10-K filings in the SEC EDGAR database for the period 1989-2006. The authors chose to study durable manufacturing firms that met one of four distress criteria: operating loss, bottom line loss, negative working capital, or negative retained earnings in the last three years. For comparison, these firms were then matched to similar firms that had not received a modified audit report and financial and market data was gathered for both types of firms.

    Findings:
    • The issuance of a going-concern modified audit report in the U.S. conveys substantial value relevant information about the abandonment risk of a firm.
    • Market valuation is significantly altered from the traditional measures of a focus on both the income statement and balance sheet to a focus on solely the balance sheet in the year that a firm receives a going-concern modified opinion for the first time.
    • The market increases the value of assets and liabilities that are directly related to abandonment value such as, cash, receivables, and long-term assets and liabilities, while it devalues assets that would generally possess more value if the firm continued in existence and were not liquidated such as inventory.
    • The book value of equity has a greater valuation weight for firms receiving a first-time going-concern modified audit report compared to their earlier years and to similarly financially distressed firms that did not receive a modified audit report for going-concern.
    • These results hold even after controlling for several other measures of financial distress, expanding the control sample of distressed firms, and examining individual sub-periods within the 18 year examination period.
    • The market interprets the going-concern modified audit opinion as an important communication of risk that results in a substantial shift in the structure of the market valuation for distressed firms. The market perceives the auditor’s opinion as incrementally value-relevant even when paired with other financial distress measures that exist in the financial statements.
       
    Category:
    Accountants' Reporting, Auditor Judgment
    Sub-category:
    Going Concern Decisions, Going Concern Decisions
  • Jennifer M Mueller-Phillips
    Auditor Differentiation, Mitigating Management Actions, and...
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Auditor Differentiation, Mitigating Management Actions, and Audit-Reporting Accuracy for Distressed Firms
    Practical Implications:

    SAS No. 59 requires auditors to evaluate the adequacy and feasibility of management’s plans to mitigate financial distress.  The results of this study show that industry specialization improves auditors’ ability to more accurately evaluate management’s initiatives and the likelihood of going-concern issues.  Though BRA methodology was not shown to improve reporting accuracy, the implementation of the methodology was limited to only two firms at the time of the study.     This study suggests the importance of auditor specialization in improving reporting accuracy which can impact the approach audit clients take in obtaining an auditor. 

    For more information on this study, please contact Liesbeth Bruynseels.
     

    Citation:

    Bruynseels, L., W.R. Knechel, and M. Willekens. 2011. Auditor differentiation, mitigating management actions, and audit-reporting accuracy for distressed firms. Auditing: A Journal of Practice & Theory 30 (1): 1-20.

    Keywords:
    audit reporting, going-concern, management plans, audit methodology, auditor industry specialization
    Purpose of the Study:

    Since auditors are required to evaluate the adequacy of management plans to mitigate financial distress, when bankruptcies occur that were not preceded by a going-concern report, the audit report is perceived to lack quality.   This study investigates whether enhanced industry knowledge (auditor specialization) or an increased focus on business risk auditing methodologies improves audit-reporting accuracy.  These are the two areas of focus because:

    • Prior research has shown that industry specialization produces higher audit quality.
    • A new audit approach defined as “business risk auditing” (BRA) forces an auditor to determine whether the client’s strategic objectives are being met and to assess the likelihood of going-concern issues.  BRA is embedded in international auditing standards (ISA 315) and proposed standards by the PCAOB to require the auditor to assess a client’s business environment and risks in the audit.  Recent studies have shown that BRA can lead to more efficient and effective audits.

    Recent research has also indicated that information obtained about the client’s strategic plans to mitigate financial distress can have a significant impact on the likelihood that an auditor will issue a going-concern report.  Therefore, this paper examines the impact of auditor specialization and auditor risk methodology on audit-reporting accuracy in the setting of financially distressed firms in which managers take initiatives to reduce this distress.

    Design/Method/ Approach:
    • The data consists of U.S. public companies from manufacturing industries that declared bankruptcy between 1999-2002.
    • Auditor specialization is measured based on audit firm market share within a particular industry.
    • Two of the Big 5 firms in the study implemented the BRA methodology. Therefore, only audits conducted by these two firms are considered to have employed BRA methodology.
    • The authors also report if a company in the sample had a significant strategic or operating initiative reported in its 10-Ks as a sign of management’s actions to mitigate financial distress.
       
    Findings:
    • For companies that subsequently declared bankruptcy:
      • Specialist auditors were more likely than non-specialists to issue a going-concern opinion even when management had undertaken strategic turnaround initiatives.
      • Audit firms that used a BRA methodology were less likely to issue a going-concern opinion if the client had undertaken operating initiatives to mitigate financial distress.
      • All auditors, irrespective of type, were less likely to issue a going-concern opinion when the client had plans to raise cash in the short-term.

    Contrary to the authors’ expectations, the reporting accuracy of BRA auditors is reduced when a client implements short term operating initiatives to reduce financial distress.  Specialist auditors correctly interpret the information contained in management’s strategic long-term initiatives and more accurately signal the potential for a future bankruptcy by issuing a going-concern report. 

    Category:
    Audit Quality & Quality Control, Auditor Judgment
    Sub-category:
    Going Concern Decisions, Industry Experience
  • Jennifer M Mueller-Phillips
    To What Extent are Auditors’ Attitudes toward the Evidence I...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 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:
    To What Extent are Auditors’ Attitudes toward the Evidence Influenced by the Self-Fulfilling Prophecy?
    Practical Implications:

    This study is important to regulators, standard setters, users of financial information and the auditing professions as it relates to the going concern evaluation and biases in auditor judgment.  If auditors are motivated to achieve a desired result to ensure that a client continues, then the negative perception of the going concern opinion and the public’s expectation gap of what a going concern means will remain.  As such, the profession needs to evaluate whether the self-fulfilling prophecy exists and ways to address the lack of knowledge surrounding the going concern opinion.


    For more information on this study, please contact Andres Guiril.
     

    Citation:

    Guiral, A., Ruiz, E. and W. Rodgers. 2011. To What Extent are Auditors’ Attitudes toward the Evidence Influenced by the Self-Fulfilling Prophecy? Auditing:  A Journal of Practice and Theory 30 (1): 173-190.

    Keywords:
    Going concern evaluation, self-fulfilling prophecy, attitude toward the evidence, motivated reasoning, framing
    Purpose of the Study:

    This study seeks to evaluate the self-fulfilling prophecy effect and the impact that is has on biasing auditor judgments in a going concern setting.  The authors use the self-fulfilling prophecy effect in their experiment by creating instruments that may influence an auditor’s decision to arrive at a specific conclusion given how the information is framed and presented.  A motivated reasoning theory is used to understand how asymmetrical evidence is evaluated by auditors and how it influences the decision-making process.  Furthermore, there is also a notion that auditors that are motivated to arrive at a specific conclusion may evaluate audit evidence in a way that causes them to arrive at this desired outcome.  More weight may be assigned to the evidence that supports the preferred outcome. 

    In the going-concern context, an auditor may believe that issuing a going-concern opinion implies that the client will inevitably go bankrupt.  A client’s bankruptcy will then ultimately result in the auditor’s loss of audit fees.  Given this, the auditor’s self-fulfilling prophecy may create a strong desire for the client to continue, which, in turn, may bias the auditor’s judgment of audit evidence.  As a result, the auditors may weigh the audit evidence that supports the viability of the client’s business and may please less weight on evidence that is to the contrary in order to forego the potential issuance of a going concern opinion.  The authors of the study hypothesize that authors are influenced by the stigma that a going concern opinion may decrease the client’s ability to continue.  Issuing an unqualified opinion provides the appearance that client is viable and results in the auditor retaining the client’s fees. 
     

    Design/Method/ Approach:

    The authors perform an experiment using 88 partners and senior managers from an international accounting firm.  The research design was a 2x2 between-subjects design.  The participants were asked to assess the going concern status of a client with different groups of participants receiving confirming or disconfirming evidence.  The framing condition was in the context of whether the company’s operations were deemed to viable.  Specifically, the auditors were asked to evaluate whether the client had the “ability to continue to exist” versus whether there was a “possibility that a client will fail.”  The participants are also presented with mitigating factors (i.e. plans to cut production costs, receive a grant from the government, etc.) and contrary evidence (i.e. potential employee strikes, a credit line will not be renewed with a bank and the use of another bank will raise interest costs).

    Findings:

    The results of the study indicating that auditor’s expectation of a desired outcome tends to influence their evaluation of audit evidence so that they can achieve that desired outcome (i.e. not issue a going concern opinion). The auditors had a greater sensitivity to mitigating factors and had a lower tendency to favor contrary evidence.

    Category:
    Audit Quality & Quality Control, Auditor Judgment
    Sub-category:
    Evaluation of Evidence, Going Concern Decisions, Going Concern Decisions
  • The Auditing Section
    The Effects of Experience on Complex Problem Representation...
    research summary posted May 9, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Effects of Experience on Complex Problem Representation and Judgment in Auditing: An Experimental Investigation
    Practical Implications:

    The results of this study have implications for training future professionals.  In the classroom problem-solving techniques that more closely resemble the experienced group can be incorporated to advance professionals to the expert level faster.  Further, a stage approach may be more efficient.  This idea incorporates having two “expert systems”, one to move novices to the intermediate level of knowledge more quickly and another to move intermediates up to the level of experts faster. 

    Citation:

    Lehmann, C.M., and C.S. Norman. 2006. The effects of experience on complex problem representation and judgment in auditing: an experimental investigation. Behavioral Research in Accounting 18 (1): 65-83.

    Keywords:
    expertise; problem representation; going concern; expert-novice paradigm
    Purpose of the Study:

    The purpose of this study is to evaluate how an accounting professional’s level of experience affects their ability to describe a problem (problem representation) and their judgment regarding a going-concern task.  The authors argue that as auditors become more experienced, they become more concise in their problem representations, capturing only the information most relevant to the judgment at hand.  Thus recent graduates and staff level auditors are the least concise and include more superficial analysis; senior associates are more concise and able to focus on relevant information better than novices, while partners/managers are able to provide the most condensed summaries.  

    This study also examines whether the different types of concepts noted in the problem representations are related to differences in judgment regarding a company’s ability to continue as a going-concern and which audit report is recommended. 

    Design/Method/ Approach:

    The experiment was performed with both graduate students and audit professionals.  Participants were split into three groups based on experience level: novice (graduate students and less than 1 year experience), intermediate (1-6 years’ experience), and experienced (more than 6 years’ experience).   

    Participants were provided industry background and financial information that included evidence of going-concern issues and were asked to summarize the financial condition, assess going-concern and recommend a type of audit report.  The authors based their conclusions on these responses. 

    Findings:
    • Experienced individuals are more concise in their problem representations (i.e. mentioned fewer concepts, relationships, and summaries) than intermediates or novices.
    • Intermediates noted fewer relationships than novices. 
    • The novices provided significantly more causation links than the experience group and the intermediate groups. The novice group provided significantly more summaries than the experienced group, but not the intermediate group.
    • The authors examined the effect of including certain concepts in an individual’s problem representation on their going-concern judgments and find that line of credit issues are related to lower assessment of survival and cash flow issues are associated with modifying the audit opinion.  However, the inclusion of regulatory issues or the industry in the summary is associated with higher assessment of survival.  These results did not differ by experience level, indicating judgments were not impacted by experience level. 
    Category:
    Auditor Judgment, Accountants' Reporting
    Sub-category:
    Going Concern Decisions, Going Concern Decisions
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  • The Auditing Section
    Independence Threats, Litigation Risk, and the Auditor’s D...
    research summary posted May 4, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Independence Threats, Litigation Risk, and the Auditor’s Decision Process
    Practical Implications:

    This study is important for audit firms and audit regulators, as it provides a more complete picture of how threats to auditor independence and litigation risk affect auditor performance. Rather than just focusing on the auditor’s final decision, this study demonstrates that the above incentives affect auditors through their evaluation of information during the decision process. Therefore, firms and regulators may be interested in research that specifically addresses processing biases. This research advocates using decision aids, such as artificial neural networks, to attenuate processing bias. Accountability-inducing controls, like those promoted by audit documentation standards, are unlikely to achieve this goal. Further, reviews conducted by individuals within the same firm are less likely to detect process bias. Review by independent parties, such as an audit committee, would likely be more effective.

    Citation:

    Blay, A.D. 2005. Independence Threats, Litigation Risk, and the Auditor’s Decision Process. Contemporary Accounting Research 22 (4): 759-789.

    Keywords:
    Auditor independence, auditor reporting, decision process, going concern, motivated reasoning
    Purpose of the Study:

    The preservation of auditor independence is a concern of audit regulators. The Sarbanes-Oxley Act of 2002 attempts to minimize the economic bond between the auditor and the client, but cannot completely eliminate it. Litigation risk is often proposed as a safeguard to mitigate independence threats. Prior studies about auditor independence focus solely on auditors’ final reporting choices, but this paper addresses auditors’ judgment and decision-making process as well. Particularly, this paper investigates whether independence threats (high versus low) and litigation risk (high versus low) influence auditors’ evaluation of information and their subsequent reporting choices. 

    The author expects that when high threats to auditor independence are present, auditors will be more supportive of the client-preferred position (unqualified opinion) both during the decision process and in the final reporting decision.  However, when high litigation risk is present, the author expects auditors will be less supportive of the client-preferred position. 

    These expectations are derived from the psychology literature on directional goals and motivated reasoning. Directional goals arise when an individual is dependent on a particular decision outcome. Though accurate judgment should be the auditor’s ultimate goal, the literature on motivated reasoning suggests that, as long as the conclusion is justifiable, individuals will evaluate information consistent with a desired conclusion. Thus, economic incentives associated with independence threats and litigation risk are likely to affect not just the auditor’s final decision, but also his/her evaluation of information during the decision process.

    Design/Method/ Approach:

    The research evidence was collected in the early-2000s (pre-SOX). Audit managers from three Big-4 firms participated in the experiment.  Participants completed a simulated task involving a hypothetical manufacturing client where they assessed the initial likelihood of going-concern, searched for informational cues, and reassessed the likelihood of going-concern. As informational cues were obtained, auditors also assessed whether the cues provided positive or negative support for the client’s going concern.

    Findings:
    • The author finds that auditors facing greater threats to independence will be more supportive of an unqualified opinion (client-preferred) when:
      • Assessing initial information,
      • Evaluating additional information cues,
      • Making a final report choice.  
    • The author finds that auditors facing higher litigation risk will be less supportive of an unqualified opinion (client-preferred) only when:
      • Evaluating additional information cues,
      • Making a final reporting choice  
    • The author finds that both threats to independence and litigation risk affect final report choice completely through their influence on the auditor’s evaluation of additional information cues. Thus, it appears that independence threats and litigation risk lead to information processing bias, as opposed to an up-front choice bias. 
    • The author finds that when both threats to independence and litigation risk are high, auditors gather additional information cues and spend more time evaluating evidence.  Further, there is no significant difference in final reporting choice when independence threats and litigation risk are low, supporting regulators’ claim that litigation risk offsets independence threats.
    Category:
    Independence & Ethics, Auditor Judgment, Accountants' Reporting
    Sub-category:
    Impact of Fees on Decisions by Auditors & Managmeent, Going Concern Decisions, Going Concern Decisions
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  • The Auditing Section
    “Order Effects” Revisited: The Importance of Chronology
    research summary posted April 13, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    “Order Effects” Revisited: The Importance of Chronology
    Practical Implications:

    The results of this study are important for auditors to consider when making going concern assessments as well as other audit judgments.  Specifically, auditors should consider the importance of establishing the chronological order of audit evidence to avoid presentation order effects inappropriately influencing their judgments

    Citation:

    Favere-Marchesi, M. 2006. “Order Effects” Revisited: The Importance of Chronology. Auditing: A Journal of Practice and Theory
    25 (1): 69-83.

    Keywords:
    going concern, chronology, temporal order, presentation order, order effects, trend effect
    Purpose of the Study:

    Going-concern assessments are an important part of the audit process because inaccurate going-concern assessments may have severe economic consequences for both auditors and clients.  However, prior research shows that the presentation order of audit evidence unduly influences auditors’ going concern assessments leading to larger differences of opinion among auditors reviewing the same evidence, albeit in a different order.  This is important because audit evidence is not always uncovered in chronological order. No prior research study has attempted to separate the presentation order of evidence from the chronological order of evidence.  This paper addresses these concerns by investigating whether the chronological trends in the evidence (trend effects) overcome influences of the order of presentation (order effects).

    Design/Method/ Approach:

    The research evidence was collected prior to March 2004.  The author uses a sample of audit partners and senior managers from the six largest audit firms in the United States to complete a simulated task involving a going concern assessment for a manufacturer and marketer of teleconference hardware and software.  Participants made going concern assessments after reading background material and after reviewing each of four pieces of positive and negative audit evidence related to the going concern decision.  The author varied the presentation order of the negative and positive evidence as well as the chronological order of the evidence such that in some cases the presentation and chronological order matched in others a mismatch occurred.  The author also utilized two presentation orders with undated evidence.

    Findings:
    • The author finds that auditors display the same recency effects when presented with undated evidence as when presented with evidence in chronological order, suggesting that auditors infer chronological order from the order of presentation.  
    • When the presentation order of evidence is inconsistent with the chronological order, chronological trend effects substantially reduce presentation order effects.  This implies that auditors appropriately place more weight on chronological trends in a client’s viability than on mere presentation order of evidence.
    Category:
    Auditor Judgment
    Sub-category:
    Going Concern Decisions, Going Concern Decisions
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