Posts

Posts

  • Jennifer M Mueller-Phillips
    The Effect of Information Choice on Auditors’ Judgments a...
    research summary posted October 12, 2016 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.05 Diversity of Skill Sets e.g., Tenure and Experience, 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind, 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:
    The Effect of Information Choice on Auditors’ Judgments and Confidence
    Practical Implications:

     Implications for the practicing audit community are developed from the findings that less experienced auditors are susceptible to the information choice effect. In situations where litigation risk is low (high) and the auditor has less experience, auditors place greater (lower) significance on information given to them by an external party than information they sought out themselves. More experienced auditors are not subject to the information choice effect. Additionally, more experienced auditors are confident in judgments based on information sought themselves, even in a setting with elevated litigation risk. The results of this study may interest audit clients providing information to auditors, auditors reviewing the work of less (more) experienced colleagues, auditors performing a critical self-review, and regulators reviewing the work of auditors.

    Citation:

     Smith, S. D., W. B. Tayler, and D. F. Prawitt. 2016. The Effect of Information Choice on Auditors' Judgments and Confidence. Accounting Horizons 30 (3): 393–408.

    Keywords:
    information choice, litigation risk, confidence, experience, judgment impact
    Purpose of the Study:

    During the course of an audit, auditors choose what information they need to search for; however, they obtain both sought and unsought information.  These auditors must then use the information obtained to make judgements and decisions that ultimately lead to an audit opinion.  Thus, the weight auditors place on the information obtained when making judgements and the auditors’ confidence in those judgements has important implications for audit quality.  The authors of this paper investigate whether it matters if information is gotten by the auditor or given to the auditor.  Understanding that the way in which information is received affects information processing, the authors examine how the auditors’ receipt of additional sought or unsought information impacts the auditors’ judgment and confidence in that judgement given judgements with different levels of importance (e.g., high vs. low litigation risk) and auditors with different levels of experience (e.g., high vs. low).

    Design/Method/ Approach:

    Evidence was obtained during the 2010’s through an experiment using 136 auditors as participants.  Participants read a case and evaluated the likelihood of obsolescence in inventory.  The researchers manipulated the (1) choice to acquire relevant information (i.e., given a choice or not given a choice) and (2) litigation risk levels (i.e., high or low).  Furthermore, they measured auditor experience, and classified participants as more or less experienced based on number of years in public accounting.

    Findings:
    • In the high litigation setting, sought information is weighed more heavily than unsought information.  This result appears to be driven by auditor experience.  Specifically, when auditor experience is low and litigation risk is high, sought information is weighed more heavily than unsought information.
    • In the low litigation setting, sought information is weighed less heavily than unsought information.  This result appears to be driven by auditor experience.  Specifically, when auditor experience is low and litigation risk is low, information is weighed less heavily than unsought information.
    • Auditor confidence in their judgment of inventory obsolescence was greater when they chose to obtain additional information than when they were just given the additional information.  This result appears to be driven by auditor experience.  Specifically, more experienced auditors had greater confidence after obtaining sought information than unsought information.  This results also appears to depend on the litigation level.  In the high litigation setting, more experienced auditors had greater confidence after obtaining sought information than unsought information.
    Category:
    Audit Quality & Quality Control, Audit Team Composition, Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Diversity of Skill Sets (e.g. Tenure & Experience), Evaluation of Evidence, Litigation Risk, Prior Dispositions/Biases/Auditor state of mind
  • Jennifer M Mueller-Phillips
    Construal instructions and professional skepticism in...
    research summary posted February 17, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.02 Documentation Specificity, 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:
    Construal instructions and professional skepticism in evaluating complex estimates.
    Practical Implications:

    The findings of this study have important implications for practice. Given the concern from the PCAOB regarding auditors’ lack of professional skepticism, this paper finds a mechanism to increase and improve the level of professional skepticism. In addition, the technique the author finds (providing high-level construal instructions) to auditors is “simple to use, inexpensive, and can easily be tailored for a firm’s specific needs or language

    Citation:

    Rasso, J.T. 2015. Construal instructions and professional skepticism in evaluating complex estimates. Accounting, Organizations and Society 46: 44-55.

    Keywords:
    professional skepticism, material misstatement, auditor judgment
    Purpose of the Study:

    The purpose of this study is to examine whether instructing auditors to create summaries of their audit findings during evidence evaluation in a broad/abstract manner (creating high-level construals) increases professional skepticism. Theoretical research suggests that using these high-level construals (or interpretations) helps individuals to process and understand numerous pieces information. The author suggests that this method could help auditors to ‘see the big picture’, which could help identify patterns in the evidence or possible material misstatements. Then, auditors may be more willing to gather and evaluate additional evidence to test for these potential problems.

    Design/Method/ Approach:

    Data for this paper was collected prior to April 2015 by using a computerized experiment. Auditors were used as participants in the study, and they averaged 5.4 years of audit experience (ranging from staff auditor to partner). In addition, ninety percent of the auditors had audited fair value estimates in the past.

    Findings:

    Auditors that were given documentation instructions to create high-level construals were more likely to exert professional skepticism compared to auditors given low-level construals (identifying specifically how an estimate could be fairly stated or misstated) or auditors given no instructions. Specifically, they spent more time collecting and evaluating audit evidence, collected more evidence, and rated the risk of the fair value estimate higher. These findings suggest that auditors using the high-level construal instructions process the information from their findings better and recognize a need to gather more evidence when given an incomplete amount of evidence. In addition, when evidence suggests that the fair value is overstated, auditors given the high-level construal instructions are more likely to realize the high risk.

    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent, Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Auditors’ Professional Skepticism, Documentation Specificity, Evaluation of Evidence
  • Jennifer M Mueller-Phillips
    Audits of Complex Estimates as Verification of Management...
    research summary posted October 19, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience, 11.09 Evaluation of Evidence in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audits of Complex Estimates as Verification of Management Numbers: How Institutional Pressures Shape Practice.
    Practical Implications:

    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.  

    Citation:

    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.

    Keywords:
    Complex Estimates, Subjectivity, Institutional Theory, Valuation Specialists, Professional Skepticism, Interviews
    Purpose of the Study:

    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.

    Design/Method/ Approach:

    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.

    Findings:

    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:

    • Both audit firm policies and professional standards generally emphasize management process verification techniques over other potential techniques. Additionally, regulators (i.e., PCAOB) reinforce/encourage this behavior because inspection findings largely focus on problems with auditing management’s process instead of suggesting alternative, superior auditing methods.
    • Audit firms employ valuation specialists who have the necessary knowledge to more critically analyze complex estimates. This fact means that financial statement auditors generally do not have the necessary knowledge to critically analyze management’s models or develop an independent expectation. When auditors do use such specialists, they over-rely on their work.
    • Given the lack of guidance regarding complex estimates, firms tend to use practices that have been previously legitimized. For auditing of complex estimates, verification (which works well to audit less subjective accounts) is used to audit more subject complex estimates. Auditing standards also mainly emphasize verification.
    • Given inspection pressures, firms find it safer and more legitimate to mimic each other’s policies and procedures for auditing complex estimates instead of develop new ones.
    Category:
    Audit Quality & Quality Control, Audit Team Composition, Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Adequacy of Evidence, Auditors’ Professional Skepticism, Evaluation of Evidence, Impact of potential post-audit review (e.g. PCAOB - internal firm inspections), Sustainability ServicesTraining & General Experience, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • Jennifer M Mueller-Phillips
    Do Joint Audits Improve or Impair Audit Quality?
    research summary posted July 22, 2015 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence, 15.0 International Matters in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Do Joint Audits Improve or Impair Audit Quality?
    Practical Implications:

    This study provides timely policy implications for regulators. To encourage the growth of small-sized audit practices, the European Commission is considering a mandate that large companies hire at least one audit firm outside the Big 4 firms to conduct joint audits. The analysis suggests such a mandate could damage audit quality. In light of international convergence of audit practice and standards, the paper can inform global regulators’ deliberations on the desirability of joint audits.

    Citation:

    Deng, M., Lu, T., Simunic, D. A., & Ye, M. 2014. Do Joint Audits Improve or Impair Audit Quality? Journal Of Accounting Research 52 (5): 1029-1060.

    Keywords:
    audit evidence precision, audit fees, joint audits
    Purpose of the Study:

    Conventional wisdom holds that joint audits, where two audit firms simultaneously and yet separately audit a company and sign a common audit report, would improve audit quality by enhancing audit evidence precision because “Two heads are better than one.” This paper challenges this wisdom. To reconcile the difference, the authors identify an economic force that may work against joint audits, that is, free-riding. In joint audits, one of the audit firms may save audit resource cost by investing less in its own audit work and taking advantage of the other audit firm’s hard work. The authors consider three regimes that may vary in the magnitudes of potential free-riding problems: single audits by one big firm (Regime B); joint audits by two big firms (Regime BB); joint audits by one big firm and one small firm (Regime BS). The goal of the paper is to compare audit evidence precision and audit fees in these three regimes.

    Design/Method/ Approach:

    The authors use analytical modeling to establish empirically testable predictions comparing audit evidence precision and audit fees under joint and single audits.

    Findings:

    The authors make two assumptions to capture the differences between a big audit firm and a small one. First, a big audit firm has an advantage in its auditing technology in the sense that it has a lower marginal cost of audit evidence precision than a small firm. Second, a big audit firm bears a larger proportion of misstatement costs (such as litigation risk and reputation loss) than a small firm. Under the model assumptions, the authors find that Regime BB generates the same audit evidence precision as Regime B. Also, audit fees are lower under Regime BB than Regime B. Comparing Regime BS with Regime B, the authors find that the total precision of audit evidence under joint audits is lower than that under a single audit. In addition, the audit fees under joint audits are lower than that under single audits if the technological difference between the two audit firms is small and the big firm bears a large proportion of misstatement cost.

    Category:
    Audit Quality & Quality Control, International Matters
    Sub-category:
    Evaluation of Evidence
  • Jennifer M Mueller-Phillips
    The Auditors’ Approach to Subsequent Events: Insights from t...
    research summary posted February 19, 2015 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.11 Auditor judgment in the workpaper review process, 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:
    The Auditors’ Approach to Subsequent Events: Insights from the Academic Literature
    Practical Implications:

    A concern noted by the authors is the inherent complexity associated with the search for and evaluation of SEs arising from the seemingly boundless universe of potential SEs and the continuous nature of the search. Auditors’ SE procedures may be more effective if the universe of SE possibilities was better understood. One way to understand this universe is to identify undiscovered or incorrectly resolved SEs. Doing this might make these issues more salient to auditors and mitigate judgment biases in the search and evaluation of SEs. Further, auditors would be better equipped to consider potential SEs earlier in the audit if the consideration of potential SEs were incorporated into the risk assessment process during audit planning. This ensures that SE risks are given more detailed attention in the audit program.

    For more information on this study, please contact Janne Chung.

    Citation:

    Chung, J. O. Y., C. Cullinan, M. Frank, J. Long, J. Mueller, and D. O’Reilly. 2013. The Auditors’ Approach to Subsequent Events: Insights from the Academic Literature. Auditing: A Journal of Practice and Theory 32 (Supplement 1): 167-207.

    Keywords:
    Contextual factors, cognitive processing strategies, heuristics and biases, subsequent events judgment process.
    Purpose of the Study:

    Approximately one-third of the PCAOB’s inspection reports and several SEC enforcement releases identify deficiencies in the audit of subsequent events (SEs). Despite these issues, little research has been conducted to understand how and why these deficiencies occur. This paper integrates the psychology and behavioral accounting and auditing literatures to develop a model of the factors that influence the effectiveness of SE audit procedures. The model suggests that the effectiveness of these procedures is largely influenced by the auditor’s cognitive processing mode, which is initially affected by environmental, individual and task specific factors. The model provides a theoretical basis for future research into the causes of these deficiencies and suggests potential mitigating strategies that auditors can employ to improve the effectiveness of the audit of SEs. Suggestions for improving the audit of SEs include improved training for auditors in understanding the nature and frequency of SEs, incorporating the consideration of potential SEs into the risk assessment process during audit planning, employing brainstorming sessions to develop a priori expectations about SEs, and assigning both the SE search and evaluation steps to more experienced auditors.

    Design/Method/ Approach:

    The research was based on professional guidance and academic literature as of 2012. . First, the authors searched and summarized PCAOB’s inspection reports and SEC enforcement releases to identify deficiencies in the audit of SEs. Second, the authors developed a model of the factors that influence the effectiveness of SE audit procedures by searching and integrating the psychology and behavioral accounting and auditing literatures. Third, the authors propose research questions to guide future research in this area.

    Findings:

    •The authors find that approximately one-third of PCAOB’s inspection reports and several SEC enforcement releases identify deficiencies in the audit of SEs.

    •These reports and releases show a propensity toward Type I SE errors, the failure to evaluate SEs adequately, and a tendency for SE errors to be concentrated on certain accounts (including accounts receivable and current liabilities).

    Category:
    Audit Quality & Quality Control, Auditor Judgment
    Sub-category:
    Auditor judgment in the workpaper review process, Evaluation of Evidence
  • Jennifer M Mueller-Phillips
    Research on Auditor Professional Skepticism: Literature...
    research summary posted November 17, 2014 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind, 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:
    Research on Auditor Professional Skepticism: Literature Synthesis and Opportunities for Future Research
    Practical Implications:

    We find that while research studies provide insights into both the antecedents to skeptical judgments and actions, the majority of research efforts to date have focused on the antecedents to skeptical judgments and on auditor characteristics in particular. In addition, in order to understand how skeptical judgment translates into skeptical action, additional research on skeptical action is needed. Also, given the growth of multicultural audit teams, it is necessary to examine whether an auditor’s culture matters and whether it negatively impacts efforts by multinational accounting firms to deliver the same services throughout the world.

    To enhance professional skepticism, auditors should be encouraged to assess strategic and business-related risks, as well as risks of material misstatement in financial statements, in order to develop the expertise necessary to engage in skeptical judgments. Additionally, a demonstrated decrease in skepticism as one moves up through the firm hierarchy, can be addressed through training and education, as well as task specific experience, or expertise. In addition, future research could focus more on how the environment of audit firms can motivate auditors to exhibit more skeptical judgment and action.

    For more information on this study, please contact R. Kathy Hurtt.

    Citation:

    Hurtt, R.K., H. Brown-Liburd, C. E. Earley, and G. Krishnamoorthy. 2013. Research on Auditor Professional Skepticism: Literature Synthesis and Opportunities for Future Research. Auditing: A Journal of Practice & Theory 32 (Supplement 1): 45-97.

    Keywords:
    professional skepticism; skepticism; auditor skepticism; auditor judgment; skeptical behavior.
    Purpose of the Study:

    Both researchers (e.g., Nelson 2009) and regulators (e.g., the PCAOB) have emphasized the importance of exercising the appropriate level of professional skepticism when conducting an audit. However, professional skepticism remains a hard concept to define and measure.  In addition, it is often difficult to determine if a lack of skepticism is the primary cause of audit deficiencies and if so, what factors led to the lack of skepticism. The purpose of this paper is threefold: 1) extend the work of Nelson (2009) by synthesizing research related to auditors’ professional skepticism to identify antecedents to both skeptical judgment and skeptical action; 2) identify areas where research is lacking on a particular dimension and suggest avenues for future research; and 3) discuss the implications of research findings for regulators and auditing professionals.

    Design/Method/ Approach:

    We adopt two foundational aspects of the framework introduced in the seminal paper by Nelson (2009), which proposes that lack of skepticism can either be the result of a failure in problem recognition (lack of skeptical judgment) or a failure to act on a problem recognized (lack of skeptical action). We organize research studies into four categories of antecedents: 1) studies relating to auditor characteristics, 2) studies relating to evidence characteristics, 3) studies relating to client characteristics, and 4) studies relating to environmental characteristics. 

    Findings:

    Auditors approach audits with the intention of being professionally skeptical and they often respond to risk by changing behaviors (e.g., expand budgeted audit hours, identify more contradictions, negotiate more forcefully with a client).  In addition, auditors’ professional behavior is affected by cultural differences (Bik 2010) which suggests that culture influences values and these values influence professional and audit judgment (Patel et al. 2002). When professional skepticism is found lacking by the PCAOB and the SEC, researchers have noted the following as possible explanations: individual auditor characteristics may influence the ability of an auditor to recognize situations where additional work or investigation is required; unconscious bias may influence an auditor’s judgments or actions; and lack of knowledge, experience or expertise may impede skeptical judgments.   

    Category:
    Audit Quality & Quality Control, Auditor Judgment
    Sub-category:
    Evaluation of Evidence, Prior Dispositions/Biases/Auditor state of mind
  • Jennifer M Mueller-Phillips
    Haphazard Sampling: Selection Biases Induced by Control...
    research summary posted October 20, 2014 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.02 Sample Selection – use of statistical sampling, 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:
    Haphazard Sampling: Selection Biases Induced by Control Listing Properties and the Estimation Consequences of these Biases
    Practical Implications:

    These findings suggest that the properties of haphazard samples chosen from control listings are likely to differ from those of random samples.  Subconscious effort minimization and diversification behaviors, coupled with visual perception artifacts, yield samples that violate requirements for independence and equal selection probability.  These violations, in turn, are likely to produce biased error projections with difficult to discern risk properties.  Although widely used and specifically identified in audit standards as a sampling technique that can be employed to obtain a representative sample, haphazard sampling may not be a reliable substitute for random sampling.

     

    For more information on this study, please contact Thomas W. Hall

    Citation:

    Hall, T. W., A. W. Higson, B. J. Pierce, K. H. Price, and C. J. Skousen. 2012. Haphazard sampling: Selection biases induced by control listing properties and the estimation consequences of these biases. Behavioral Research in Accounting 24 (2):101-132.

    Keywords:
    nonstatistical sampling, haphazard sampling, sample selection bias
    Purpose of the Study:

    Audit samples represent an important type of evidence used to assess the error status of accounting populations.  As a result of its professional acceptance and lower cost, nonstatistical sampling historically has played a prominent role in audit sampling.  Haphazard sampling is a nonstatistical technique commonly used to emulate random sampling and consequently when used no explicit selection strategy should be employed.  However, a number of sampling experts have expressed doubts about whether haphazard sampling is a reliable substitute for random sampling.

     

    We hypothesized that haphazard samples differ from random samples because the haphazard selection process is influenced by: (1) auditor behaviors intended to minimize sample selection effort and to ensure a diversified sample composition, and (2) variations in the appearance of control listing entries.

    Design/Method/ Approach:

    We created two control listings representing a population of accounts receivable and a population of inventory items.  The accounts receivable control listing consisted of 22 pages with 792 customer accounts, while the inventory control listing consisted of 26 pages with 1,404 inventory items.

     

    We conducted three experiments in which participants were instructed to select haphazard samples from the control listings.  Participants in the first experiment were 75 students enrolled in either senior or master’s-level accounting courses at a public university located in the southwestern United States.  The second experiment utilized 40 university students in the United Kingdom who were enrolled in either senior or master’s-level accounting courses.  These students serve as effective proxies for entry-level auditors, who select most samples.  The third experiment utilized 53 audit seniors from two offices of a Big 4 audit firm located in the southwestern United States.  Because of time constraints, the audit seniors sampled only from the inventory control listing.  Upon completion of the sample selection process, all participants completed an exit survey.  The data collection was completed by the middle of 2009.

    Findings:

    As expected, we observed unequal page selection rates.  Most participants began the sample selection process on the first page of control listings.  Also, sample selections exhibited a high positive correlation with listing serial position, indicating that participants tended to proceed through the control listings in serial fashion.  Statistical analyses confirmed that participants exhibited higher selection rates for early pages, followed by declining selection rates for middle pages, with an upturn in selection rates for ending pages.  All of these results are inconsistent with the properties of random samples.

     

    Line selection rates also were unequal and consistent with expectations that visual perception biases influence sample selections.  Line entries with a low level of visual crowding tended to have higher selection rates than line entries with a high level of visual crowding.  Similarly, line entries with a high level of luminance contrast were selected more often than line entries with lower levels of luminance contrast.  Statistical tests confirmed that lines at the top and bottom of pages were overrepresented in each participant group’s samples. As with page selection, these results are inconsistent with the properties of random samples.

    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Evaluation of Evidence, Sample Selection – use of statistical sampling
  • Jennifer M Mueller-Phillips
    Auditors’ Consideration of Material Income-Increasing v...
    research summary posted April 28, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.06 Earnings Management – Detection and Response, 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:
    Auditors’ Consideration of Material Income-Increasing versus Material Income-Decreasing Items during the Audit Process
    Practical Implications:

    The results of this study suggest that auditors spend a greater effort on analyzing income-increasing items compared to income-decreasing items. They also suggest that auditors compensate for greater risk associated with income-increasing items by requiring greater verification of such items. Because of the limitations placed on the results of this study due to the specific context of the experiment, future research should try and examine such differences in auditors’ decision-making processes.

    For more information on this study, please contact Naman K. Desai.
     

    Citation:

    Desai, N. K., and G. J. Gerard. 2013. Auditors’ Consideration of Material Income-Increasing versus Material Income-Decreasing Items during the Audit Process. Auditing 32 (2).

    Keywords:
    accruals; auditing; conservatism; memory; risk
    Purpose of the Study:

    The purpose of this study is to examine whether auditors’ consideration of material items, as evidenced by recognition memories, is influenced by the direction of material items. During the gathering of audit evidence, auditors come across evidence in support of material items that affect earnings in a positive or negative manner. Because earnings can be managed upward or downward depending on management’s objectives and incentives, auditors should be sensitive to both material increasing and deceasing items. Prior research indicates that auditors face greater litigation risk for non-detection of fraudulent income-increasing items compared to income-decreasing items. Therefore, the expectation is that auditors will spend greater cognitive effort evaluating material income-increasing items, resulting in superior memories for such items.

    Design/Method/ Approach:

    The experimental design is a 2 x 2 mixed design with data collected using a signal detection theory paradigm. The participants were randomly assigned to treatments. A total of 60 experienced auditors (all CPAs) participated in the experiment. The participants had an average of 9.83 years of auditing experience. The minimum experience was two years and the maximum was 19 years. The experiment was conducted on site during firm training sessions. 

    Findings:
    • Auditors’ memories for income-increasing items are significantly greater than that for income-decreasing items when auditors are not asked to form expectations about the future effects of the items.
    • This difference above is not observed when auditors are asked to form expectations about future effects of each item.
    • Auditors are less likely to refer back to the work papers to verify the accuracy of income-decreasing items compared to income-increasing items.
       
    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management – Detection and Response, Earnings Management, Evaluation of Evidence
  • 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
    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