Menu

AMERICAN ACCOUNTING ASSOCIATION

http://aaahq.org

CONTACT: Ben Haimowitz (718-398-7642 or 917-903-9287)

Email: hhaimowitz@aol.com

 

NEW RESEARCH
Audit reviews aren't as effective as generally thought in correcting for preparers' personal biases about clients

 

Does it pay to be chummy with the outside auditor? The question is likely to occur to any corporate or business manager involved in financial reporting, and, indeed, some research suggests that outside auditors’ fondness or dislike forclient personnelthey work with doessignificantly sway theiraccounting judgments.It is generally believed, though, that accounting-firm reviewers who are aware of such feelings will guard against their influencing the conclusions of the final audit.

 

This is why a new scholarly paper on how reviewers respond to audit preparers’ affective biases comes as a surprise. The study in the current issue of the American Accounting Association journal The Accounting Review finds the result of bias awareness to be the reverse of what one might expect. Instead of causing reviewers to discount audit preparers' judgments, it leads them to rely on those conclusions more thanthey would do without such awareness.

 

In the words of the study, "Reviewers who are not informed about the preparer’s affect are not significantly influenced by the preparer’s judgment and arrive at judgments more consistent with the audit evidence. In contrast, reviewers who receive the same preparer judgment and workpaper evidence, but who are also informed of the preparer’s affect, are significantly influenced by the preparer’s judgment."

 

In other words, "despite their belief that affect biases the preparer's judgment, reviewers fail to mitigate this bias when reaching their own judgment."

 

"Failure to mitigate doesn't mean that reviewers simply adopt a preparer's recommendation," explains Vicky B. Hoffman, a professor of business administration at the University of Pittsburgh, who carried out the study with doctoral candidate Michele L. Frank. "It does mean letting a preparer's bias significantly impede a reviewer's own good judgment."

 

The new study has affinities with earlier research on the difficulty people experience when confronted with an adviser's conflict of interest or that jurors encounter when they are instructed to ignore information improperly introduced in the course of a trial. No earlier research, however, has probed whether professionals, such as auditors, fall prey to what is called the “ironic rebound effect” – that is, letting themselves be swayed by judgments of colleagues who acknowledge personal bias.

                                                            

The authors, who were both auditors at Big-4 accounting firms before pursuing careers in academe, believe the issue to be of considerable practical importance, since, in the words of the study,“partners often visit audit staff on client engagements, taking them to lunch or interacting with them in other informal social settings. In these settings…it is not unusual for preparers with relatively strong personal feelings toward the clients’ personnel to discuss them with the rest of the audit team."

 

The paper's findings emerge from an online experiment involving 119 audit managers and senior managers from two Big-4 accounting firms who had an average of 9.37 years of experience. All participants are provided with the same background information, of about 500 words, on a manufacturer of electronic components whose primary competitor has developed a prototype of a product that may be technically superior to the focal company's version and is expected to sell for about 20% less. Subjects are asked to assume the role of an audit manager assigned to review inventory judgments made by a hypothetical senior auditor, the preparer.

 

In half the cases the preparer has reached a conclusion, very favorable to the client, that no writedown of inventory is required, while in the remaining cases a highly unfavorable writedown of $1.2 million has been recommended. Further, half the reviewers of the favorable recommendation are informed that the preparer mentioned having previously worked with the client’s controller at a different company and really liking him. And half the reviewers of the unfavorable conclusion are informed that the preparer had.an unhappy prior experience at another firm with the controller, whom he found arrogant, condescending, and extremely unpleasant. The remaining subjects, serving as control groups, receive no information at all about personal likes and dislikes.

 

The study's authors note that the background information presented to participants "indicated that client personnel were competent and that the audit firm had issued unqualified opinions in each of the last five years." Moreover, "by design the preparer's relationship with the controller was based on their interactions at a different company to avoid unintentionally providing participants in the affect conditions with additional information about the company's current audit situation." Further, post-experimental questioning of participants revealed that they "perceived client personnel to be relatively competent and audit risk to be relatively low."

 

Still, assurances of client competence notwithstanding, reviewers made widely variant judgments that were apparently influenced by whether the preparer liked or disliked the controller. Among the subjects who reviewed judgments favorable to the client (no writedown required), those who were informed that the controller was very pleasant urged an average writedown of $42,000, which was only about one third the $119,200 suggested by those who were told nothing of personal relationships. As for participants who reviewed judgments unfavorable to the client ($1.2 million writedown proposed), reviewers with no knowledge of personal likes or dislikes recommended an average of $183,103, while those whose preparer said the controller was extremely unpleasant called for almost double that, a whopping $357,333.

 

What accounts for these wide disparities? It is highly unlikely, the study reveals, that reviewers were naive about preparers' potential to be unduly influenced by their feelings toward clients: in a supplementary experiment involving 40 seasoned auditors, 38 said that there was at least some chance that preparers' personal feelings toward clients would lead them to make more favorable or unfavorable judgments than warranted, and 27 estimated that the chance of this was 50% or better.

 

Instead the authors seek a cause in the"ironic rebound effect." Psychological research, they explain, has found that when people attempt to ignore or minimize facts (in this study the preparer’s biased judgment), a subconscious monitoring process occurs to alert them when they are relying on this information. If there is uncertainty about how much to discount the facts, the monitoring process intensifies, keeping theawkward info prominent in working memory and thereby increasing its effect on judgments. Among settings where the effect has been studied are law courts, where it was found that jurors told to disregard a piece of evidence ironically attend to that evidence more than those who are not trying to ignore it.

 

The authors also surmise that in actual audits this effect on reviewers may be increased by“secondhand affective reactions, which are subconsciously positive toward client personnel that the preparer likes and negative toward those that the preparer dislikes."

 

As to how the ironic rebound effect can be countered, the authors are cautious, given the complexity of the psychological mechanisms involved. "Hopefully, future research can test how to improve the review process," Prof. Hoffman says. "Meanwhile, it may help to simply recognize that the process is not as effective as generally believed and that reviewers should recognize their susceptibility to being unduly swayed by preparer bias. A little alarm bell should go off when personal feelings about client personnel come to light, prompting reviewers to consider what judgment the preparer would likely have reached based on the evidence in the workpapers."

 

Entitled "How Audit Reviewers Respond to an Audit Preparer's Affective Bias: The Ironic Rebound Effect," the study is in the March/April issue of The Accounting Review, published every other month by the American Accounting Association, a worldwide organization devoted to excellence in accounting education, research, and practice. Other journals published by the AAA and its specialty sections include Auditing: A Journal of Practice and Theory,  Accounting Horizons, Issues in Accounting Education, Behavioral Research in Accounting, Journal of Management Accounting Research, Journal of Information Systems, and The Journal of the American Taxation Association.

Copyright © 1998 - 2017 by American Accounting Association. All rights reserved.