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Troy Hyatt, Seattle University,
and Brad Reed, Southern Illinois University–Edwardsville

“The Effects of Experience and Explicit Fraud Risk Assessment in Detecting Fraud with Analytical Procedures,” by C. A. Knapp and M. C. Knapp, Accounting, Organizations and Society, (Vol. 26, No. 1, 2001): 25–37.
This paper reports on the results of an experiment designed to examine the effects of audit experience and explicit fraud risk assessment instructions on auditors’ ability to use analytical procedures to effectively assess the risk of fraudulent financial reporting. Fifty-seven audit managers and 62 seniors from six international CPA firms participated in the experiment (which was conducted prior to the issuance of SAS No. 82 that requires explicit fraud-risk assessments). The experiment used a 2 × 2 × 2 between-subjects design with two experience levels (senior and manager), the presence vs. absence of fraud in the financial statements evaluated by participants, and the presence vs. absence of explicit instructions in the case materials that asked auditors to perform preliminary analytical procedures with the specific objective of assessing the risk that financial statement fraud was present in the financial statements (auditors in the no- explicit-instructions condition were simply asked to perform preliminary analytical procedures). The financial statements used in the case were based on an actual company that had issued fraudulent financial statements that were subsequently restated and reissued under requirements of the SEC. Results indicate that managers were more effective in using the analytical procedures to assess the risk of financial statement fraud than were seniors (i.e., managers assessed the risk of fraud as high when fraud was present and low when fraud was absent, while the seniors’ risk assessments did not significantly differ between the two conditions). In addition, results show that auditors’ fraud-risk assessments were more effective when they were explicitly instructed to perform preliminary analytical procedures with the objective of assessing the risk of financial statement fraud than when they were not so instructed. Finally, the participants who made the most effective fraud risk assessments were the managers who were given the explicit instructions.

“The Effect of a Bidding Restriction on the Audit Services Market,” by K. Hackenbrack, K. L. Jensen, and J. L. Payne, Journal of Accounting Research, (Vol. 38, No. 2, 2000): 355–374.
This paper investigates the audit price and quality effects of a Florida law that existed between 1969 and 1992 that required nonprice competition and prohibited price competition among auditors. Essentially, the law required auditees to rank order prospective auditors based on nonprice preference factors and then negotiate a contract (including fee) only with the highest ranked auditor. The stated purpose of the law was to ensure that auditees contracted with auditors based on ability instead of price. The authors examined data from 675 municipal audits (141 in Florida and 534 from other southeastern states that did not restrict bidding). The municipal audit market was selected because these auditees are located entirely within relevant regulatory jurisdictions. Results indicate that municipalities in Florida (the bidding-restricted market) paid higher audit fees than municipalities in states without bidding restrictions. Additionally, Florida municipalities, on average, engaged larger audit firms, engaged more specialized auditors (as measured by the number of municipal clients audited by the firms), and were more likely to receive recognition for excellence in financial reporting than municipalities in other states. The authors conclude that the bidding restrictions in Florida created an environment that impeded the entry of lower quality and lower priced auditors and induced the entry of higher quality and higher priced auditors.

“The Meaning of a Defined Accounting Concept: Regulatory Changes and the Effect on Auditor Decision Making,” by J. J. F. Hronsky and K. A. Houghton, Accounting, Organizations and Society, (Vol. 26, No. 2, 2001): 123–139.
This study reports on the results of an experiment designed to assess whether the change in definition of “extraordinary items” in Australian accounting standards affects auditor decision making. The old definition was criticized for being not specific enough and thereby allowing too much flexibility in its interpretation. The new definition added an important phrase that states items classified as extraordinary cannot be of a recurring nature. Forty auditors who had at least three years of experience (and a mean of five years) and worked for four of the Big 6 firms in Australia participated in the experiment. Subjects were provided with either the old or new definition of extraordinary items and then were asked to make a decision as to whether 10 different situations should be classified as either an operating item or an extraordinary item. Subjects also completed a semantic differential to ascertain their meaning of the extraordinary item definition they were provided. Results indicate that the measured connotative meaning of the old and new definitions were significantly different. Also, there was a significant difference in the classification decisions (extraordinary vs. operating) for 4 of the 10 cases. Results show that the change in classification decision was influenced by the variability in measured meaning of the extraordinary item definition provided. The authors suggest that their experimental approach could also be used to evaluate the potential impact of proposed accounting standard changes.

“Modeling the Audit Opinions Issued to Bankrupt Companies: A Two-Stage Empirical Analysis,” by J. R. Casterella, B. L. Lewis, and P. L. Walker, Decision Sciences, (Vol. 31, No. 2, 2000): 507–530.
Auditors have the responsibility to determine whether they believe their clients will continue as a going concern during the next year. Consequently, users and regulators often believe that an audit failure has occurred if an unmodified opinion is issued for a company that subsequently files for bankruptcy within one year. Prior research has shown that the audit opinion is not a reliable predictor of bankruptcy filings. However, after companies file for bankruptcy there usually is a period of reorganization, and after this period companies either liquidate or reemerge for business. The authors contend that if reorganization through bankruptcy can be viewed as not violating the going-concern assumption, then perhaps auditors may be “exonerated” for issuing an unmodified opinion for those companies that successfully reorganize. Building on prior research, the authors develop an audit opinion prediction model and test it using 100 companies that filed for bankruptcy between 1982 and 1992. Consistent with prior studies, the authors find that the audit opinion does not predict bankruptcy filings. Contrary to expectations, results also indicate that the audit opinion does not predict bankruptcy resolutions.

“Determinants of Audit Fees: Evidence from the Companies Listed in Bahrain,” by P. L. Joshi and H. Al-Bastaki, International Journal of Auditing, (Vol. 4, July, 2000): 129–138.
Although many studies have examined the determinants of audit fees in a variety of Anglo-Saxon countries, none has examined this issue in a Middle Eastern country. The purpose of this paper is to examine audit fee determinants in Bahrain. Results are based on all 38 companies that are listed on the Bahrain Stock Exchange. The study’s results confirm those found in other countries. Specifically, audit fees in Bahrain are positively associated with client size (log of total assets), client risk (long-term debt to total assets), the complexity of client operations (clients with foreign operations), and client profitability (return on assets). However, no association was found between audit fees and the timing of the client’s fiscal year end. The paper concludes by offering suggestions for future research.

“The Association of Formal and Informal Public Accounting Mentoring with Role Stress and Related Job Outcomes,” by R. E. Viator, Accounting, Organizations and Society, (Vol. 26, No. 1, 2001): 73–93.
This study investigates the associations between mentoring (formal and informal), three measures of role stress (role conflict, role ambiguity, and perceived environmental uncertainty), and two measures of job outcomes (job performance and turnover intentions). The relationships are examined using structural equation modeling based on survey responses received from 794 auditors (seniors through senior managers) from the Big 6 and other national firms in the U.S. Some of the study’s more significant findings are as follows. Results indicate that auditors who have informal mentors consistently report lower levels of role ambiguity. However, results are mixed for the effects of informal mentors on auditors’ reported role conflict and perceived environmental uncertainty (for some subgroups of respondents these role stress measures decreased, but for other subgroups they increased). Auditors who have informal mentors also reported higher job performance compared to auditors without a mentor. The study also found limited positive effects due to formal mentors.

“An Experimental Study of Auditor Analytical Review Judgments,” by K. Z. Lin, I. A. M. Fraser, and D. J. Hatherly, Journal of Business Finance & Accounting, (Vol. 27, No. 7 and No. 8, 2000): 821–857.
This study examines auditors’ analytical review judgments. The authors investigate how auditors’ analytical review judgments are influenced by factors that are listed in the U.K. standard SAS No. 410 that guides the auditors’ performance of analytical review. The authors use a within-subject repeated measures experiment to determine the auditors’ reaction to changes in five independent variables. The auditors’ response is measured with two dependent variables, the likelihood of material error and audit hours. The authors designed the experiment to contrast the importance of configural (expectation) effects with the importance of the independent variables listed in the auditing standard. The authors find that the independent variables listed in the auditing standard are much more important than the configural effects in explaining the auditors’ analytical review judgments.

“Do Companies Successfully Engage in Opinion Shopping? Evidence from the U.K.,” by C. Lennox, Journal of Accounting and Economics, (Vol. 29, 2000): 321–337.
Prior research has noted that audit reports do not generally become more favorable after companies switch auditors, leading some to argue that companies do not successfully engage in opinion shopping. However, most prior research has compared pre- and post-switch audit reports while this study tests for opinion shopping by predicting the opinions companies would have received had they made opposite switch decisions. The paper has two key findings. First, auditor changes occur more often after companies receive modified opinions. Second, switching auditors increases the probability of a change in audit opinion. These two results imply that companies receive modified reports less frequently than they would under opposite switch decisions. While observed audit opinions do not generally improve, the reports companies would have received under opposite switch decisions are predicted to be significantly less favorable, suggesting that companies do successfully engage in opinion shopping.

“The Effects of Industry Specialization on Auditors’ Inherent Risk Assessments and Confidence Judgements,” by M. H. Taylor, Contemporary Accounting Research, (Vol. 17, No. 4, 2000): 693–712.
The author of this study examines how auditor risk assessments for a bank differ between a group of banking specialist auditors and an equally experienced group of nonbanking auditors. The study gathers risk assessments for these two groups of auditors for two different accounts. The first account, loans receivable, is an industry-specific account while the second account, property plant and equipment, is a nonindustry-specific account. The author finds that for the industry-specific account the nonbanking auditors are more conservative in assessing inherent risk than are the banking auditors. For the nonindustry-specific account, the difference between risk assessments for the two groups of auditors is not as great. Because of the importance of inherent risk assessments in planning an audit, the author notes that the observed difference in risk assessments is likely to lead to different audit approaches. The study also finds that the nonbanking auditors are less confident in their risk assessments than are the banking auditors, even for the nonindustry-specific account of property, plant, and equipment.

“Auditor Quality and the Accuracy of Management Earnings Forecasts,” by P. M. Clarkson, Contemporary Accounting Research, (Vol. 17, No. 4, 2000): 595–622.
A sample of one-year ahead management earnings forecasts, included in IPO prospectuses from the Toronto Stock Exchange, is analyzed to determine forecast accuracy. Forecast accuracy is then analyzed to investigate the association between auditor quality and forecast accuracy and also the association between forecast accuracy and the type of assurance (audit or review) provided by the auditor. Contrary to prior research, the authors find that after controlling for business risk, the relationship between forecast accuracy and auditor quality is not significant for review-level assurance engagements. However, when data from the audit-level assurance regime is analyzed it is found that Big 6 auditors are associated with smaller absolute forecast errors than non-Big 6 auditors.

“Auditors’ Recognition and Disclosure Materiality Thresholds: Their Magnitude and the Effects of Industry,” by E. R. Iselin and T. M. Iskandar, British Accounting Review, (Vol. 32, No. 3, 2000): 289–309.
The objective of this research is to study auditors’ recognition and disclosure thresholds within the context of industry, which is divided into the industry of the firm and the industry specialization (experience) of the auditor. The study uses a judgmental experiment to study the individual judgments about losses from a decline in the market value of land and buildings. The authors find that auditors have a recognition threshold that is lower than their disclosure threshold. The mean disclosure threshold is 8.7 percent of net profit, while the mean recognition threshold is 5.7 percent. The study finds that the thresholds of specialists in the higher risk finance industry were lower than thresholds of specialists in the lower risk retail industry. Thus, in the higher risk industry more information is available for decision-making purposes. Finally, auditors appear to use the thresholds from the industry in which they specialize in an industry in which they do not specialize, where the thresholds may be inappropriate.

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