bluuebunny/crossref_metadata_2025 huggingface dataset:
Auditors' Evaluation of Evidence Obtained Through Management Inquiry: A Cascaded-Inference Approach
Authors: Haynes Christine M.
Published: April 2008

This study uses the cascaded-inference paradigm to investigate how auditors evaluate evidence received during management inquiry. Contrary to predictions made by cascaded-inference theory, results indicate that auditors are relatively more sensitive to source-related uncertainties than evidence-related uncertainties when evaluating information provided by client management. In addition, management-provided evidence has less impact on auditors' beliefs than on nonauditors' beliefs. Finally, results also suggest that, under certain conditions, auditors may fail to recognize the value of information received during management inquiry.
The Role of Auditee Profitability in Pricing New Audit Engagements
Authors: Walker Paul L. , Casterella Jeffrey R.
Published: April 2008

This paper examines the role of auditee profitability in pricing new audit engagements. Changes in the auditing environment are noted that suggest that auditors are managing their practices differently than they did in prior years. Audit fees are examined to answer two questions: (1) whether CPA firms still discount fees for new engagements in the current audit environment; (2) whether such fee discounts are dependent upon auditee profitability. The results suggest that auditors still discount new engagements in the 1990s, but that they are less willing to offer discounts when auditees show losses in the year prior to the new audit engagement. Further, this result is stronger for companies that switch from non-Big 6 firms to Big 6 firms than it is for intra-Big 6 switches. These findings suggest that auditors are managing their exposure to audit risk by adjusting audit fees.
Inherent Risk and Control Risk Assessments: Evidence on the Effect of Pervasive and Specific Risk Factors
Authors: Messier William F. , Austen Lizabeth A.
Published: April 2008

This paper reports on a study that examines the effect of pervasive and specific risk factors on auditors' inherent risk and control risk assessments in an experimental setting. Two hypotheses concerning the significance of inherent and control risk factors on auditors' inherent risk (IR) and control risk (CR) assessments were tested by having 124 senior auditors and managers provide risk assessments on eight cases. The results show that the pervasive and specific risk factors included in the experiment were significant to both the auditors' IR and CR assessments. For the case used in this study, there was a significant positive association between auditors' IR and CR assessments. Taken together, these findings are consistent with Waller's (1993) notion of a knowledge-based dependency between IR and CR assessments. The findings are not consistent with Kinney's (1989) reformulation of the (IR×CR) component of the audit risk model.
Auditor Selection and Audit Committee Characteristics
Authors: Abbott Lawrence J. , Parker Susan
Published: April 2008

The role of the audit committee in corporate governance is the subject of increasing public and regulatory interest. We focus on one frequently noted function of the audit committee: auditor selection. We argue that independent and active audit committee members demand a high level of audit quality because of concerns about monetary or reputational losses that may result from lawsuits or SEC sanction. Auditors who specialize in the client's industry are expected to provide a higher level of audit quality than do nonspecialists. Thus, we predict that firms with audit committees that are both independent and active are more likely to employ an industry-specialist auditor.

We find that firms with audit committees that do not include employees and that meet at least twice per year are more likely to use specialists. This study contributes to our understanding of audit committee functions and provides evidence that industry specialization is an important element of auditor selection.
Long-Term Trends in Audit Fees
Authors: Menon Krishnagopal , Williams David D.
Published: April 2008

The audit fees literature contains little by way of systematic evidence on long-term trends in audit fees. This study analyzes trends in audit fees from 1980 through 1997, adjusting for changes in client size, complexity, and risk.

The sample is restricted to clients of Big 6 firms that voluntarily disclosed audit fees in the period 1980–1997. Evidence is found that audit fees increased in the 1980s but stayed flat in the 1990s. Most important, a significant increase is noted in 1988, the year in which the Auditing Standards Board issued the “expectation gap” standards. These results hold even after controlling for wage increases in accounting firms, suggesting an expansion of auditing effort. There is no evidence that auditors obtain any price premium from industry specialization. The 1989 Big 8 mergers appear to have had a short-term, but not long-term, effect on fees. Finally, the magnitude of the audit fee model coefficient for accounts receivable and inventory has declined over the period, presumably due to productivity improvements.
Additional Evidence on Audit Report Lag
Authors: Knechel W. Robert , Payne Jeff L.
Published: April 2008

The process for providing accounting information to the public has not changed much in the last century even though the extent of disclosure has increased signifi-cantly. Sundem et al. (1996) suggest that the primary benefit of audited financial statements may not be decision usefulness but the discipline imposed by timely confirmation of previously available information. In general, the value of information from the audited financial statement will decline as the audit report lag (the time period between a company's fiscal year end and the date of the audit report) increases since competitively oriented users may obtain substitute sources of information. Furthermore, the literature on earnings quality and earnings management suggests that unexpected reporting delays may be associated with lower quality information.

The purpose of this paper is to extend our understanding about the determinants of audit report lag using a proprietary database containing 226 audit engagements from an international public accounting firm. We examine three previously uninvestigated audit firm factors that potentially influence audit report lag and are controllable by the auditor: (1) incremental audit effort (e.g., hours), (2) the resource allocation of audit team effort measured by rank (partner, manager, or staff), and (3) the provision of nonaudit services (MAS and tax). The results indicate that incremental audit effort, the presence of contentious tax issues, and the use of less experienced audit staff are positively correlated with audit report lag. Further, audit report lag is decreased by the potential synergistic relationship between MAS and audit services.
The Effects of Small Monetary Incentives on Response Quality and Rates in the Positive Confirmation of Account Receivable Balances (Retracted)
Authors: Engle Terry J. , Hunton James E.
Published: April 2008

The AICPA has indicated that the use of small monetary incentives might be an effective technique for improving confirmation response rates. A significant body of accounting and nonaccounting research supports the AICPA's position; however, studies in marketing and public opinion polling suggest that the quality of survey-based responses can either increase or decrease with the use of monetary incentives. Existing auditing research has not looked at the potential effect of monetary incentives on response quality in the context of confirming account receivable balances. This study was designed to investigate this important issue.

In this field experiment, four large, independent newspaper organizations mailed a total of 7,200 trade accounts receivable confirmations. The experiment employed a three (no misstatement, understatement, and overstatement) by three (no incentive, quarter, and dollar) between-subjects, full-factorial design. Consistent with prior research, the use of monetary incentives improved response rates in all misstatement conditions and response quality was higher for overstated, when compared to understated, accounts. However, monetary incentives did not close the quality gap between overstated and understated accounts and, surprisingly, the use of incentives was associated with an overall decrease in response quality.
The Effectiveness of Increasing Sample Size to Mitigate the Influence of Population Characteristics in Haphazard Sampling
Authors: Hall Thomas W. , Herron Terri L. , Pierce Bethane Jo , Witt Terry J.
Published: April 2008

Over 40 years ago both Deming (1954) and Arkin (1957) expressed concerns that the composition of samples chosen through haphazard selection may be unrepresentative due to the presence of unintended selection biases. To mitigate this problem some experts in the field of audit sampling recommend increasing sample sizes by up to 100 percent when utilizing haphazard selection. To examine the effectiveness of this recommendation 142 participants selected haphazard samples from two populations. The compositions of these samples were then analyzed to determine if certain population elements were overrepresented, and if the extent of overrepresentation declined as sample size increased.

Analyses disclosed that certain population elements were overrepresented in the samples. Also, increasing sample size produced no statistically significant change in the composition of samples from one population, while in the second population increasing the sample size produced a statistically significant but minor reduction in overrepresentation. These results suggest that individuals may be incapable of complying with audit guidelines that haphazard sample selections be made without regard to the observable physical features of population elements and cast doubt on the effectiveness of using larger sample sizes to mitigate the problem. Given these findings, standard-setting bodies should reconsider the conditions under which haphazard sampling is sanctioned as a reliable audit tool.
On Audit Committee Appointments
Authors: Vafeas Nikos
Published: April 2008

This study examines determinants of audit committee appointment by comparing characteristics of 262 nonexecutive directors appointed to corporate audit committees between 1995 and 1998 with characteristics of 262 nonexecutive, age-matched control directors. The likelihood of audit committee appointment is found to increase with the degree of outside director independence, and decrease with compensation committee membership, other committee memberships, and the length of board tenure. Importantly, audit committee appointments are unrelated to the amount of stock owned by directors and the number of other directorship posts they hold. Together, these results highlight several director attributes beyond affiliation that could be important in guiding director decisions and suggest the need for further research toward understanding the quality of audit committee appointments.
Board Independence and Audit-Firm Type
Authors: Beasley Mark S. , Petroni Kathy R.
Published: April 2008

This paper investigates the role of outside members of the board of directors in the choice of external auditor for property-liability insurance companies. Consistent with our hypothesis that we derive from theories of both corporate governance and audit quality, we find that the likelihood of an insurer employing a brand name auditor that specializes in the insurance industry is increasing in the percentage of the members of the board of directors that are considered outsiders. However, we do not find a significant association between board composition and the choice of using a nonspecialist brand name (Big 6) auditor and a nonbrand name auditor, suggesting specialization is considered to be important, but not brand name in this setting.
The Effects of Judgments of New Clients' Integrity upon Risk Judgments, Audit Evidence, and Fees
Authors: Beaulieu Philip R.
Published: April 2008

Client integrity concerns auditors when they plan new audit engagements because it is related to both fraud risk and the source credibility of clients. Auditors may increase audit work and fees when they judge integrity to be below normal. In an experiment, a sample of 63 Canadian audit partners read information about a prospective audit client, including information about the client's CFO. This information was manipulated to support a judgment of either high or low integrity. As hypothesized, judgments of client integrity were negatively related to risk judgments, audit evidence extent recommendations (indirectly through risk judgments), and fee recommendations (indirectly through risk judgments and extent recommendations).
Profitability Regulation, Earnings Management, and Modified Audit Opinions: Evidence from China
Authors: Chen Charles J. P. , Chen Shimin , Su Xijia
Published: April 2008

This study, using data from the Chinese stock market, investigates the relationship between earnings management induced by profitability regulation and modified audit opinions (MAOs). We review recent developments in the accounting profession and in independent auditing to foster an understanding of the environment in which Chinese auditing operates. Based on annual reports published by listed companies from 1995 to 1997, we analyze the underlying reasons for MAOs. Our test results show a significant association between receiving MAOs and reporting profits marginally above the target levels specified in stock de-listing and rights offering regulations. Our findings are consistent with the notion that asymmetric profitability requirements exacerbate managers' propensity to engage in earnings management, which in turn is positively associated with receiving MAOs. Though based on Chinese data, our findings are of general interest because they address a fundamental issue of trade-offs between expected costs and expected benefits in deciding whether to avoid MAOs in a transitional economy.
Feasibility and Economics of Continuous Assurance
Authors: Alles Michael G. , Kogan Alexander , Vasarhelyi Miklos A.
Published: April 2008

Given the growing interest in the topic, both in practice and academia, it is timely and important to examine the concept of continuous assurance (CA) and the possible paths along which such services will evolve. There has been a tendency to see CA purely from the point of view of its technological enablers. As such, it has virtually been taken for granted that CA will follow as a matter of course. What has been less thought through is the business architecture that must underlie CA. In particular, we show that the key driver of CA is the demand for it. While there may be many economic transactions between the company and its stakeholders that could benefit from the provision of CA, there is no guarantee that CA is either cost effective—the only way of enhancing efficiency—or actually has to be continuous. Other factors that will affect the development of CA are the need for a new infrastructure to pay for it, as well as concerns about the independence of the assurors. We also identify some important research issues.
The Timing and Information Content of Auditors' Exhibit Letters Relating to Auditor Changes
Authors: Krishnan Jayanthi
Published: April 2008

This study examines auditors' exhibit letters that are filed as part of reporting requirements for auditor changes. The two other reporting requirements (an initial 8-K filing by the client and the AICPA notification letter sent by the auditor) have been the subject of prior work (Schwartz and Soo 1996a; Ettredge et al. 2001). The auditor's exhibit letter, in which the auditor is required to comment on client disclosures in the initial 8-K, is intended to ensure accurate reporting by the client particularly on potentially troublesome conditions such as reportable events, disagreements, and resignations. I investigate the content, timeliness, and informativeness of the auditors' letters. The results indicate a low incidence of inconsistencies between the initial 8-K and the auditor's letter, and a low degree of noncompliance with the timing requirements suggesting that the auditor's exhibit letter contributes positively to the monitoring of corporate disclosures concerning auditor changes. Importantly, a relatively high proportion of inconsistencies between the initial 8-K and the auditor's letter are associated with reportable events and accounting disagreements. Delays in filings are associated with client size, auditor type, auditor resignations, and with the presence of inconsistencies between the initial 8-K and the auditor's letter.

Market tests indicate that the market response to the initial 8-K is negative for nonconcurrent filings (filings that do not contain the auditor's letter), but not for concurrent filings (filings that include the letter), suggesting that investors take an adverse view of the absence of the auditor's letter. Late letter filers and filers whose letters point out omissions or inadequacies in the disclosures made in the initial 8-K experience a significant negative reaction from the date of the initial 8-K filing to the date of the filing of the auditor's letter. This is consistent with the possible presence of information leakage prior to the actual filing of the auditor's letter, for example through analyst reports. However, despite this information leakage, late letter filings experience a significant negative reaction at the time of the letter filing. Filings involving inconsistencies between the auditor's letter and the initial 8-K also experience a negative, albeit weaker, reaction on the date of the letter filing. Thus, investors react negatively to the absence of the letter at the time of the initial 8-K filing, and negatively in the period following the initial 8-K filing to late letter filers and filers with inconsistencies. Overall, the results provide support that the auditor's exhibit letter has information content.
The Effects of Decision Aid Orientation on Risk Factor Identification and Audit Test Planning
Authors: Bedard Jean C. , Graham Lynford E.
Published: April 2008

In auditing, risk management involves identifying client facts or issues that may affect engagement risk, and planning evidence-gathering strategies accordingly. The purpose of this paper is to examine whether auditors' identification of risk factors and planning of audit tests is affected by decision aid orientation, i.e., a “negative” focus wherein client risk and its consequences are emphasized, or a “positive” focus where such factors are not emphasized. Specifically, we expect that auditors will identify more risk factors using a negatively oriented risk identification decision aid, but only when engagement risk is relatively high. We address this issue in the context of auditors' knowledge of actual clients, manipulating decision aid orientation as negative or positive in a matched-pair design. Results show that auditors using the negative decision aid orientation identify more risk factors than do those using a positive orientation, for their higher-risk clients. We also find that decisions to apply substantive tests are more directly linked to specific risk factors identified than to direct risk assessments. Further, our results show that auditors with repeat engagement experience with the client identify more risk factors. The findings of this study imply that audit firms may improve their risk management strategies through simple changes in the design of decision aids used to support audit planning.
Debiasing the Outcome Effect: The Role of Instructions in an Audit Litigation Setting
Authors: Clarkson Peter M. , Emby Craig , Watt Vanessa W.-S.
Published: April 2008

The outcome effect occurs where an evaluator, who has knowledge of the outcome of a judge's decision, assesses the quality of the judgment of that decision maker. If the evaluator has knowledge of a negative outcome, then that knowledge negatively influences his or her assessment of the ex ante judgment. For instance, jurors in a lawsuit brought against an auditor for alleged negligence are informed of an undetected fraud, even though an unqualified opinion was issued. This paper reports the results of an experiment in an applied audit judgment setting that examined methods of mitigating the outcome effect by means of instructions. The results showed that simply instructing or warning the evaluator about the potential biasing effects of outcome information was only weakly effective. However, instructions that stressed either (1) the cognitive nonnormativeness of the outcome effect or (2) the seriousness and gravity of the evaluation ameliorated the effect significantly. From a theoretical perspective, the results suggest that there may both motivational and cognitive components to the outcome effect. In all, the findings suggest awareness of the outcome effect and use of relatively nonintrusive instructions to evaluators may effectively counteract the potential for the outcome bias.
An Examination of Memory Conjunction Errors in Multiple Client Audit Environments
Authors: Lindberg Deborah L. , Maletta Mario M.
Published: April 2008

This study is the first in an auditing context to examine auditor susceptibility to memory conjunction errors, a type of systematic memory error that is related to the memory reconstruction process. Conjunction errors occur when memory traces associated with one event are incorrectly attributed to another event during memory reconstruction. Auditors may be particularly susceptible to memory conjunction errors due to their simultaneous exposure to multiple audit clients and their use of standardized audit forms and checklists to capture information. Unrecognized, such errors could adversely affect the efficiency and/or effectiveness of the financial statement audit process. We conducted an experiment that employed practicing audit professionals addressing multiple audit clients. Consistent with our hypotheses, the results indicate that memory conjunction errors in an audit environment are a complex function of (1) the consistency between the audit evidence recalled from an unrelated audit and the characteristics of the client that is the target of the memory reconstruction, (2) the consistency between this recalled audit evidence and the characteristics of the client to which the evidence is actually associated, and (3) the level of risk present in the audit environment that is the target of the memory reconstruction. While research has shown that audit risk factors can generally serve to decrease some types of auditors' memory recognition errors in single client situations (e.g., Sprinkle and Tubbs 1998), our results show that increases in audit risk can actually exacerbate memory errors involving multiple audit clients and memory conjunction errors. Finally, the findings of the study suggest that auditors are not only susceptible to memory conjunction errors, but also that such errors may play a significant role in elements of the audit-planning process related to auditors' likelihood of material error assessments.
The Impact of Pressure from Potential Client Business Opportunities on the Judgments of Auditors across Professional Ranks
Authors: Moreno Kimberly , Bhattacharjee Sudip
Published: April 2008

This study examines the impact of the pressure to obtain potential client business opportunities on auditor judgments. Thirty-two lower rank auditors (staff and seniors) and 39 higher rank auditors (managers and partners) were either provided or not provided with information on additional client business opportunities when assessing a client's potential inventory obsolescence risk. Lower rank auditors judged the obsolescence risk to be lower when provided with information on additional business opportunities than when such information was not provided. In contrast, there were no differences in the judgments of higher rank auditors when either provided or not provided with such information. These findings suggest that, through greater tacit management skills and exposure to other counter-pressures such as litigation and risk-management concerns, higher rank auditors are better able to manage competing goals and recognize the importance of freedom from client pressure than are lower rank auditors. Implications for training procedures and audit judgment research are discussed.
The Persuasiveness of Client Preferences: An Investigation of the Impact of Preference Timing and Client Credibility
Authors: Jenkins J. Gregory , Haynes Christine M.
Published: April 2008

Explicitly stated client preferences are intended to persuade the auditor to accept a preferred outcome. This experimental study investigates two determinants of a preference's persuasiveness—timing and client credibility. Sixty-four experienced auditors completed two hypothetical cases, one involving disclosure of a contingent liability and the other involving the collectibility of a customer account. The findings suggest that audit judgments regarding contingent liability disclosure may be biased toward a client's preference if the preference is received prior to evidence evaluation (i.e., an early preference) but not if the preference is received at the end of the evidence evaluation process (i.e., a late preference). No such bias, however, is present for the collectibility judgment. Results also indicate that auditors who receive an early preference ask to examine more additional audit evidence than those who receive a late preference, although whether they seek additional evidence to confirm or disconfirm the client's preference remains unclear. Finally, no support is found for the ordinal interaction hypothesizing that only a highly credible client in the early preference condition will differentially influence contingent liability disclosure and accounts receivable collectibility judgments.
Auditors' Strategies to Protect Their Litigation Reputation: A Research Note
Authors: McCracken Susan A.
Published: April 2008

Litigation may be harmful in terms of direct costs such as damages and defense costs, as well as indirect costs such as harming the auditor's general reputation and name. When a case is initiated, the auditor may choose to settle out of court or fight. Often settling is less costly in the short run, but may be costlier in the long run as the auditor develops a reputation for not fighting, thus, inducing greater future litigation. This study investigates whether reputational concerns for future litigation motivate auditors to strategically take costly actions to fight rather than settle.

I use an experiment involving 48 partners to examine auditors' actions in a situation where auditors report their litigation outcomes to future litigants, allowing them to develop reputations, and a situation where auditors do not report their litigation outcomes. As predicted, I find that auditors take costly actions to protect their litigation reputation. Auditors are more likely to predict that their side will win and have more difficulty settling, even if settling is less costly, when reputation can be protected as compared to when it cannot. In contrast, inexperienced auditors are not influenced by reputation concerns. Thus, litigation reputation concerns that influence auditors' decisions and actions appear to develop with an auditor's experience and tenure in the audit profession.
The Development and Transferability of Task Knowledge
Authors: Thibodeau Jay C.
Published: April 2008

This study provides experimental evidence related to the management of audit task knowledge. Specifically, the research explores whether a certain type of task knowledge, loan credit review knowledge, develops differently for in-charge auditors working in different industry specializations. Since auditors are often asked to choose an industry specialization at the in-charge level, understanding whether certain industries provide the opportunity for differential knowledge development is important (Libby and Frederick 1990), especially if such knowledge can be transferred to aid performance in tasks completed in several other industries. As such, the study explores whether the task knowledge under investigation can be transferred across both industry and task contexts to aid performance in the going concern judgment, a task that is required to be completed in all industries.

An experiment was administered to 60 in-charge auditors from one of the then Big 6 firms, with 32 participants specializing in the financial services industry and 28 in manufacturing. Importantly, financial services auditors have extensive experience evaluating the collectibility of loans and the underlying financial condition of borrowers; this knowledge is expected to also be valuable in assessing the going concern of any client. Participants evaluated the going concern status of four cases of actual troubled clients from two industry settings: manufacturing and casino gambling. The findings support the transferability of knowledge across task and industry contexts. This result is important because it is the first study in the audit literature to demonstrate that a specific type of task knowledge can be transferred across both task and industry contexts (Be´dard and Chi 1993). In so doing, the results provide an important theoretical foundation for audit researchers and practitioners regarding the conditions for the transfer and dissemination of audit knowledge throughout a firm.
Factors Affecting the Choice to Participate in Flexible Work Arrangements
Authors: Almer Elizabeth Dreike , Cohen Jeffrey R. , Single Louise E.
Published: April 2008

Assurance services firms have attempted to mitigate turnover and personnel shortages by offering flexible work arrangements (FWAs) to their professional staff. Little is known however, about what factors affect whether these professionals choose to adopt a FWA. This study examines factors potentially associated with both intentions to adopt and ultimate adoption of a FWA for a sample of seniors, managers, and partners at two national and one regional assurance services firms. Results indicate that intentions to adopt a FWA are significantly affected by the importance of opinions of workplace referents, family considerations, and gender. A marginally significant effect was also found for likelihood of organizational support and work consequences. A subset of these factors was found to affect actual adoption of a FWA. The results are discussed in terms of implications for the human resources department of assurance services firms striving to create an appropriate work/family balance for their professionals as well as suggesting avenues for future research.
The Effectiveness of Expectation Models in Recognizing Error Patterns and Generating and Eliminating Hypotheses While Conducting Analytical Procedures
Authors: Leitch Robert A , Chen Yining
Published: April 2008

This study analyzes the hypothesis generation and elimination capability of analytical procedures using Structural, Stepwise, Martingale, and ARIMA (Auto Regressive Integrated Moving Average) expectation models. We seed 14 errors into 36 complete sets of actual monthly financial statements from three companies. The bivariate pattern of differences, along with the structure of the accounting, business process, and economic system, are used to analytically determine (hypothesize) the most likely cause of the error. We then test the capability of these expectation models to generate correct hypotheses or to eliminate incorrect hypotheses. Positive and negative testing approaches, founded on multivariate normal theory, are examined.

From a hypothesis generation perspective using the positive testing approach, the results indicate that the Structural and Stepwise models, yield lower effectiveness risks (type II error) than the ARIMA and Martingale models, with the edge going to the Structural model. From a hypothesis elimination perspective using the negative approach, the results indicate that the Structural and Stepwise models yield lower efficiency risks (type I error) than the Martingale and ARIMA models, with the edge going to the Stepwise model. This study provides strong evidence to support the use of the structure of an organization's business processes (McCarthy 1982; Bell et al. 1997), its associated accounting system, and economic structure to build an expectation model. Moreover, the joint consideration of errors is found to be superior to the marginal approach advocated by Kinney (1987). The results presented here have the potential to assist auditors in directing audit efforts.
Audit Committee Member Support for Proposed Audit Adjustments: A Source Credibility Perspective
Authors: DeZoort F. Todd , Houston Richard W. , Hermanson Dana R.
Published: April 2008

This study reports the results of an experiment that investigates the effects of financial-report timing, EPS proximity to analyst forecast, and external auditor argument consistency on audit committee members' support for a proposed audit adjustment. We use source credibility theory to predict greater support for the audit adjustment when the financial report is at year-end rather than at interim, when unadjusted EPS is above rather than below forecast, and when the auditor consistently argues for adjustment rather than agrees with management's preference to avoid adjustment. One hundred thirty-one audit committee members participated in a between-subjects experiment. Consistent with theory, the participants were more likely to recommend adjustment for annual statements and for adjustments that the auditor consistently supported. Two significant interactions indicate that the effect of report timing holds only in the under forecast and inconsistent auditor conditions. Finally, audit committee members who were CPAs were less likely to recommend adjustment. We discuss implications and future research directions.
The Impact of Retention Incentives and Client Business Risks on Auditors' Decisions Involving Aggressive Reporting Practices
Authors: Chang C. Janie , Hwang Nen-Chen
Published: April 2008

This research examines the individual and interactive effects of client retention incentive and client business risks on auditors' decisions regarding whether to accept clients' aggressive reporting practices. Fifty-five audit seniors and managers from all of the Big 5 accounting firms participated in this experimental study. We find a significant main effect of client business risks and an interactive effect between client retention incentives and client business risks on auditors' decisions. Specifically, the results indicate that, when a client's business risks are high, auditors tend to scrutinize such risks and carefully evaluate a client's proposed accounting practices. However, when there is less concern over a client's business risks, auditors may be willing to accept the client's aggressive reporting proposal if retention incentives are high.
An Empirical Study on the Impact of Culture on Audit-Detected Accounting Errors
Authors: Chan K. Hung , Lin Kenny Z. , Mo Phyllis Lai Lan
Published: April 2008

This study draws on the theoretical framework of Hofstede's model to examine the impact of different cultural dimensions on audit-detected accounting errors. Based on the accounting errors detected in 80 foreign enterprises of different cultures operating in China, we test the direct effect of the cultural dimensions, power distance and individualism, on the magnitude of accounting errors. The results indicate that power distance and individualism have significant explanatory power in describing the differences in the relative magnitude of errors. Centralization of power in a few individuals, management override of controls, and less competent personnel are important attributes of a large power distance enterprise that contribute to larger errors. Enterprises of an individualist culture, which are characterized by higher personnel turnover and more reliance on accounting numbers for individual performance evaluation, are found to have larger errors. These results should be useful for auditors in assessing the likelihood of material errors from a cultural perspective.
Factors Affecting Auditors' Assessments of Planning Materiality
Authors: Blokdijk Hans , Drieenhuizen Fred , Simunic Dan A. , Stein Michael T.
Published: April 2008

This study investigates the planning materiality values used by auditors in The Netherlands for a sample of engagements performed by Big 5 and non-Big 5 firms in 1998–99. We find that, consistent with archival evidence from KPMG in Elliott (1983), planning materiality is not a constant percentage of a base, but increases at a decreasing rate with client size. In addition, we find that planning materiality values increase with the quality of the client's control environment and the magnitude of the client's rate of return on assets, while decreasing with the complexity of the client. We also find that Big 5 firms use lower planning materiality values than non-Big 5 firms, ceteris paribus, which is consistent with the production of relatively higher audit quality levels by the Big 5. Finally, we find that auditors use lower materiality values in situations where earnings might be managed to show a small profit or a small loss.
Auditor Industry Specialization, Client Bargaining Power, and Audit Pricing
Authors: Casterella Jeffrey R. , Francis Jere R. , Lewis Barry L. , Walker Paul L.
Published: April 2008

Porter's (1985) analysis of competitive strategy is used to explain industry specialization by Big 6 accounting firms. In Porter's framework, industry specialization can be viewed as a differentiation strategy whose purpose is to create a sustainable competitive advantage relative to nonspecialist auditors. A differentiation strategy will lead to higher audit fees if valued by clients. We find evidence of higher fees for Big 6 industry specialists relative to nonspecialists in the U.S. audit market, but only for companies in the lower half of the sample based on size (assets <$123 million). By contrast, companies in the upper half of the sample do not pay a specialist premium, and audit fees actually decrease as a company becomes increasingly large relative to its auditor's industry clientele. Together these results suggest that audit fees are higher when clients are small and have little bargaining power, but audit fees are lower when clients have greater bargaining power and this is more likely when companies are large in absolute size and large relative to their auditor's industry clientele.
Comparing Audit Team Effectiveness via Alternative Modes of Computer-Mediated Communication
Authors: Murthy Uday S. , Kerr David S.
Published: April 2008

In various stages of an audit, it is common for individual members of the audit team to possess audit-relevant information not known by other members of the team. In many situations, such information must be shared and integrated with other relevant information in order to make accurate decisions. Computer-mediated communication (CMC) technologies, which are deployed in most large public accounting firms, could potentially facilitate information exchange in audit teams. This study employs a theory of Task-Technology Fit (Zigurs and Buckland 1998) as the basis for examining the relative effectiveness of alternative modes of audit team communication in a task requiring the exchange and processing of uniquely held information. Using student teams, the modes of communication investigated are face-to-face, a bulletin-board tool, and a chat tool. Results reveal that teams using the bulletin-board tool outperformed teams using the chat tool and teams communicating face-to-face. There were no significant perfor-mance differences between teams using the chat tool and teams interacting face-to-face. The study has implications for accounting firms contemplating or already using computer-mediated communication to facilitate the collaborative work of audit teams.
Professional Service Fees and Auditor Objectivity
Authors: Reynolds J. Kenneth , Deis Donald R. , Francis Jere R.
Published: April 2008

This study investigates whether an auditor's objectivity is impaired by nonaudit services or by the level of economic dependence on a client. Like several contemporaneous studies, we use recent mandated proxy statement audit and nonaudit fee disclosures to measure economic dependence and we use discretionary accruals as a surrogate for auditor objectivity. The results in the extant literature are mixed. We provide some explanations for those inconsistent results.

First, we replicate the results of Frankel et al. (2002), finding, as they did, a significantly positive association between the relative level of nonaudit fees and discretionary accruals. Second, we document that this initial result is primarily due to small-tomedium-sized high-growth firms, especially firms having initial public offerings and in the e-commerce, biomedical, telecommunication, and pharmaceutical industries. After factoring these characteristics into the analysis, we find no evidence that the relative level of nonaudit service fees impairs an auditor's objectivity.
The Effects of Immediate Context on Auditors' Judgments of Loan Quality
Authors: O'Reilly Dennis M. , Leitch Robert A. , Wedell Douglas H.
Published: April 2008

This study examines whether auditors, when making a series of similar, independent judgments are non-normatively influenced by their earlier judgments. Two judgment biases are considered: contrast effect and assimilation effect.

We conducted an experiment where experienced auditors classified a number of commercial loans based on collection risk. The auditors' judgments displayed a significant contrast effect, and range-frequency theory explains a significant portion of the variance in their judgments (Parducci 1965). The results suggest that auditors tended to use the range principle more than the frequency principle to classify loans. This bias has potential implications for audit practice. By comparing auditors to graduate accounting students we find evidence that task experience moderates the magnitude of the judgment bias.
The Effect of Audit Committee and Board of Director Independence on Auditor Resignation
Authors: Lee Ho Young , Mande Vivek , Ortman Richard
Published: April 2008

This study examines the relationship between audit committee and board independence and auditor resignations. Independent audit committee and board members, who are concerned about incurring legal liability and harming their reputations, support the external auditors in accomplishing their assurance duties. We use a logit model to compare audit committee and board independence between two types of auditor switches: 190 auditor-initiated switches versus 190 matched client-initiated switches during the time period 1996 to 2000. Our results show that audit committee and board of director independence are both negatively associated with the likelihood of an auditor resignation. Our results also show that audit committee independence is positively related to the quality of the firm's successor auditor. This suggests that independent audit committees also play a mitigating role in reducing the negative consequences associated with an auditor resignation.
The Voluntary Choice of an Auditor of Any Level of Quality
Authors: Hay David , Davis David
Published: April 2008

We examine the choice of auditor by 380 incorporated societies in New Zealand. Incorporated societies may choose whether to be audited, and are free to choose an auditor of “any level of quality.” We measure audit quality levels, in order of increasing quality, as: (1) whether the entity chooses to be audited, (2) whether the auditor is a qualified or unqualified accountant, (3) whether the qualified accountant is an individual or a chartered accountancy firm, (4) whether the audit firm is large, and (5) whether the large audit firm is a member of the Big 5. We test whether variables representing demand for auditing by incorporated societies are associated with mechanisms that indicate auditor quality to users. We find that larger entities, and entities with higher salaries as a proportion of revenues and higher debt as a proportion of assets are more likely to be audited; they are also more likely to choose chartered accountancy firms and to choose larger audit firms. Entities with a higher proportion of their revenue from members are more likely to choose Big 5 auditors. These results are consistent with DeAngelo's (1981) and Watts and Zimmerman's (1986) explanations for professional auditing institutes, audit firm size, and audit firm reputation as surrogates for auditor quality.
Nonlitigation Risk and Pricing Audit Services
Authors: Houston Richard W. , Peters Michael F. , Pratt Jamie H.
Published: April 2008

In this study we expand the audit fee model introduced by Simunic (1980) and extended by Houston et al. (1999) by adding a third factor, nonlitigation risk, which refers to general business risks and/or opportunities that extend beyond litigation risk or the conduct of the audit (e.g., opportunities for future audit and nonaudit revenues, potential damage to the auditor's reputation from involvement with a client). In an experiment, we ask audit partners and managers to assess various risks and develop an audit plan after reviewing one of four risk-increasing audit scenarios—the discovery of an error, the discovery of a GAAP inconsistency, a client buyout where the audited financial statements are used in the determination of the exchange price, and the loss of a major client customer. We find that, in the error and buyout cases, audit fee increases are explained only by the planned increase in audit investment; in the GAAP inconsistency case, the audit fee increase is explained in part by the planned increase in audit investment, but to a greater extent by residual litigation risk; in the loss of customer case, the audit fee increase is explained by the planned audit investment, residual litigation risk, and nonlitigation risk. These results suggest that business risk is comprised of at least three factors (acceptable audit risk, residual litigation risk, and nonlitigation risk), and that auditors are compensated to act as auditors, provide insurance for investor losses, and bear risks associated with factors that extend beyond the conduct of the audit. We also discuss how nonlitigation risk can clarify the results of previous research and be used in future research.
Applying Digital Analysis Using Benford's Law to Detect Fraud: The Dangers of Type I Errors
Authors: Cleary Richard , Thibodeau Jay C.
Published: April 2008

At first glance the application of digital analysis using Benford's Law holds great promise as a fraud detection process. However, a closer look at the underlying statistical assumptions reveals that auditors seeking to use Benford's Law must be aware of the costs of the potential Type I errors that can occur during the analysis stage. For example, statistical considerations indicate that there is a far greater chance of making a Type I error if the Benford's Law analysis is completed on a “digit-by-digit” basis, as compared to the “test-by-test” basis typically employed by statisticians. In this paper, we explain the merits of each choice in terms of statistical concepts and practical audit process considerations.