Have You Seen...?

Dennis M. O'Reilly
Xavier University
Brad Reed,
Southern Illinois University-Edwardsville
John T. Reisch
East Carolina University

"An Analysis of Group Influences on Going Concern Audit Judgments," by S. S. Ahlawat and T. J. Fogarty, Advances in Accounting Behavioral Research (Vol. 6, 2003): 27–51.

This study uses a going concern task to investigate whether group dynamics can mitigate judgment bias in an audit setting. The experiment used experienced auditors who made a series of judgments about a firm’s going concern (GC) status and recommended the type of report to issue. Judgments were made privately by individuals or collaboratively in groups. The results indicate the judgments of auditors working in groups are less influenced by the order in which information is received and evaluated than those working individually. More specifically, the recency effects of individual decision makers were not present for the same judgments made by groups. Group responses were less extreme and exhibited greater confidence than those of individuals.

"Continuing Dangers of Disinformation in Corporate Accounting Reports," by E. Kane, Review of Financial Economics (Vol. 13, 2004): 149–164.

This paper is critical of what the author argues is the special treatment that the accounting profession has received from the Congress and SEC on regulatory issues. The author argues that external auditing firms earn substantial profits from lending credibility to "loophole-ridden measurement principles that conceal adverse developments from outside stakeholders" and that they lobby regulatory agencies to protect these profits. He further argues that although the Sarbanes-Oxley Act now requires top corporate officers to attest to the "economic accuracy" of their financial reports, this requirement was not extended to outside auditors resulting in a significant asymmetry in obligations and exposure to penalties.

"Institutional Ownership and the Selection of Industry Specialist Auditors," by U. Velury, J. T. Reisch, and D. O’Reilly, Review of Quantitative Finance and Accounting (Vol. 21, No. 1, 2003): 35–48.

This study provides evidence linking corporate governance mechanisms to the choice of audit quality. The authors theorize and test an association between the level of institutional ownership of corporations and the selection of higher-quality audits by those corporations. Institutional investors are likely to invest in companies with high audit quality and to demand higher levels of audit quality in the companies in which they invest. Using audit firm industry specialization as a proxy for audit quality, the results indicate that demand for audit quality is positively associated with the level of institutional ownership of the corporation.

"The Effect of Constrained Processing on Auditor’s Judgments," by V. B. Hoffman, J. R. Joe, and D. V. Moser. Accounting, Organizations and Society (Vol. 28, No. 7/8, 2003): 69–714.

The authors examine the effects of manipulating the processing conditions of experienced and inexperienced auditors in going concern judgments. In the constrained condition, auditors processed information in a pre-established sequence and were not allowed to refer back to and reorganize the information. In the unconstrained condition, the information was presented simultaneously and the auditors were allowed to process the information as they chose. The study finds that when the processing of experienced auditors is constrained, they perform similar to inexperienced auditors. When unconstrained, the experienced auditors applied their usual processing strategies and their judgments reflected their expert processing; specifically, the experienced auditors were able to attend to more mitigating evidence in the unconstrained condition. The going concern judgments of the inexperienced auditors did not differ across the conditions.

"An Investigation of the Pricing of Audit Services for Financial Institutions," by L. P. Fields, D. R. Fraser, and M. S. Wilkins. Journal of Accounting and Public Policy (Vol. 23, No. 1, 2004): 53–77.

In this study, the authors investigate audit pricing for financial institutions by modifying standard fee models for industrial companies by incorporating measures of risk and complexity for banks. Using a sample of 277 banks in fiscal 2000, the authors find that firms charge higher fees for banks having more transaction accounts, higher degrees of credit and capital risk, less operational efficiency, and greater involvement in acquisition activity. They also find that banks with more transparent asset portfolios received fee discounts, while entities identified as savings institutions were charged significant premiums relative to other banks. Additionally, the results indicate that because no single auditing firm dominates the banking industry, the top bank auditors were unable to earn fee premiums for their presumably specialized services.

"A Structural Equation Model of Auditors’ Professional Commitment: The Influence of Firm Size and Political Ideology," by J. T. Sweeney, J. J. Quirin, and D. G. Fisher. Advances in Accounting Behavioral Research (Vol. 6, 2003): 3–25.

This study investigates five factors posited to affect auditors’ professional commitment (PC), where PC is measured using a 15-item scale adapted from an organizational commitment questionnaire. The findings show a negative association between PC and firm size suggesting smaller firms tend to have employees who possess higher levels of professional commitment. The model also finds that the PC of politically conservative auditors is higher than that of liberal auditors suggesting that political ideology is an influential socialization variable in public accounting. In addition, the authors find a positive relationship between position and professional commitment; specifically, that auditors employed at higher levels exhibit higher levels of PC, although the relationship is not linear. Two factors not found to have a significant association with PC were gender and ethical development (measured as DIT P scores).

"The Effect of Training on Auditors’ Acceptance of an Electronic Work System," by J. C. Bedard, C. Jackson, M. L. Ettredge, and K. M. Johnstone, International Journal of Accounting Information Systems (Vol. 4, 2003): 227–250.

Using data from a large audit firm that was introducing a new electronic workpaper system, the researchers study the role of users’ perceptions of computer and task self-efficacy in system acceptance associated with training. The audit firm provided intensive hands-on training to both preparer and reviewer level employees. The study found that training is associated with shifts in preparers’ perceptions of their task and computer self-efficacy but reviewers’ self-perceptions did not change on average. The results suggest that when training is successful at shifting perceptions, an important mechanism through which training improves system acceptance is through its effect on users’ views of both their task and computer self-efficacy.

"Can Financial Ratios Detect Fraudulent Financial Reporting?" by K. A. Kaminski, T. S. Wetzel, and G. Liming, Managerial Auditing Journal (Vol. 19, 2004): 15–28.

This exploratory study involved comparing the financial ratios of 79 companies known to have committed fraud with 79 matched nonfraudulent companies during a period surrounding the fraud year. Out of the 21 ratios examined, 5 were significant during the period prior the fraud year. The results, however, suggest that ratios are of limited use in predicting fraudulent financial reporting. A discriminant prediction model misclassified fraud firms from 58 percent to 98 percent of the time.

"Dimensions of Pressures Faced by Auditors and Its Impact on Auditors’ Independence: A Comparative Study of the USA and Australia," by A. Umar and A. Anandarajan, Managerial Auditing Journal (Vol. 19, 2004): 99–116.

Case studies involving an auditor/client conflict situation were mailed to auditors in both the USA and Australia. Participants’ responses suggest that auditors’ independence of judgment is affected when subjected to pressures. Factor analysis indicates that the pressures that were identified in prior research fall into two dimensions: pressure to retain the client and pressure to conform. In this study, pressure to retain the client had greater influence than did pressure to conform. Further, the results suggest that the underlying dimensions of the pressures are similar for the auditors in these two countries.

"Audit Fee Determinants and Auditor Premiums: Evidence from the Micro-Firm Sub-Market," by M. J. Peel and R. Roberts, Accounting & Business Research (Vol. 33, No. 3, 2003): 207–233.

This paper provides theory and evidence relating to audit pricing for smaller audit clients. The sample is drawn from the smallest companies operating in the U.K. manufacturing sector (i.e., manufacturing firms employing fewer than 10 employees), which are known as micro-firms. A key finding of the study is that, in the highly competitive market under consideration, independent small audit clients willingly paid a premium to be audited by a Big 6 auditor. The authors also find that the fee premium existed (although to a smaller extent) for midtier audit firms. The authors conclude that the fee premium is attributable to the perceived higher quality audits conducted by large auditors, for which small firms are willing to pay a premium to obtain associated reputational and signaling benefits. The authors find that, consistent with studies of larger firms, corporate size is found to be a key driver of audit fees.

"Audit Quality, Earnings, and the Shanghai Stock Market Reaction," by F. A. Gul, S. Y. J. Sun, and J. S. L. Tsui, Journal of Accounting Auditing & Finance (Vol. 18, No. 3, 2003): 411–428.

This study examines whether audit quality in the Shanghai Stock Exchange affects the positive association between change in earnings per share and a firm’s cumulative abnormal return. The authors find that the positive market reaction to an increase in earnings is stronger for firms audited by high-quality auditors. While most studies in the U.S. have identified Big 5 auditors as high-quality auditors, this classification cannot be used in China, because many companies are audited by domestic CPA firms. The authors use market share of CPA firms to proxy for audit quality and conclude that audit quality plays an important role in China and that investors in the Shanghai market differentiate between high- versus low-quality auditors.

"Congress Enacts Sarbanes-Oxley Act of 2002: A Two-Ton Gorilla Awakes and Speaks," by J. Wiesen, Journal of Accounting Auditing & Finance (Vol. 18, No. 3, 2003): 429–449.

This article describes the Sarbanes-Oxley Act and compares the Sarbanes-Oxley Act to the Federal Securities Acts. The article provides interesting insights into the Sarbanes-Oxley Act; for example, the author notes that lawyers had managed to stay out of the securities laws for 70 years, but the Sarbanes-Oxley Act places a whistle-blowing responsibility on lawyers. Lawyers now have to report to the CEO or the board "evidence of a material violation of securities law or breach of fiduciary duty." Another interesting aspect of the Sarbanes-Oxley Act is the series of studies commissioned by the Act. The author notes that there never has been, nor is there likely to be, other legislation requiring so much homework. For example, the Act requires the SEC to study its enforcement actions over the previous five years "to identify areas of reporting that are most susceptible to fraud, inappropriate manipulation, or inappropriate earnings management, such as revenue recognition and the accounting treatment of off-balance sheet special purpose entities."

"Exploring the Term of the Auditor-Client Relationship and the Quality of Earnings: A Case for Mandatory Auditor Rotation?" by J. N. Myers, L. A. Myers, and T. C. Omer, The Accounting Review (Vol. 78, No. 3, 2003): 779–799.

This study examines the relationship between auditor tenure and audit quality. Prior research has not examined this issue in detail, and it has been a hot political topic because Sarbanes-Oxley requires the Comptroller General to study the issue. The authors measure audit tenure as the number of years of the auditor-client relationship. The proxy for audit quality is abnormal discretionary accruals, consistent with prior financial reporting research. The results suggest that auditors place greater constraints on both abnormal income-increasing and income-decreasing accruals as auditor tenure increases. That is, these accruals decrease with longer audit tenure. The authors conclude that audit and earnings quality do not appear to decline with audit tenure. These results are robust to firm size, age, and cash flow performance.

"An Examination of Memory Conjunction Errors in Multiple Client Audit Environments," by D. L. Lindberg and M. M. Maletta, Auditing: A Journal of Practice & Theory (Vol. 22, No. 1, 2003): 127–141.

This study examines whether memory on an audit is adversely impacted by a previous audit. Because auditors work on several audits at the same time, a problem may arise if their memory reconstruction process from a current audit recalls items from a previous audit. An experiment was conducted in which auditors first evaluated audit work performed on the inventory account for two separate companies. Next, auditors were given recognition tests for one (the target) company. These tests included features from the target company, the nontarget company, and features that were not included in any of the previous two company descriptions. The authors manipulated inherent risk (high/low) and similarity between target and nontarget companies (similar/dissimilar). The results suggest that auditors commit significantly more recognition errors when audit evidence that is recalled from an unrelated audit is consistent with features of the target company as opposed to when evidence is inconsistent. The authors propose several strategies for audit firms to address this issue during audits.

"Risk Management in Client Acceptance Decisions," by K. M. Johnstone and J. C. Bedard. The Accounting Review (Vol. 78, No. 4, 2003): 1003–1025.

This paper examines whether auditors apply risk-management strategies to bring the risk/return levels of prospective high-risk clients to acceptable levels. The authors use data from a large audit firm on client acceptance decisions made in actual practice. The authors propose a theory and a conceptual model of the client-acceptance process and then test the model using the data from this audit firm. The results suggest that auditors employ risk-management strategies to retain clients that would otherwise be too risky or provide an inadequate return. Auditors employ one of two risk-management strategies, depending on the type of risk: auditors charge higher billing rates when the audit client is a higher going-concern risk or is a public firm and assign specialist personnel when the audit client has a high risk of errors and/or fraud. The authors discuss how these results can help clarify recent research on audit firm portfolio management decisions.

"A Longitudinal Field Investigation of Auditor Risk Assessments and Sample Size Decisions," by R. J. Elder and R. D. Allen, The Accounting Review (Vol. 78, No. 4, 2003): 983–1002.

This study examines changes in auditor risk assessments and sample sizes between 1994 and 1999. The data over this five-year interval was collected from three large accounting firms. While prior research has examined the relationship between risk assessments and planned audit hours, it has not examined whether such assessments are associated with the extent of evidence (i.e., sample size). Consistent with the audit risk model, the results suggest that a significant relationship exists between inherent and control risk assessments and sample size. This result was more pronounced in the earlier years of the 1994–1999 time period. The authors also found that risk assessments and sample sizes decreased during this time period. Follow-up discussions with personnel at the three firms suggest that this decrease may in part be attributable to increased competition among audit firms.

"Materiality Uncertainty and Earnings Misstatement," by E. Patterson and R. Smith, The Accounting Review (Vol. 78, No. 2, 2003): 819–846.

The authors examine a game-theoretic model of the auditor/client relationship in which the materiality threshold is uncertain. They find that increasing the uncertainty about whether an earnings misstatement is material induces conservatism on the part of the auditor. This, in turn, induces the client to limit earnings misstatements. Audit risk, however, may increase or decrease as a result, because the change in auditor strategy may not fully compensate for the overall increase in risk.

The Assessment of Task Structure, Knowledge Base, and Decision Aids for a Comprehensive Inventory of Audit Tasks, by M. J. Abdolmohammadi and C. A. Usoff (Quorum Books, 2001).

The authors develop, from several different sources, a comprehensive inventory of audit tasks organized by phase of the audit. For each task, highly experienced auditors assessed the level of structure of the task, the amount of experience required to perform the task independently, and the type of decision aid that might be suitable to support the task. The results of these recent assessments for 433 audit tasks were compared to similar assessments made by auditors for a smaller number of tasks in Abdolmohammadi’s (1999) study. Also, while Abdolmohammadi (1999) collected data on rank of the auditor required to perform the task, this study collected years of experience and the number of supervised instances of practice before an auditor is viewed as qualified to perform the task. The comprehensive reporting of these audit task assessments provide useful data for auditing researchers, students, and professionals to better understand the nature of, and knowledge requirements for, audit tasks at a detailed level.

Finally, the latest issue of the IIA Educator newsletter is available online: http://www.theiia.org/newsletter/index.cfm?iid=238

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