Have You Seen...?

Brad Reed, Southern Illinois University Edwardsville,
and John Reisch, East Carolina University

“The Impact of Political Pressure on Novice Decision Makers: Are Auditors Qualified to Make Going-Concern Judgments?” by V. Arnold, P. A. Collier, S. A. Leech, and S. G. Sutton, Critical Perspectives on Accounting (Vol. 12, 2001): 333–338.
The authors report on a field study that that captures the decision processes of 44 experienced and 41 novice insolvency practitioners (individuals who specialize in determining the viability of financially distressed entities) and compares these findings with the decision processes used by external auditors in assessing entities’ abilities to continue as going concerns. A key finding is that the strategies of both auditors who make going-concern decisions and novice insolvency practitioners tend to focus on financial information and how the company became financially distressed. More experienced insolvency practitioners tend not to focus on financial factors because it is often difficult to identify a root cause of a financial problem; instead, they focus on nonfinancial information such as the viability of products/services, continuity of management, and skill level of management and employees. The authors discuss how different socio-political pressures may explain why auditors tend to use low-level knowledge in making going-concern decisions as compared to experienced insolvency practitioners.

“Academic Auditing Research: An Exploratory Investigation into Its Usefulness,” by Y. Gendron and J. Bedard, Critical Perspectives on Accounting (Vol. 12, 2001): 339–368.
This article investigates the usefulness of auditing research by integrating a theoretical discussion of the benefits of auditing research with an empirical assessment. The motivation for the article is to provide a more global assessment of auditing research usefulness than that provided by the 1995 AICPA/AAA monograph on the subject. The authors use content analysis to assess the usefulness of articles published by North American auditing researchers in five leading journals. The authors conclude that contemporary auditing research is useful because it possesses a relatively high degree of applicability (e.g., enhances efficiency and improves auditing techniques) and poises a relatively low threat to the legitimacy of the profession. Two commentaries on the article (by Humphrey and Mauws, respectively) are also included in this issue of the journal.

“An Investigation of Australian Auditors’ Use of the Management Representation Letter,” by P. J. Carey and B. Clarke, British Accounting Review (Vol. 33, 2001): 1–21.
Auditors’ use of management representation letters is addressed in this article. The authors surveyed 174 Australian auditors to determine whether auditors use representation letters as primary audit evidence as suggested by auditing standards (e.g., to document management’s plans and intentions, as in plans to discontinue a product line) or as a tool to provide information to their clients (e.g., use the letter to clarify management’s understanding of their responsibilities and enhance management’s sense of accountability). The authors find that, consistent with professional guidance, auditors’ generally use management letters as audit evidence; however, two anomalies were noted. First, some auditors indicated doubt about the legal acceptability of management letters as primary audit evidence and, accordingly, one-third of the respondents did not use the letter to provide sole audit evidence. Second, a minority of auditors appears to over rely on the management representation letter by using it as sole audit evidence when other appropriate audit evidence is available. The authors also find that most auditors consider the management letter to be an effective way to inform management of their responsibilities.

“Auditor Concentration and Market Shares in the US: 1988-1998: A Descriptive Note,” by C. M. Wolk, S. E. Michelson, and C. W. Wootton, British Accounting Review (Vol. 33, 2001): 157–174.
This study investigates the effects of the 1989 and 1998 Big 8 (6) accounting firm mergers on the concentration for audit services in the U.S. using Herfindahl indices and other concentration ratios. In addition, the authors examine the impact on the market shares of the merged firms. The results indicate that the mergers impacted concentration and market structure in the large client audit market, with firm concentration ratios having increased significantly over the 1988–1998 period. Results differ with regard to the effects of the Big 8 mergers on individual market shares. While the merged firm of Ernst & Young was able to maintain its market share, Deloitte & Touche lost market share subsequent to the merger of DH&S and Touche Ross.

“An Analysis of Hong Kong Auditors’ Perceptions of the Importance of Selected Red Flag Factors in Risk Assessment,” by A. Majid, F. A. Gul, and J. S. L. Tsui, Journal of Business Ethics (Vol. 32, 2001): 263–274.
This study examines the perceptions of a small number of audit partners and managers in three prominent Hong Kong firms regarding the relative level of risk of fraud and material irregularities associated with six red flag factors. The quality of the auditors’ judgments were also evaluated. The participants first ranked the importance of 15 factors that proxied the existence of material misstatement. The six most important factors were identified and used in a lens model experiment that required participants to assess the likelihood of fraud or error occurring in different scenarios relating to the six selected red flags. The results indicate that misstatements in prior audits and going-concern problems were perceived as the most significant factors in alerting auditors to the risk of fraud and material irregularities. The authors attribute differences between the ranking of factors between the survey and lens model study to the role of heuristics in the survey and probabilistic functionalism in the lens model experiment.

“The Impact of Internal Auditor Compensation and Role on External Auditors’ Planning Judgments and Decisions” by F. T. DeZoort, R. W. Houston, and M. F. Peters, Contemporary Accounting Research (Vol. 18, No. 2): 257–281.
This paper investigates how external auditors use information regarding an internal auditor’s compensation plan and the type of work normally performed by the internal auditor, in assessing the amount of reliance to place on the internal auditor’s work. Seventy-six external auditors from four Big 5 public accounting firms participated in an experiment that manipulated internal auditor compensation (fixed salary vs. inventive compensation), the type of work that the internal auditors routinely perform (primarily auditing vs. primarily consulting), and audit task subjectivity (objective tests of controls vs. subjective inventory valuation). The authors find that the opportunity for internal auditors to receive incentive compensation results in less reliance on internal auditors’ work and greater budgeted audit hours on the part of the external auditor, but only for the subjective task. Although a consulting role decreases perceived internal auditor objectivity, it has a limited effect on audit planning recommendations.

“The Directional Effects of Discussion on Auditors’ Moral Reasoning” by L. Thorne and J. Hartwick, Contemporary Accounting Research (Vol. 18, No. 2): 337–361.
The authors of this paper perform an experiment using 286 public accountants to examine how discussion with peers may influence auditors’ subsequent resolution of realistic audit- specific moral dilemmas. Auditors’ professional judgments are typically made following a discussion of difficult issues with other auditors. The authors investigate if the type of discussion affects the moral reasoning of the auditor. Specifically, two types of discussion are used in the experiment. Auditors were asked to prescriptively discuss how an accountant ideally would resolve a moral dilemma, or to deliberatively discuss how an accountant actually would resolve a moral dilemma. The authors find that auditors have higher moral reasoning scores after prescriptive discussion with peers and lower moral reasoning scores after deliberative discussion with peers. These findings point to the importance of discussion of contentious dilemmas with peers and the importance of type of discussion for predicting and explaining auditors’ moral reasoning. The authors note that these results indicate the importance of informal mechanisms, such as peer discussion, as part of the social control system in audit firms.

“Market Expectations for First-Time Going-Concern Recipients” by A. D. Blay and M. A Geiger, Journal of Accounting, Auditing & Finance (Vol. 16, No. 3): 209–226.
This paper examines the market’s reaction to going-concern opinions. The authors contend that there should be no significant market reaction to going-concern opinions when the market is expecting such an opinion. However, when the going-concern opinion is not expected by the market, the authors expect to find a significant market reaction. For a sample of 121 firms the results indicate that abnormal returns, surrounding the announcement of a going-concern audit report unpartitioned on market expectations, are not significantly different from zero. The authors use the subsequent viability of the firm as a proxy for market expectations. When partitioned based on subsequent viability status, abnormal returns were significantly lower for the viable group compared to the subsequently bankrupt group. Thus, the market appears to have significantly adjusted downward their viability expectations for the subsequently viable firms, but not for the subsequently bankrupt firms, upon receipt of a first-time going-concern-modified audit report. These results were robust to controlling for several commonly used measures of market expectations. The authors interpret the results to indicate that actual subsequent bankruptcy or viability acts as a proxy for market expectations of firm performance that is not currently included in measures of market expectations developed in the literature. The authors contend that these results provide motivation for researchers to consider expanded models of market expectations for firms receiving going-concern audit reports and financially distressed firms in general.

“Professionalism vs. Commercialism: The Association Between Non-Audit Services (NAS) and Audit Independence” by D. S. Sharma and J. Sidhu, Journal of Business Finance & Accounting (Vol. 28, No. 5 and No. 6): 595–625.
The authors of this paper examine 49 bankrupt Australian public companies to determine if the provision of NAS influences the auditors’ decision to issue a going-concern qualification. The authors contend that this also indirectly addresses the impact of NAS on auditor independence. The authors use a logit model to estimate the auditor’s decision to issue a going-concern audit report in the year prior to client bankruptcy. The following variables are considered in the logit model: the proportion of non-audit service fees to total fees, financial distress, mitigating factors, client size, auditor reputation, and audit time. The authors find an inverse relationship between the auditors’ likelihood of issuing a going-concern qualification and the proportion of NAS to total fees, consistent with the possibility that NAS might impair auditor independence. However, the authors also note that there are other possible explanations for the observed relationship.

“CEO Domination, Growth Opportunities, and Their Impact on Audit Fees” by J. S. L. Tsui, B. Jaggi, and F. A. Gul, Journal of Accounting, Auditing & Finance (Vol. 16, No. 3): 189–207.
Prior research has indicated a lower incidence of financial statement frauds with companies that have “higher quality” boards. This study extends that line of research by investigating the association between a firm’s internal monitoring mechanism and its impact on the audit fee. Specifically, the paper hypothesizes that firms with independent corporate boards (chief executive officer and chairman being separate individuals) provide a more effective internal monitoring mechanism and are thus associated with lower control risk, resulting in lower audit effort and fees as compared to nonindependent, CEO-dominated boards. The authors also examine whether the effectiveness of the internal monitoring mechanism provided by independent corporate boards is independent of the firm’s growth opportunities. High-growth firms are more difficult to monitor due to the existence of discretionary investments and measurement problems associated with future assets. Thus, the authors hypothesize that the negative association between independent corporate boards and audit fees is expected to be affected by a firm’s growth. Using a sample of 650 observations from Hong Kong companies, the authors find support for both hypotheses.

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