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  • Jennifer M Mueller-Phillips
    Are Juries More Likely to Second-Guess Auditors Under...
    research summary posted August 31, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 12.0 Accountants’ Reports and Reporting, 12.04 Investigations, 15.0 International Matters, 15.02 IFRS Changes – Impacts in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Are Juries More Likely to Second-Guess Auditors Under Imprecise Accounting Standards?
    Practical Implications:

     The results of this study have implications for regulatory agencies and standard-setting bodies. As regulators contemplate whether to mandate IFRS and standard setters determine the level of implementation guidance for new standards, the litigation consequences of standard precision are an important consideration. Further, these results highlight the importance of regulators developing ways for jurors to evaluate audit judgments under imprecise standards, especially in industries and areas without precise industry reporting norms. Prior discussion on this issue has focused on how professional judgment frameworks are necessary to protect auditors and their clients from second guessing. This study suggests that judgments frameworks, if effective, may help protect auditors who make conservative judgments and also help hold auditors accountable for overly aggressive judgments.

    Citation:

     Kadous, K., and M. Mercer. 2016. Are Juries More Likely to Second-Guess Auditors Under Imprecise Accounting Standards? Auditing: A Journal of Practice and Theory 35 (2): 101-117.

    Keywords:
    audit litigation, standard precision, principles versus rules, second-guessing, jury decision making, IFRS
    Purpose of the Study:

    U.S. Generally Accepted Accounting Principles (GAAP) are generally viewed as more precise than International Financial Reporting Standards (IFRS) in that the former tend to contain more detail about implementation and compliance than the latter. Convergence efforts between U.S. GAAP and IFRS are on going, and have led to greater imprecision in U.S. accounting standards in areas such as lease accounting and revenue recognition. These imprecise standards require increased professional judgment by managers and auditors, which has led to concern that the adoption of less precise standards will result in more second-guessing of auditor judgments by juries and thus greater legal liability. This study seeks to address this concern and examines whether juries are more likely to second-guess auditors’ judgments under an imprecise accounting standard compared to a precise accounting standard. 

    Design/Method/ Approach:

    The authors recruited undergraduate students enrolled in introductory accounting courses at a large university as participants for this study. Two administrations were conducted with the students who participated in a simulated case that lasted 45 minutes during their accounting lab session. Participants acted as jurors in an auditor negligence case involving revenue recognition and were given information related to SFAS No. 66 (Real Estate) to help in their evaluation. The authors manipulated the precision of the accounting guidance as either precise or imprecise. The aggressiveness of the client’s reporting choice was manipulated as either aggressive or conservative.  

    Findings:

    The results of this experiment suggest that auditors’ fear about second-guessing by juries under imprecise accounting standards is warranted. Under an imprecise standard, conservative accounting choices are more likely to be called into question and result in negligence verdicts, ex post.

    • When the client’s reporting is conservative, there appears to be more second guessing of auditor judgments under an imprecise standard compared to a precise standard.
    • When the auditor allows aggressive client reporting, there appears to be less second guessing of auditor judgments under an imprecise standard compared to a precise standard.

    These findings indicate that rather than being overly harsh, juries appear to be overly lenient when auditors allow aggressive accounting under an imprecise standard. A lack of precision appears to make it more difficult for juries to identify whether an auditor’s judgment was reasonable or unreasonable. 

    Category:
    Accountants' Reporting, International Matters, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    IFRS Changes – Impacts, Investigations, Litigation Risk
  • Jennifer M Mueller-Phillips
    How Much Does IFRS Cost? IFRS Adoption and Audit Fees.
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 15.0 International Matters, 15.02 IFRS Changes – Impacts in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    How Much Does IFRS Cost? IFRS Adoption and Audit Fees.
    Practical Implications:

    The authors document and quantify audit fees as a significant cost associated with mandatory adoption of IFRS. The empirical results concerning small firms also inform discussions on the appropriateness of mandated IFRS regulations for small to mid-sized entities. Given the emphasis of auditing in the proposed roadmap for U.S. convergence to IFRS, the results will be of particular importance to U.S. firms, auditors, and regulators. On a broader level, the authors document variation in the costs of IFRS adoption that provides insight into the significant variation in the net benefit observed in previous studies. For instance, the authors find evidence that certain IFRS requirements have higher compliance costs than others, which explains the significant heterogeneity in compliance costs during the adoption of IFRS. 

    Citation:

    De George, E. T., C. B. Ferguson, and N. A. Spear. 2013. How Much Does IFRS Cost? IFRS Adoption and Audit Fees. Accounting Review 88 (2): 429-462.

    Keywords:
    audit fees, IFRS, IFRS costs, international harmonization
    Purpose of the Study:

    Regulators and standard setters claim that International Financial Reporting Standards (IFRS) enhance the comparability and quality of financial reporting. However, the true returns to IFRS adoption should be evaluated by trading off the costs of transition and any recurring costs of reporting against the recurring benefits of comparability and increased reporting quality. Given the impending decision and renewed debate surrounding whether the Securities and Exchange Commission (SEC) should mandate the use of IFRS in the U.S. market, understanding the costs of IFRS implementation is of timely importance.

    This study quantifies the directly observable and significant cost of IFRS compliance by examining the fees incurred by firms for the statutory audit of their financial statements. The focus on audit costs is motivated by the fact that the pervasive nature of IFRS adoption is likely to have a profound impact on a firm’s financial reporting costs. Firms currently subject to IFRS have already raised concerns over increasing preparation and certification costs.

    Design/Method/ Approach:

    The sample of 907 firms consists of companies publicly traded on the Australian Stock Exchange (ASX) that adopted IFRS from January 1, 2005, and have sufficient available data from 2002 to 2006. Preceding audit fee data in the pre-IFRS period, auditor information, and IFRS transition information is hand-collected from publicly available annual reports. The authors collect data on the number of local and foreign subsidiaries directly from publicly available reports and other financial information from Aspect Huntley’s Fin Analysis database.

    Findings:
    • The authors estimate a 23 percent increase in the average level of audit fees in the year of IFRS adoption.
    • They find an abnormal increase of 8 percent in the year of IFRS adoption, beyond normal yearly increases in fees.
    • The authors find a positive and significant relation between fee increases and IFRS-exposure.
    • The results are consistent with IFRS transition costs being a function of firm-specific exposure to IFRS and a fixed economy-wide switching cost.
    • IFRS compliance is onerous for small firms.
    • The estimated percentage increase in audit fees associated with IFRS adoption is approximately 1.6 times greater for small firms.
    • Small firms exhibit a significant fixed-cost component to their fee increase in the year of IFRS adoption. This increase is in addition to their incremental fee increase explained by their IFRS adjustments.
    • In contrast, the audit fee increases incurred by large firms are primarily explained by the magnitude of their IFRS adjustments, with no discernible fixed-cost component.
    • A survey of professional auditors at a Big 4 accounting firm shows that auditors believe that certain aspects of the new IFRS reporting requirements require greater auditor effort and expertise to ensure adequate compliance.
    Category:
    Engagement Management, International Matters
    Sub-category:
    Audit Fees & Fee Negotiations, IFRS Changes – Impacts
  • Jennifer M Mueller-Phillips
    The Impact of Principles-Based versus Rules-Based Accounting...
    research summary posted July 20, 2015 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.03 Adequacy of Evidence, 15.0 International Matters, 15.02 IFRS Changes – Impacts in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Impact of Principles-Based versus Rules-Based Accounting Standards on Auditors' Motivations and Evidence Demands.
    Practical Implications:

    The heightened epistemic motivation induced by principles-based accounting standards then ultimately increases auditors’ demands for audit evidence. Thus, the results suggest the important influence of accounting standards on auditors’ motivations and consequent program planning decisions. The findings provide valuable information to regulators in their evaluation of how or whether to move forward with potential IFRS adoption or convergence of U.S. GAAP with IFRS. In a principles environment, audit firms must take measures to guard against this potential bias, e.g., review of proposed audit programs and results of tests.

    Citation:

    Peytcheva, M., Wright, A. M., & Majoor, B. 2014. The Impact of Principles-Based versus Rules-Based Accounting Standards on Auditors' Motivations and Evidence Demands. Behavioral Research In Accounting 26 (2): 51-72.

    Keywords:
    auditing, epistemic motivation, principles-based standards, process accountability, rules-based standards, IFRS, auditor judgment
    Purpose of the Study:

    There has been considerable discussion about the effects of principles-based versus rules-based accounting standards on financial reporting quality, particularly given the debate concerning the adoption of, or convergence with, International Financial Reporting Standards (IFRS) in the United States. Auditing research has investigated the effects of different accounting standards on auditors’ decisions to constrain aggressive reporting by clients. Missing from this literature is evidence on how the type of accounting standard influences auditors’ cognitive motivations and demand for audit evidence. This study addresses this gap in the literature, which is important since the financial statements are the joint product of management’s and the auditor’s actions.

    This is the first study to examine the effects of the type of accounting standard on auditors’ cognitive motivations and information search patterns.  The authors address an important, and missing, piece of the puzzle: are there fundamental differences in the psychological processes employed by auditors who face principles versus rules accounting guidance? If there are differences, are auditors’ motivations under principles-based accounting standards driven by simple self-interest as opposed to a desire to understand the economic substance of the transaction at hand?

    Design/Method/ Approach:

    The theoretical model is tested using an experiment with 104 auditors from the U.S. and 48 auditors from The Netherlands. The experiment manipulates the type of accounting standard between participants at two levels: rules-based or principles-based. The evidence was gathered prior to January 2014.

    Findings:

    Findings from this experiment suggest that principles-based versus rules-based standards lead to significant differences in the judgment processes of professional auditors. In turn, greater process accountability induces higher epistemic motivation in auditorsa desire to obtain a rich and thorough understanding of the problem at hand. High levels of epistemic motivation stimulated by principles-based accounting standards then induce a greater demand for both total desired evidence and diagnostic audit evidence. These findings suggest that, while bright-line rules and thresholds can limit cognitive effort, accounting standards based on broad principles are likely to evoke systematic and thorough information processing, thereby leading auditors to strive for a rich and accurate understanding of the issues under consideration.

    The results also indicate that, although auditors exposed to IFRS over a prolonged period (e.g., Dutch auditors) may experience lower process accountability and epistemic motivation when working with principles-based standards than U.S. auditors, principles-based accounting standards still induce greater epistemic motivation than rules-based accounting standards in these auditors, suggesting a greater desire to obtain a rich understanding of the matter at hand.

    Category:
    Auditor Judgment, International Matters
    Sub-category:
    Adequacy of Evidence, IFRS Changes – Impacts
  • Jennifer M Mueller-Phillips
    How Does the Strength of the Financial Regulatory Regime...
    research summary posted November 26, 2014 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 15.0 International Matters, 15.02 IFRS Changes – Impacts in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    How Does the Strength of the Financial Regulatory Regime Influence Auditors’ Judgments to Constrain Aggressive Reporting in a Principles-Based Versus Rules-Based Accounting Environment?
    Practical Implications:

    From a public policy perspective, the results indicate that auditors’ judgments under principles-based standards, regardless of the strength of the financial regulatory regime, lead to more conservative reporting when compared to rules-based standards coupled with a stronger financial regulatory regime, which is how the U.S. environment is often characterized. The results also provide insights to regulators who are concerned about the implementation of IFRS across different countries with varying regulatory standards.

    For more information on this study, please contact Jeffrey R. Cohen.

    Citation:

    Cohen, J. R., G. Krishnamoorthy, M. Peytcheva, and A. M. Wright. 2013. How does the strength of the financial regulatory regime influence auditors' judgments to constrain aggressive reporting in a principles-based versus rules-based accounting environment? Accounting Horizons 27 (3): 579-601.

    Keywords:
    financial regulatory regime; principles-based standards; rules-based standards; audit judgments; public policy
    Purpose of the Study:

    With the movement towards adoption of International Financial Reporting Standards (IFRS) worldwide, a question arises as to whether a principles-based approach such as IFRS will ultimately result in higher quality financial reporting. This issue is particularly relevant because, even though for now the SEC is not adopting IFRS, the securities markets and the SEC still need to ponder the implications of a decision that may lead to the ultimate adoption of IFRS, or at the least result in some degree of convergence with U.S. GAAP. Further, some argue that the strength of enforcement regimes within a country is as important as a focus on principles or rules in determining the quality of reporting.

    Design/Method/ Approach:

    To examine this issue, the authors employ an experiment with 97 experienced auditors as participants. Using a case setting involving the classification of a lease (operating versus capital), they vary the accounting standard type as rules-based or principles-based, and the regulatory regime as stronger or weaker. The lease setting is one where there are indications of management’s incentives to leave the debt off of the balance sheet and hence engage in aggressive reporting. The research evidence is collected in 2010—2011. Participants are assigned the role of an auditor and need to determine the final lease classification as a capital lease or an operating lease.

    Findings:

    The study finds, as expected, that auditors are more likely to constrain aggressive reporting under principles-based accounting standards than under rules-based standards, under both stronger and weaker regulatory regimes. 

    Category:
    Auditor Judgment, International Matters
    Sub-category:
    IFRS Changes – Impacts
  • Jennifer M Mueller-Phillips
    The Impact of Mandatory IFRS Adoption on Audit Fees: Theory...
    research summary posted November 25, 2014 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 15.0 International Matters, 15.02 IFRS Changes – Impacts in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Impact of Mandatory IFRS Adoption on Audit Fees: Theory and Evidence
    Practical Implications:

    This study should be of interest to regulators and policy makers. IFRS adoption influences audit complexity and financial reporting quality, which have countervailing effects on audit fees. On the one hand, IFRS are generally believed to be superior to local accounting standards; hence the adoption of IFRS potentially improves financial reporting quality. This reduces audit risk and thus audit fees. On the other hand, IFRS are comprehensive, fair-value oriented, and principles-based. Using them generally requires accountants and auditors to make more complex estimates and use greater professional judgment. In other words, IFRS adoption increases the complexity of audits, which can increase audit fees. Our results suggest that, on average, the effect of audit complexity dominates the effect of improvement in financial reporting quality, leading to an overall increase in audit fees in the post-IFRS period. Moreover, our cross-country analysis sheds light on how the institutional features of different countries, including legal environments and characteristics of pre-IFRS domestic accounting standards, affect the audit fee increase associated with IFRS adoption.

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

    Citation:

    Kim, J.-B., X. Liu, and L. Zheng. 2012. The impact of mandatory IFRS adoption on audit fees: Theory and evidence. The Accounting Review 87 (6): 2061-2094.

    Keywords:
    IFRS adoption, audit fees, audit complexity, reporting quality, legal regime
    Purpose of the Study:

    This study examines the impact of International Financial Reporting Standards (IFRS) adoption on audit fees. Over 100 countries now require or permit IFRS reporting for domestically listed companies. Recent academic research mainly focuses on the economic benefits of adopting IFRS. Very few studies directly examine the costs associated with IFRS adoption. A survey conducted by the Institute of Chartered Accountants in England and Wales revealed that EU companies ranked increases in audit fees as one of their largest IFRS-related costs. This study aims to provide systematic evidence on the cost side of mandatory IFRS adoption, with a focus on audit fees. Specifically, we examine changes in external audit fees from 2004 to 2008 to determine whether the EU decision to mandate IFRS increased the fees paid to auditors. In addition, we investigate how the institutional features of different countries affect the audit fee increase associated with IFRS adoption. These institutional factors include (i) the increase in audit complexity arising from IFRS adoption, (ii) the change in financial reporting quality brought about by IFRS adoption, and (iii) the strength of a country’s legal regime. The findings of this study provide insights into the channels through which IFRS adoption impacts audit fees.

    Design/Method/ Approach:

    We examine audit fee changes from the pre-IFRS adoption period to the post-IFRS adoption period during 2004–2008. We employ a difference-in-difference design to control for the general trend or changes in the economic environment unrelated to IFRS adoption. Specifically, we use IFRS adopter firms from EU countries as the treatment sample and the non-adopter firms from non-EU OECD (Organization for Economic Co-operation and Development) countries as the control sample.

    Findings:
    • IFRS adoption causes an increase in audit fees. The audit fee increase is on average 5.44 percent greater for the adopter firms, compared with that for the non-adopter firms in our control sample.
    • The IFRS-related audit fee increase is positively related to the increase in audit complexity brought about by IFRS adoption.
    • The IFRS-related audit fee increase is negatively related to the improvement in financial reporting quality brought about by IFRS adoption.
    • The IFRS-related audit fee increase is negatively related to the strength of a country’s legal regime. 
    Category:
    Engagement Management, International Matters
    Sub-category:
    Audit Fees & Fee Negotiations, IFRS Changes – Impacts
  • Jennifer M Mueller-Phillips
    Preparers’ Perceptions of the Costs and Benefits of IFRS: E...
    research summary posted November 12, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 15.0 International Matters, 15.02 IFRS Changes – Impacts in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Preparers’ Perceptions of the Costs and Benefits of IFRS: Evidence from Australia’s Implementation Experience
    Practical Implications:

    Respondents tended to be quite negative about IFRS, with responses conveying a strong sense of IFRS being more trouble than it was worth.  It is possible that these preparers were biased by the immediacy of the problems involved and the relative remoteness of the benefits of IFRS. It may be that preparers’ perceptions of IFRS have become more positive as the new system has bedded down and the postulated benefits realized, but we cannot tell from our data. However, the findings do provide insights about the kinds of concerns that may arise on the implementation of IFRS, from a preparers’ perspective, and so are likely to be relevant to any country taking on the IFRS challenge in the future.

     

    For more information on this study, please contact Richard D. Morris.

    Citation:

    Morris, R. D., S. J. Gray, J. Pickering, and S. Aisbitt. 2014. Preparers' Perceptions of the Costs and Benefits of IFRS: Evidence from Australia's Implementation Experience. Accounting Horizons 28 (1): 141-173.

    Keywords:
    International Financial Reporting Standards; IFRS Adoption; IFRS Implementation; corporate perceptions; IFRS costs and benefits; Australia
    Purpose of the Study:

    IFRS adoption from 2005 in Australia was a major change for most companies.  Given the widespread adoption of IFRS around the world and the possibility of future US adoption, Australian preparers’ experiences with IFRS in the first year the new system was implemented should be of interest.  Most other studies of IFRS adoption focus on financial statement users’ reactions to IFRS and ignore preparers’ views.

    The paper reports responses to a mailed-out questionnaire survey from 305 senior financial executives in Australian listed companies, administered at the time these executives were actually implementing IFRS for the first time.  The survey thus provides unique insights into preparers’ perceived problems with implementation of IFRS, the costs involved and the benefits expected.

    Design/Method/ Approach:

    Most Australian companies have a 30 June balance date so the year ended 30 June 2006 was the first year that these companies adopted IFRS.  The questionnaire was mailed out in June 2006 and again in October 2006.  A usable sample of 305 responses was received. 

    The questionnaire asked respondents to rate on a 7 point scale 50 questions about the perceived difficulties with IFRS, the expected capital market impacts of IFRS, the one-off and ongoing costs of implementing IFRS, and the perceived benefits of IFRS. Background questions were also asked about the respondents and their companies.

    Respondent companies were broadly representative of those listed on the Australian Stock Exchange with regard to size and industry membership.  Of the respondents themselves,  92 percent have accounting qualifications, 89 percent have over 10 years accounting or financial experience and 48 percent have over 20 years experience.

    Findings:
    • The questionnaire responses were compressed using Principal Components Analysis into five constructs that we found ran through the data.  They are: General Issues with IFRS which captures difficulties that accounting staff were experiencing with the implementation of IFRS; Issues with Non Accounting Professionals which concern dealings with professionals such as lawyers; Benefits of IFRS which covers eight areas suggested as potential benefits of IFRS; Accounting Issues which covers eight specific accounting issues; and Capital Market Impact of IFRS which captures the perceived impact of IFRS on market valuation of equity, debt raising ability, not violating debt covenants, financing, credit ratings, dividends, earnings volatility.

     

    • Significantly more respondents rated as difficult, considerable, or serious, rather than as easy or little, the General Issues with IFRS and Accounting Issues.  On the other hand, significantly more respondents rated as little, rather than as significant, Capital Market Impact of IFRS and Benefits of IFRS.  Issues with Non Accounting Professionals were rated as average or below average.

     

    • The general tone of the responses was one of pessimism, frustration or hostility with IFRS.

     

    • One-off and ongoing costs of IFRS adoption were estimated to be up to $500,000 on average in each case.

     

    • Our multivariate analysis shows that the primary sources of concerns about the General Issues with IFRS, Issues with Non-Accounting Professionals the low level of Benefits are difficulties with specific accounting issues, the ongoing monetary costs involved and the limited capital market impact of the changes introduced.  Firm size, auditor type, and overseas listing or sales are almost always not significant.
    Category:
    International Matters, Standard Setting
    Sub-category:
    IFRS Changes – Impacts
  • Jennifer M Mueller-Phillips
    The Influence of Process Accountability and Accounting...1
    research summary posted October 22, 2014 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 15.0 International Matters, 15.02 IFRS Changes – Impacts in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Influence of Process Accountability and Accounting Standard Type on Auditor Usage of a Status Quo Heuristic
    Practical Implications:

    The results of this study are important for both audit firms and regulators to consider as standards change to become more principles-based (or as firms move towards using IFRS). The evidence indicates that auditors will sometimes fixate on the prior year accounting treatment, even if the applicable accounting standard has changed, and/or there are changes in the scenario. However, this bias towards maintaining the status quo can be mitigated by holding auditors accountable for their decision making process, particularly through a partner asking about the auditors’ decision making process.

     

    For more information on this study, please contact Scott Vandervelde.

    Citation:

    Messier, Jr., W. F., L. A. Quick, and S. D. Vandervelde. 2014. The influence of process accountability and accounting standard type on auditor usage of a status quo heuristic. Accounting, Organizations and Society 39 (1): 59-74

    Keywords:
    International Financial Reporting Standards, principles-based standards, status quo bias, accountability, auditor judgment
    Purpose of the Study:

    There has been considerable discussion about the U.S. reporting standards becoming less rules based, similar to International Financial Reporting Standards (IFRS). One proposed advantage of a change to IFRS is increased comparability across multinational and non-U.S. companies. Additionally, some believe that IFRS afford greater flexibility in its principles, thereby enabling firms’ accounting choices to better reflect the true economic nature of any given transaction. With fewer rules, both financial statement preparers and auditors would be expected to adjust to having more options with regards to financial reporting. However, some proposed changes leave the option open to implement IFRS (or other principles-based standards) in ways that still follow rules in U.S. GAAP. This paper investigates whether prior year accounting treatments influence the judgment for current year treatments when one way to implement the standard is to follow the prior year treatment.

    The authors motivate their expectations based on status quo theory and accountability theory. Status quo theory suggests that individuals often choose to maintain a prior decision when faced with a new choice. Accountability theory suggests that when individuals are held accountable for their decision making process, this will reduce the bias towards the status quo. 

    Design/Method/ Approach:

    The research evidence is collected in 2010 through 2013. The authors use an experiment to collect data from auditors, mainly at the senior and manager level, from Big 4 and large national accounting firms in the United States and Norway.

    Findings:
    • The authors find that some auditors fixate on prior year scenarios and judgments, even if the current year scenario and applicable accounting standards are different.
    • The authors find that holding auditors accountable for their decision making process reduces the likelihood of sticking with the prior year treatment, most notably when the prior year standards were U.S. GAAP.
    Category:
    Auditor Judgment, International Matters
    Sub-category:
    IFRS Changes – Impacts
  • Jennifer M Mueller-Phillips
    Does Mandatory IFRS Adoption Improve the Information...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 15.0 International Matters, 15.02 IFRS Changes – Impacts in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Does Mandatory IFRS Adoption Improve the Information Environment?
    Practical Implications:

    The results of this study have important implications for the debate on the globalization of accounting standards and for regulators that are considering a transition towards IFRS. Although the effects of IFRS adoption are not homogenous for all firms, the adoption of one set of accounting standards is likely to generate both information and comparability effects and improve the quality of information intermediation in capital markets.

    For more information on this study, please contact Joanne Horton.
     

    Citation:

    Horton, J., G. Serafeim, and I. Serafeim. 2013. Does Mandatory IFRS Adoption Improve the Information Environment? Contemporary Accounting Research 30 (1).

    Keywords:
    international financial reporting standards; impact analysis; earnings forecasting; quality.
    Purpose of the Study:

    With over 120 countries requiring or permitting the use of IFRS by publicly listed companies, the idea of pushing for mandatory IFRS adoption has become a popular topic. Mandatory IFRS adoption has the potential to improve worldwide financial reporting quality and contribute to better functioning capital markets. Potential benefits includes facilitating cross-border comparability, increase reporting transparency, decreasing information costs, and improving the efficiency of the markets. The idea relies on the presumption that mandatory IFRS adoption provides superior information to market participants and/or increased accounting comparability compared to previous accounting regimes. This study examines whether such a global transition towards a single set of accounting standards has been met by these presumed benefits. Based on prior research the authors derived these three hypotheses to test:

    1.    Mandatory IFRS adoption provides comparability benefits and as a result affects analyst earnings forecast accuracy for firms adopting IFRS mandatorily.
    2.    Mandatory IFRS adoption provides information quality benefits and as a result affects analyst earnings forecast accuracy for firms adopting IFRS mandatorily.
    3.    The increase in forecast accuracy following mandatory IFRS is associated with increased opportunities for firms to manage earnings towards a target.
     

    Design/Method/ Approach:

    To test the three hypotheses above, the authors first needed to verify that adoption of IFRS improves the information environment for the firms in the sample. Specifically, the authors tested for difference in forecast errors before and after mandatory IFRS compliance for nonadaptors, mandatory adaptors, and voluntary adaptors. To test for the effect of IFRS adoption, several models were developed to analyze firm data and forecasting information. Other analysis is conducted to determine whether improvements in information environment could be driven by factors outside of IFRS adoption.   

    Findings:
    • The information environment improves for mandatory adopters.
    • The larger the difference between IFRS earnings and local GAAP earnings the larger is the improvement in the information environment.
    • Forecast accuracy improves more for analyst-firm pairs that are affected by either information or comparability benefits.
    • There is no evidence suggesting that the increase in forecast accuracy is driven by earnings manipulation.
       
    Category:
    International Matters, Standard Setting
    Sub-category:
    Changes in Audit Standards, IFRS Changes – Impacts
  • Jennifer M Mueller-Phillips
    Rules-Based Accounting Standards and Litigation
    research summary posted September 26, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 12.0 Accountants’ Reports and Reporting, 12.05 Changes in Reporting Formats, 15.0 International Matters, 15.02 IFRS Changes – Impacts in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Rules-Based Accounting Standards and Litigation
    Practical Implications:

    This study exploits variation in U.S. accounting standards to study the effect of rules-based standards on litigation. It provides evidence of an association between rules-based accounting standards and a lower incidence of securities class action litigation. This evidence informs the debate about switching from a more rules-based U.S. GAAP to a more principles based IFRS.


    For more information on this study, please contact John McInnis.
     

    Citation:

    Donelson, D., J. McInnis, and R. Mergenthaler. 2012. Rules-Based Accounting Standards and Litigation. The Accounting Review 87 (4): 1247-1279.

    Keywords:
    securities litigation, safe harbor, rules-based standards, principals-based standards
    Purpose of the Study:

    There is substantial debate about whether U.S. GAAP is too rules-based and should be scrapped for a more principles-based set of standards such as IFRS. Rules-based standards, which explicitly state bright-line thresholds and have detailed implementation guidance, are often criticized because they are said to shield firms from litigation. Critics argue that when firms do not clearly admit to an error by issuing a restatement they can rely on a “safe harbor” defense provided by rules-based standards. Since detailed standards require little managerial judgment and are objectively implemented prosecutors have difficulty calling managerial discretion into question thus creating a “safe harbor” within the rules. Furthermore, critics claim that even when firms admit to a misstatement by restating their financial statements, the complex nature of rules-based standards allows firms to avoid litigation due to the difficulty in ruling out the potential for unintentional mistakes (i.e. rules based standards provide a “innocent misstatement” defense).
        On the other hand, proponents of rules-based standards argue that they provide plaintiffs a “roadmap” to successful litigation. The specificity of rules-based guidance provides plaintiffs the ability to establish intent in situations where they clearly ignored specific guidance and were forced to restate as a result. This argument is essentially the opposite of the “innocent misstatement” argument.
    This study intends to provide evidence that is pertinent to this debate. The authors attempt to determine whether rules-based standards are associated with the incidence and outcomes of securities class action litigation.
     

    Design/Method/ Approach:


    The authors exploit variation in the extent to which some U.S. GAAP standards are more rules-based and some are more principles-based. They use data on resolved securities class action lawsuits filed from 1996-2005 that allege GAAP violations as well as restatement data from the same time period. They perform three analyses with this data:

    • Using a sample of lawsuits unrelated to restatements the authors test whether plaintiffs tend to allege violations of principles-based standards in order to leverage management’s more subjective implementation.
    • Using a sample of all restating firms, the authors test whether restatements are more likely to lead to litigation if they are related to rules-based statements in order to understand if rules-based standards actually provide a “roadmap” to successful litigation.
    • Using a sample of lawsuits the authors test whether meritorious lawsuit outcomes are associated with alleged violations rules-based standards.
       
    Findings:
    • The authors find that in cases where litigation is not connected to a restatement, plaintiffs allege violations of principles-based standards more often than violations of rules-based standards. This evidence is consistent with rules-based standards providing a “safe harbor” from litigation prompting them to be cited less often in litigation.
    • The authors find that when a restatement occurs, violations of rules-based standards are associated with a lower probability of litigation. This finding does not support the idea that rules-based standards provide a “roadmap” to successful litigation. Instead it is consistent with the “innocent misstatement” argument.
    • The authors find no relationship between rules-based standards and litigation outcomes.


    These findings are indicative of rules-based standards deterring litigation. However, the authors note that the overall effect of a shift to a more principles-based accounting system is difficult to predict due to numerous additional factors that would accompany this type of change.
     

    Category:
    Accountants' Reporting, International Matters, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Changes in Reporting Formats, IFRS Changes – Impacts, Litigation Risk
  • Jennifer M Mueller-Phillips
    Can Reporting Norms Create a Safe Harbor? Jury Verdicts...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 15.0 International Matters, 15.02 IFRS Changes – Impacts in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Can Reporting Norms Create a Safe Harbor? Jury Verdicts against Auditors under Precise and Imprecise Accounting Standards
    Practical Implications:

    The results of this study are important for audit firms to prepare for the adoption of IFRS and/or less precise standards under U.S. GAAP. The results indicate that a move to less precise standards will not necessarily result in more verdicts against auditors. There is only one condition in which an imprecise standard leads juries to return more verdicts against the auditor: when the client’s reporting complies with the precise standard and is inconsistent with the industry reporting norm. The results suggest that auditors can reduce this liability by ensuring that their client’s reporting is consistent with industry reporting norm.

    For more information on this study, please contact Kathryn Kadous.
     

    Citation:

    Kadous, K., and M. Mercer. 2012. Can Reporting Norms Create a Safe Harbor? Jury Verdicts against Auditors under Precise and Imprecise Accounting Standards. The Accounting Review 87 (2):565-587.

    Keywords:
    Audit litigation, principles versus rules, jury decision making, IFRS
    Purpose of the Study:

    The transition from U.S. GAAP to International Financial Reporting Standards (IFRS) has been a topic of debate among regulatory bodies, standard-setters, firms, and their auditors. IFRS tend to provide less precise guidance than current U.S. accounting standards, so their application requires more professional judgment. Auditors have expressed concern that the adoption of IFRS will result in increased legal liability. This paper addresses this concern by investigating how the level of precision in accounting standards affects jury verdicts in auditor negligence lawsuits. Based on legal studies and the psychology literature, this paper studies how the effect of accounting standard precision on jury verdicts depends on two factors:

    • The aggressiveness of the audit client’s reporting choice
    • Whether the audit client’s reporting choice is consistent with the industry reporting norm
       
    Design/Method/ Approach:

    The authors collected their evidence prior to September 2010.  They use a group of undergraduate students to act as jurors in a simulated auditor negligence case. The participants deliberate in juries of six persons. Each jury is asked to assess the auditor’s conduct and to provide a verdict.  

    Findings:
    • The authors find that effect of accounting standard precision on jury verdicts depends on both the aggressiveness of the client’s reporting choice and on the industry reporting norm. Jurors use a hierarchy of decision rules. When the accounting standard does not provide a clear decision criterion, jurors seek other decision rules such as whether the client’s accounting is consistent with the industry reporting norm. 
    • The authors find that when the client’s accounting is more aggressive and violates the precise standard, a majority of juries return verdicts against the auditor, regardless of whether the industry reporting norm is met. When the client’s reporting is less aggressive and does not violate the precise standard, juries rarely return verdicts against the auditor, regardless of whether the reporting is consistent with the industry reporting norm. 
    • The authors find that when the accounting standard is imprecise, compliance with the industry reporting norm is a stronger predictor of jury verdicts. In particular, under the imprecise standard, no juries find against the auditor for allowing the more aggressive client reporting when the reporting is consistent with the industry reporting norm; when the reporting norm is violated, about half of the juries find the auditor negligent.
       
    Category:
    International Matters, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    IFRS Changes – Impacts, Litigation Risk