bluuebunny/crossref_metadata_2025 huggingface dataset:
The Effects of Internal Audit Structure on Perceived Financial Statement Fraud Prevention
Authors: James Kevin L.
Published: March 2008

This study examines whether internal audit reporting structure and internal audit sourcing arrangement affect financial statement users' perceptions of ability of the internal audit function to prevent financial statement fraud. A survey of lending officers finds that in-house internal audit departments that report to senior management are perceived as less able to provide protection against fraudulent reporting compared to in-house departments that report solely to the board of directors' audit committee. This finding is particularly important in light of the SEC's recent consideration of whether the audit committee should be directly responsible for oversight of the internal auditor.

This study does not find a difference in users' perceptions of financial statement fraud prevention between outsourced internal audit teams and in-house internal audit departments when both report to the audit committee. Results suggest that increases in perceived audit expertise may occur with outsourcing, but such increases may not significantly enhance user confidence in the internal audit function because users perceive outsourced teams to have less in-depth knowledge of the company than in-house internal audit departments.
Firm Value and Employee Attitudes on Workplace Quality
Authors: Ballou Brian , Godwin Norman H. , Shortridge Rebecca Toppe
Published: March 2008

This paper investigates the relation between the value of a firm and employee attitudes on the firm's workplace quality—workplace attitudes. Workplace attitude refers to recognition of those organizational characteristics that enhance employee work experiences and assist employees in balancing their jobs and personal lives. Using inclusion on Fortune's annual list of “The 100 Best Companies to Work for in America” as a proxy for successful efforts in creating high workplace attitudes, we compare the market values of listed firms to the market values of nonlisted firms in the same industry matched on earnings. After controlling for book value, past operational performance, and research and development expense, we find that market values of listed firms exceed those of matched firms. We also provide evidence that firms ranked high on the Fortune list receive higher market values than those ranked lower on the list. Finally, the two-year forward market returns for listed firms exceed the returns for the matched sample while the two-year prior returns are not significantly different between the two groups. This result suggests that market performance does not determine inclusion on the Fortune list.
Likely Effects of Stock Exchange Governance Proposals and Sarbanes-Oxley on Corporate Boards and Financial Reporting
Authors: Klein April
Published: March 2008

One of the primary aims of the Sarbanes-Oxley Act of 2002, the New York Stock Exchange, and the NASDAQ corporate governance proposals is to improve the reporting systems for publicly traded companies. Many of the exchange proposals redefine the composition and duties of firms' boards of directors and their compensation and nominating committees. Sarbanes-Oxley places new duties on audit committees and provides oversight and restraints on public accounting companies. This paper describes many of the exchange proposals and puts them in their historical context. I also present the likely effects of the new corporate governance proposals on future boards of directors and assess their impact on the financial reporting system.
Accounting for Company-Owned Life Insurance
Authors: Nurnberg Hugo
Published: March 2008

This paper examines the alternative methods of accounting for investments in company-owned life insurance (COLI) and the resulting effects on reported net cash flow from operating activities (NCFO). Examples from annual financial reports suggest that these alternative methods potentially result in substantial differences in reported NCFO. Additionally, financial report disclosures do not make transparent the efects of these alternative methods on reported NCFO. This lack of transparency potentially impairs the reliability of investment decisions and the findings of empirical studies that take reported NCFO directly from financial reports without adjustment. Suggestions are offered to make annual financial reports more transparent with respect to COLI transactions.
Accounting for Employee Stock Options
Authors: Kirschenheiter Michael , Mathur Rohit , Thomas Jacob K.
Published: March 2008

Accounting for employee stock options is affected by whether outstanding options are viewed as equity or liabilities. The common perception is that the FASB's recommended treatment (per SFAS No. 123), which is based on the options-as-equity view, results in representative financial statements. We argue that this treatment distorts performance measures for three reasons. First, the deferred taxes associated with nonqualified options should also be included as equity, but are not. Second, since unexpected share price changes affect optionholders and equityholders differently, combining their interests provides an average earnings effect that is not representative for either group. We show that efforts to isolate the interests of common stockholders via diluted earning per share calculations (per SFAS No. 128) are inherently incapable of identifying wealth transfers between stockholders and optionholders. Finally, projections of future cash flow statements prepared under SFAS No. 95 overstate cash flows to current equityholders by the pretax value of projected option grants. We show that these distortions can be avoided simply by accounting for options as liabilities at grant and thereafter recognizing changes in option values (similar to the accounting for stock appreciation rights).

Our analysis of stock option accounting leads to two, more general implications: (1) all securities other than common shares should be treated as liabilities, thereby simplifying the equity versus liability distinction, and (2) these liabilities should be recorded at fair values, thereby obviating the need to consider earnings dilution.
Reporting Financial Performance
Authors: Barker Richard
Published: March 2008

Income, expenses, gains, and losses with similar informational properties can, in principle, be aggregated and presented as subsets of comprehensive income without losing information. Of particular importance is the splitting of comprehensive income into earnings and all other items. Earnings is typically conceptualized as an aggregation that excludes items that are nonoperating, nonrecurring, or outside management's control. This paper analyzes the concept of earnings and finds that it cannot be defined satisfactorily for the purposes of an accounting standard. The paper proposes an alternative approach to the reporting of financial performance, which provides a useful disaggregation of comprehensive income without attempting to define earnings. This approach is based upon the separate presentation, in a matrix format, of remeasurements, which are amounts resulting from revisions to the carrying amounts of assets and liabilities. This approach is shown to parallel the concept of earnings in its predictive and feedback properties, yet it is also shown to have additional benefits. In particular, the proposed approach has a relatively objective, consistently applied measurement basis, it displays clearly the effects of the mixed attribute accounting model, and it facilitates analysis of the effects of measurement subjectivity on reported financial performance. The analysis in this paper has been discussed extensively by the IASB and is expected, in due course, to form part of an IASB public consultative document.
The Changing Role of Accounting Numbers in Public Lending Agreements
Authors: Begley Joy , Freedman Ruth
Published: March 2008

The use of accounting number in loan agreement is an important part of the demand for accounting information. We examine new public debt contrast from three time periods to investigate the changing role of accounting number of public lending agreements, nothing a dramatic decline in the use of accounting numbers over the last quarter century. Accounting-based covenants restricting dividends and additional borrowing appear in less than 10 percent of the most recent sample of debt contracts examined. Moreover, accounting-based covenants included in public debt contracts tend to focus more one cash flow numbers and less on balance sheet measures of leverage than in the past. The evidence presented here suggests that recently executed public covenants provide little incentive for managers to manipulate accounting numbers. We also find a declining correlation between leverage and use of accounting-based debt covenants in public debt This finding suggests that leveragema not be a good proxy for public debt covenant slack in accounting policy choice studies.
Using Game Theory and Strategic Reasoning Concepts to Prevent and Detect Fraud
Authors: Wilks T. Jeffrey , Zimbelman Mark F.
Published: March 2008

This commentary examines academic research that can assist auditors in detecting and preventing fraudulent financial reporting. We review theoretical and empirical research from game theory, social psychology, judgment and decision making, and auditing to identify improvements in audit practice and promising areas for future research. This review focuses on the strategic fraud setting and suggests modifications in auditing standards that should facilitate auditors' use of strategic reasoning in this setting. We emphasize three critical audit tasks—fraud risk assessment, audit planning, and audit plan implementation—and recommend changes to current auditing standards and identify potential research questions for each task.
How Do Investors Assess the Credibility of Management Disclosures?
Authors: Mercer Molly
Published: March 2008

This paper synthesizes the existing literature on disclosure credibility and identifies four factors that investors consider when assessing the credibility of a management disclosure: (1) situational incentives at the time of the disclosure, (2) management's credibility (i.e., competence and trustworthiness), (3) the levels of external and internal assurance, and (4) characteristics of the disclosure itself. Disclosure credibility tends to be higher when management has few incentives to mislead investors and/or is perceived to be competent and trustworthy. Validation by external or internal sources also can enhance a disclosure's credibility. Moreover, disclosure credibility is influenced by various characteristics of the disclosure itself, such as its precision, venue, timing, inherent plausibility, and amount of supporting information.
Where Are We with Long-Term Contract Accounting?
Authors: Larson Robert K. , Brown Karen L.
Published: March 2008

In response to practices by major U.S. corporations, the SEC and the FASB initiated major revenue recognition projects. This commentary examines the accounting for long-term contracts, an aspect of revenue recognition often overlooked in academic research. The exploratory study reported here describes current practices and disclosures about long-term contracts by Fortune 500 corporations, examines the level of comparability in these disclosures, and provides explanations for current practices.
The Impact of Continuity on Concurring Partner Reviews: An Exploratory Study
Authors: Favere-Marchesi Michael , Emby Craig E. N.
Published: March 2008

Public expectations of auditors' objectivity, the on-going debate over auditors' independence (SEC 2001), and previous research motivate our study of one aspect of auditor rotation. Using an experimental case, we examine the impact of continuity on concurring partner reviews. Continuity specifically refers to a concurring partner's assumed degree of prior involvement with a client engagement. We explore two levels of prior involvement—a continuing concurring partner (i.e., involved as a concurring partner in the current and prior year's engagement) and a new concurring partner (i.e., involved as a concurring partner in the current year's engagement only).

Based on information in the case, audit partners in the role of concurring partners make judgments related to goodwill impairment. Consistent with our expectation, continuing concurring partners are less likely than new concurring partners to conclude that purchased goodwill may be impaired. Based on our results, the recent regulatory actions mandating within-firm rotation of concurring partners are likely to affect audit firm judgments.
The Implications of Joint Cost Standards for Charity Reporting
Authors: Roberts Andrea Alston
Published: March 2008

In 1987, SOP No. 87-2 permitted charities to report a portion of the joint costs associated with combined public education efforts and fund-raising appeals as program service expenses. Charities used the standard to allocate costs related to direct mailings. A decade later, SOP No. 98-2 amended SOP No. 87-2 and provided stricter guidelines with respect to when and how charities can allocate joint costs. This paper examines: (1) whether the adoption of the joint cost standards impacts how charities classify program expenses, and thus, affects the program ratio—a widely used indicator of spending efficiency, and (2) whether the adoption of joint costing standards causes charities to alter fund-raising strategies. The data indicate a higher program ratio after the adoption of SOP No. 87-2. Furthermore, the data suggests that after passage of SOP No. 98-2, a subset of charities alter their fund-raising strategies and stop allocating joint costs. In addition, charities that continue to allocate joint costs reduce joint cost allocations to programs. Although charities report fewer joint costs under the new regime, program ratios do not decrease under SOP No. 98-2.
Mandatory Audit Firm Turnover, Financial Reporting Quality, and Client Bargaining Power: The Case of Arthur Andersen
Authors: Nagy Albert L.
Published: March 2008

This paper examines the effect of mandatory auditor change on audit quality in the unique environment created by the failure of Arthur Andersen (AA). The failure of AA forced a significant number of companies (ex-AA clients) to change auditors and also helped increase the overall skepticism exhibited on external audits. The demise of AA does not truly replicate a mandatory rotation regime, but it does provide a rich setting to examine one aspect of such a regime—the effect that a forced auditor change has on the level of audit quality. Furthermore, because ex-AA clients were forced to change auditors on a one-time basis and will not necessarily have to change auditors in the future, client bargaining power is likely to influence auditor behavior and is considered in this study's empirical analyses. This study provides evidence that, for smaller companies, the level of audit quality improved for companies forced to switch from AA, and that the negative relation between short auditor tenure and audit quality was effectively mitigated over the period of AA's demise. The lack of results for larger companies could reflect higher bargaining power toward their auditor. Further research is needed to determine if a forced auditor change would improve audit quality for larger companies in a true mandatory auditor rotation regime, where the amount of bargaining power possessed by companies would seemingly diminish.
Factors Associated with U.S. Public Companies' Investment in Internal Auditing
Authors: Carcello Joseph V. , Hermanson Dana R. , Raghunandan K.
Published: March 2008

Internal auditing has been the focus of much attention in recent years. This study examines factors associated with U.S. public companies' investment in internal auditing. Data from a survey administered to Chief Audit Executives of midsized U.S. public companies were supplemented with publicly available data. Based on data from 217 companies, the results indicate that total internal audit budgets (inhouse plus outsourced portions) are related to several factors associated with company risk, ability to pay for monitoring, and auditing characteristics. Specifically, we find evidence that internal audit budgets are positively related to company size, leverage, financial, service, and utility industries, relative amount of inventory, operating cash flows, and audit committee review of the internal audit budget. Total internal audit budgets are negatively related to the percentage of internal auditing that is outsourced. This study contributes to our understanding of internal audit services, and it allows companies to benchmark their investment in internal auditing.
Does Graduate Business Education Contribute to Professional Accounting Success? (Retracted)
Authors: Wier Benson , Stone Dan N. , Hunton James E.
Published: March 2008

We investigate the value of graduate business education in learning tacit knowledge and achieving professional accounting success. Archival (n = 5,932) and survey (n = 2,941) data from managerial accountants employed at 2,525 North American companies in three industries (publishing, paper, and chemical) indicate that job performance evaluations (JPEs) of those who hold either a Master's of Accountancy (M.Acc.) or M.B.A. degree are generally higher than non-master's (NM) degree accountants. We find some evidence that professionals with master's degrees, as compared to NM professionals, have higher levels of two forms of tacit managerial knowledge (TMK): self and others. The results also suggest that M.Acc. and M.B.A. degrees contribute to success differentially throughout the professionals' careers. Specifically, a M.Acc. degree provides greater benefit than a M.B.A. degree in the early and middle career years, while an M.B.A. degree provides greater benefit than a M.Acc. degree in later career years. The results indicate that M.Acc. and M.B.A. degrees contribute to success by increasing specific types of knowledge and enhancing ones' ability to learn.
The Financial Expertise of CFOs and Accounting Restatements
Authors: Aier Jagadison K. , Comprix Joseph , Gunlock Matthew T. , Lee Deanna
Published: March 2008

We investigate whether the characteristics of chief financial officers (CFOs) are associated with accounting errors (using accounting restatements as a proxy). We investigate several metrics of financial literacy similar to those suggested for members of audit committees by the NYSE-NASD Blue Ribbon Committee. These metrics include years of work as a CFO, experience at another company, advanced degrees (like M.B.A.s), and professional certification (like a CPA). We use a logit model to test whether the likelihood of an earnings restatement is related to the above metrics of financial literacy (measured at the date of the original accounting error). Restating and non-restating companies during the period 1997–2002 were matched on year, industry, and company size. Overall, our results are consistent with restatements being negatively associated with the CFO's financial expertise. Specifically, we find that companies whose CFOs have more work experience as CFOs, M.B.A.s, and/or CPAs are significantly less likely to restate their earnings.
The Disclosure of Material Weaknesses in Internal Control after the Sarbanes-Oxley Act
Authors: Ge Weili , McVay Sarah
Published: March 2008

This paper focuses on a sample of 261 companies that disclosed at least one material weakness in internal control in their SEC filings after the effective date of the Sarbanes-Oxley Act of 2002. Based on the descriptive material weakness disclosures provided by management, we find that poor internal control is usually related to an insufficient commitment of resources for accounting controls. Material weaknesses in internal control tend to be related to deficient revenue-recognition policies, lack of segregation of duties, deficiencies in the period-end reporting process and accounting policies, and inappropriate account reconciliation. The most common account-specific material weaknesses occur in the current accrual accounts, such as the accounts receivable and inventory accounts. Material weakness disclosures by management also frequently describe internal control problems in complex accounts, such as the derivative and income tax accounts. In our statistical analysis, we find that disclosing a material weakness is positively associated with business complexity (e.g., multiple segments and foreign currency), negatively associated with firm size (e.g., market capitalization), and negatively associated with firm profitability (e.g., return on assets).
A Contextual Analysis of Incomeand Asset-Based Approaches to Private Equity Valuation
Authors: Jenkins David S. , Kane Gregory D.
Published: March 2008

The question of how to best value privately held businesses for purposes of taxation and other legal reasons remains open to debate. In general, valuation models are asset-based, income-based, or hybrid models that aggregate asset and income information. An example of the latter is the controversial excess earnings method recommended by IRS Rev. Rul. 68–609. In this research, we focus on the relative performance of the excess earnings method vis-a`-vis other widely used valuation models. We consider the valuation accuracy of each model in a general setting along with examining contextual performance under varying levels of intangible versus tangible assets and varying levels of business profitability. We show that the hybrid model provides superior valuation accuracy in general and more consistent valuation accuracy across the contexts examined. We also show that the inclusion of two capitalization rates in the excess earnings method, which is required in order to distinguish returns from tangible versus intangible assets, provides increasing relative valuation accuracy over that of the single-rate earnings capitalization model as the two rates diverge. In summary, we demonstrate that for privately held firms, which typically lack analyst following and independent earnings forecasts, the excess earnings method represents a viable valuation alternative.
Did Conservatism in Financial Reporting Increase after the Sarbanes-Oxley Act? Initial Evidence
Authors: Lobo Gerald J. , Zhou Jian
Published: March 2008

In this paper, we investigate the change in managerial discretion over financial reporting following the Sarbanes-Oxley Act (hereafter SOX). We document an increase in conservatism in financial reporting following SOX and the resulting requirement by the SEC that financial statements be certified by firms' CEOs and CFOs. First, we find that firms report lower discretionary accruals after SOX than in the period preceding SOX. Second, based on the Basu (1997) measure of conservatism, we find that firms incorporate losses more quickly than gains when they report income in the post-SOX period. These results are obtained with alternative estimation and measurement approaches and after controlling for potentially confounding variables. This empirical evidence suggests that SOX and the resultant SEC certification requirement may have altered management's discretionary reporting behavior to make it more conservative.
The Composition of Nonprofit Audit Committees
Authors: Vermeer Thomas E. , Raghunandan K. , Forgione Dana A.
Published: March 2008

Audit committee composition has attracted significant attention from legislators and regulators in recent years. Although most of the focus has been on corporate audit committees, recent legislative efforts underscore the importance of governance in the nonprofit sector. Using data from a survey of 118 chief financial officers of nonprofit organizations as well as financial data from the GuideStar database, we examine the composition of nonprofit audit committees and factors associated with their composition. The data show that many nonprofits have not adopted Sarbanes-Oxley reforms, since we find that 36 percent of nonprofits have audit committees that are not completely independent. Organizations that are larger, receive government grants, and use a Big 4 auditor are more likely to have audit committees with solely independent directors. Surprisingly, universities and hospitals are less likely to have solely independent directors on the audit committee. Eighty-eight percent of nonprofits have at least one financial expert on the audit committee, and organizations that receive government grants and have an internal audit function are more likely to have a financial expert on the committee. Overall, our findings support the view that nonprofit audit committee composition varies in response to the demands related to the need for resources, the presence of other monitoring mechanisms, and the type of nonprofit.
The Classification by Real Estate Investment Trusts of Distributions from Unconsolidated Entities
Authors: Comiskey Eugene E.
Published: March 2008

This project was prompted by anecdotal observations of classification diversity involving distributions received by real estate investments trusts (REITs) from equity-method investments (EMIs). The common mantra “cash is a fact” results in limited attention being given by standard-setters and regulators to the statement of cash flows and associated classification issues. However, classification diversity, in the absence of supporting facts and circumstances, potentially undermines the comparability and representational faithfulness of financial information. The study of a larger sample of REITs affirmed the presence of classification diversity. Responses from a number of REITs to my inquiries suggest that some of their classification decisions deviate from relevant GAAP guidance. This direct input from REIT accounting and financial officers provides valuable insights that are not available from financial statements and associated disclosures. These GAAP deviations could arise for several reasons. The dominance of a non-GAAP measure of performance in the REIT industry, funds from operations (FFO), may diminish the perceived importance of the statement of cash flows to REIT management. Moreover, classification-related dissent by Financial Accounting Standards Board (FASB) members to SFAS No. 95, combined with commentary in the standard itself on ambiguity surrounding classification decisions, may have emboldened some firms to deviate from the classification guidance of SFAS No. 95. Finally, a combination of technical difficulty associated with implementing SFAS No. 95 and some clear misunderstandings of relevant GAAP appears to play a role. Diversity in reporting practice typically attracts the attention of the FASB. The results of this study may encourage the Board to review the classification guidance in SFAS No. 95, as well as its implementation in practice.
Enhancing Knowledge Sharing in Public Accounting Firms
Authors: Vera-Mun˜oz Sandra C. , Ho Joanna L. , Chow Chee W.
Published: March 2008

The goal of this study is to advance understanding of factors that may enhance or hinder knowledge sharing in public accounting firms and, in the end, provide practical recommendations for the firms. Attention to this topic is warranted for two reasons. First, today's regulatory environment and new auditing standards have broadened and intensified pressures on CPA firms to enhance the quality, effectiveness, and efficiency of the audit process. Second, knowledge and expertise are unevenly distributed among the members of the audit team. Thus, knowledge sharing can help CPA firms in leveraging the skills, knowledge, and best practices of their professional staff. Against this background, CPA firms' ability to effectively deploy knowledgesharing activities is increasingly vital to their competitive advantage, including gaining tangible benefits in terms of time and cost reductions. We draw upon prior research in accounting, organizational learning, psychology, and knowledge management to examine the role of three factors–information technology, formal and informal interactions among auditors, and reward systems–in encouraging knowledge sharing. We develop recommendations for public accounting firms and suggest several directions for future research.
Auditor Risk Assessment: Insights from the Academic Literature
Authors: Allen Robert D. , Hermanson Dana R. , Kozloski Thomas M. , Ramsay Robert J.
Published: March 2008

To contribute to the PCAOB project on risk assessment in financial statement audits, we draw on the academic literature to offer insights and conclusions on the risk-assessment process. We use the PCAOB's (2005) recent briefing paper on risk assessment as the organizing framework for our literature review, and we examine academic auditing literature addressing topics including business risk, inherent risk, control risk, fraud risk, linking risk assessments to subsequent testing, and the audit risk model. Overall, we believe that the results of academic research are consistent with the PCAOB staff's apparent reconsideration of the auditor's risk-assessment process. We conclude with identification of future research topics and recognition of barriers to performing research that is relevant to standard setters.
Resignations by the Big 4 and the Market for Audit Services
Authors: Rama Dasaratha V. , Read William J.
Published: March 2008

Following enactment of the Sarbanes-Oxley Act (SOX) of 2002, Big 4 auditors claimed to have a more conservative policy regarding client retention and acceptance decisions. In this paper, we examine the resignations of Big 4 audit firms in periods before and after SOX. We find that Big 4 audit firms resigned from more audit clients in 2003 than in 2001, and that the 2003 group of clients had significantly lower measures of financial stress. Our results are robust to adjustments for differences in bankruptcy probability between 2003 and 2001. We also find that the relative increases in fees charged by the Big 4 successor following the resignation of a Big 4 predecessor are higher in 2003 than in 2001; for clients with a non-Big 4 successor firm following a Big 4 resignation, we find a significant fee discount in 2001 but not in 2003. Overall, the results support the view that auditors are much more conservative in the post-Enron/SOX period than in the immediately preceding period.
Enron-Era Disclosure of Off-Balance-Sheet Entities
Authors: Chandra Uday , Ettredge Michael L. , Stone Mary S.
Published: March 2008

The scandal that followed Enron's failure to disclose billions of dollars of debt held by off-balance-sheet entities (OBSEs) prompted investor interest in these entities and motivated auditors to request more accounting guidance. The SEC responded by issuing Financial Release No. 61 (FR-61) to remind managers to follow SEC guidance for disclosures on liquidity and capital resources in the Management's Discussion and Analysis section of the annual report. FR-61 identifies disclosure objectives but does not require specific disclosures. We study how the OBSE-related disclosures of companies that sponsored OBSEs before Enron changed after Enron/FR-61. We find that while OBSEs were widely used by S&P 500 firms before Enron/FR-61, a majority of these firms either did not disclose their OBSEs or, if they did, provided little useful information. After Enron/FR-61, OBSE disclosure levels increased significantly but not uniformly across firms. The pattern of increases suggests that FR-61 reduced regulatory uncertainty and increased the perceived minimum level of required OBSE disclosure. Our results are consistent with the view that general guidance (of the type found in principles- or objectives-based accounting standards) may result in underdisclosure or a large disparity in level of disclosure, and that reminders of responsibility and suggestions to consider specific disclosures partially remedy both problems.
Strong Corporate Governance and Audit Firm Rotation: Effects on Judges' Independence Perceptions and Litigation Judgments
Authors: Jennings Marianne Moody , Pany Kurt J. , Reckers Philip M. J.
Published: March 2008

The Sarbanes-Oxley (SOX) legislation mandated modest threshold levels of corporate board independence and expertise, as well as audit partner (not firm) rotation. One objective was to create an environment supportive of enhanced actual and perceived auditor independence. This study examines whether perceptions of auditor independence and auditor liability are incrementally influenced by further strengthening corporate governance and by rotating audit firms. Our experimental study addresses these questions by analyzing responses of 49 judges attending a continuing education course at the National Judicial College. The experiment manipulates corporate governance at two levels (minimally compliant with current corporate governance requirements versus strong) and auditor rotation at two levels (partner rotation versus audit firm rotation). We find that strengthening corporate governance (beyond minimal SOX levels) and rotating audit firms (compared to partner rotation) lead to enhanced auditor independence perceptions. We also find that judges consider auditors less likely to be liable for fraudulently misstated financial statements when firm rotation is involved in a minimally compliant corporate governance environment.
Auditing Fair Value Measurements: A Synthesis of Relevant Research
Authors: Martin Roger D. , Rich Jay S. , Wilks T. Jeffrey
Published: March 2008

To contribute to the PCAOB project on auditing fair value measurements (FVMs), we synthesize relevant academic literature to offer insights, conclusions, and future research directions for auditors, standard-setters, and academics focusing on auditing FVMs. We structure our synthesis along two dimensions: (1) an emphasis on the auditor's need to understand how FVMs are prepared, and (2) the audit steps and procedures necessary to verify and attest to FVMs, including an awareness of the potential biases inherent in auditing FVMs. Drawing primarily from the judgment and decision-making literature, we highlight a number of potential biases and limitations in the preparation and audit of FVMs. Additionally, we note that the specialized valuation knowledge necessary to effectively audit FVMs will be difficult for auditors to gain and maintain.
Voluntary Disclosure of Free Cash Flow Information
Authors: Adhikari Ajay , Duru Augustine
Published: March 2008

Modern finance texts have long advocated a focus on “free cash flow” rather than on earnings for evaluating firm performance. While U.S. GAAP does not require firms to disclose free cash flow (FCF) information, some firms voluntarily report and emphasize FCF in their financial statements. FCFs are discussed and used in some finance texts, analysts' reports, and financial press articles, yet little theoretical and conceptual guidance exists on how to compute FCF. Hence, the SEC and the FASB have expressed concern about the comparability, consistency, and transparency of these reported measures. This study provides empirical evidence on a set of firms that voluntarily disclose FCF information in their 10-K and 10-Q reports filed between 1994 and 2004. The number of firms disclosing FCF information is small but has grown in recent years. We document that FCF definitions vary widely, limiting comparability of FCF disclosures across firms. Our results also indicate that FCF firms are less profitable and more leveraged than other firms in their own industries. Moreover, FCF firms have lower credit ratings and pay out higher dividends. These results suggest that FCF firms provide FCF disclosures to augment reported income and cash flow information. As such, our results suggest that FCF firms view FCF disclosures as an important complement to their traditional reporting practices.
Auditor Changes and the Pricing of Seasoned Equity Offers
Authors: Kim Yongtae , Park Myung Seok
Published: March 2008

While prior literature examines the role of auditors in the pricing of initial public offerings, little is known about the effect of auditor changes on the pricing of seasoned offers. Our examination of seasoned equity offerings shows that companies switching auditors prior to the offerings underprice their offers more than do companies without changes. While we provide evidence of issuers' opportunistic accounting decisions that are consistent with their opinion-shopping behavior, the positive association between underpricing and auditor changes suggests that switchers bear a net cost compared to non-switchers. From a practical standpoint, our findings alert a company considering a change of its auditor prior to a new equity issue.
Audit Committee Financial Experts: A Closer Examination Using Firm Designations
Authors: Carcello Joseph V. , Hollingsworth Carl W. , Neal Terry L.
Published: March 2008

The Sarbanes-Oxley Act (SOX) requires the disclosure of whether the audit committee has a financial expert. We examine disclosures related to audit committee financial experts (ACFEs) in the first year that this disclosure requirement is in effect. We find that virtually all companies disclose whether an ACFE is on the audit committee, although the transparency of the disclosure regarding the ACFE's background is limited. We also find that most ACFEs do not have a background in accounting or finance, although there are notable differences between stock exchanges on this dimension. In addition, we find that companies designate ACFEs who would not have been identified using extant research methods, and companies fail to voluntarily designate many individuals who appear to qualify as an ACFE, particularly if another audit committee member is already designated as an ACFE. Thus, some companies appear to be extremely conservative in designating directors as ACFEs, possibly due to concerns about the legal liability faced by designated ACFEs. Finally, we identify certain company characteristics that are associated with the designation or type of financial expert on the audit committee.
Sell-Side Analysts' Reports and the Current External Reporting Model
Authors: Abdolmohammadi Mohammad , Simnett Roger , Thibodeau Jay C. , Wright Arnold M.
Published: March 2008

This study explores the nature of the information (financial, nonfinancial, and other) that is disseminated by quarterly recommendation reports of sell-side financial analysts. We content-analyzed nearly 7,000 elements contained in 64 analysts' quarterly recommendation reports for companies in four different industries: two intangible-asset-intensive industries and two tangible-asset-intensive industries. The results indicate that analysts' recommendation reports provide a significantly higher proportion of financial information and lower proportion of nonfinancial information for tangible-asset-intensive companies than intangible-asset-intensive companies. We also identify the number of financial and nonfinancial information elements that are traced to SEC filings. We find that a high percentage of this information, especially nonfinancial information, is not provided in these filings. This finding raises significant concerns about the completeness of the current reporting model.
The FASB's Codification Project: A Critical Step toward Simplification
Authors: McEwen Ruth Ann , Hoey Thomas J. , Brozovsky John A.
Published: March 2008

U.S. GAAP currently is classified by levels (A through D) and organized by standards, interpretations, and related guidance rather than by topic. At the completion of the FASB's codification project, classification by levels will no longer exist; instead, GAAP will consist of only two levels, authoritative and nonauthoritative literature. Going forward, pronouncements will amend the codification instead of adding new numbered standards. The codification represents a fundamental change for accounting researchers and educators who reference U.S. GAAP through the current maze of standards, interpretations, and other authoritative guidance. This paper explains the codification process; examines issues of interest to researchers, educators, and others in the profession; and discusses potential avenues for academic research.
An Examination of Audit Information Technology Use and Perceived Importance
Authors: Janvrin Diane , Bierstaker James , Lowe D. Jordan
Published: March 2008

Information technology (IT) use can directly impact audit judgment and ultimately audit effectiveness and efficiency. Although IT has significantly changed the audit process, few studies have examined the perceived importance of IT use across a diverse group of audit firms. Our descriptive study explores audit IT use and its perceived importance across several audit applications. To address regulator concerns about barriers to entry in public accounting and to advance auditing research, we examine whether audit IT use and perceived importance of IT varies by firm size. A field-based questionnaire was used to collect data from 181 auditors representing Big 4, national, regional, and local firms. Our results indicate that auditors extensively use a variety of audit applications including analytical procedures, audit report writing, electronic work papers, Internet search tools, and sampling. Auditors perceive several applications as important (e.g., fraud review), but use them infrequently. In addition, IT specialists use is infrequent, even by auditors who examine clients with complex IT. Finally, findings suggest that audit IT use and perceived importance vary by firm size. These results describe audit IT use, but do not allow us to infer causality.
Econometrics of Fair Values
Authors: Sunder Shyam
Published: March 2008

The properties of many important valuation rules can be quantified, examined, and compared in a unified framework to assist policy decisions. Valuation rules can be viewed as econometric estimators of unobserved values of aggregates. Which valuation rule has minimum mean squared error (relative to the unobserved value of bundles of resources) is a matter of econometrics, not of theory or principle; it depends in a known fashion on the relative magnitudes of the parameters—price volatility and measurement errors—of the economy, industry, or firm. In general, no valuation rule, fair or not, dominates the others. Given the parameters of an environment, this framework can help identify efficient valuation rules.
Option Acceleration in Response to SFAS No. 123(R)
Authors: Balsam Steven , Reitenga Austin L. , Yin Jennifer
Published: March 2008

As of February 28, 2006, 958 publicly held companies accelerated the vesting of some or all of their employee stock options in advance of adopting SFAS No. 123(R). In doing so, these companies, on average, avoided $11.3 (8.4) million in pretax (after tax) expense, which represented 42 percent of prior year income. Investors, in general, react positively to acceleration announcements as we find an average cumulative abnormal return of about one-half of 1 percent for the three-day window (−1,1) surrounding the announcement, with the reaction positively associated with the expense reduction that resulted from the acceleration, the declaration by the firm that the options accelerated are out of the money, return on assets, and firm size. Additionally, we find that the decision to accelerate is positively associated with our estimate of the future expense related to unvested options; that is, the expense avoided because of the acceleration. In contrast, the intrinsic value of unvested options; that is, the expense that would have to be recognized at the time of acceleration, firm profitability, and firm size (i.e., political visibility) are negatively associated with the decision to accelerate. We interpret these results to indicate that managers consider the costs, as well as the benefits, in deciding whether to accelerate. Overall we conclude that while accelerated vesting may be motivated by expense avoidance, it appears to be beneficial to equity investors as evidenced by the positive abnormal returns associated with the announcement of the acceleration and the fact that abnormal returns are positively associated with the expense avoided via acceleration.
“Your” Intellectual Property: Who Owns It?
Authors: Tepper Robert J. , White Craig G.
Published: March 2008

State Street Bank & Trust Co. v. Signature Financial Group, Inc. brought “business methods” into the scope of patentable material. In an academic setting, this expansion may increase the importance of university intellectual property policies to business research. This article discusses criteria for protection as copyrightable or patentable work. It also addresses implications for faculty ownership and disclosure requirements. The discussion highlights rights universities have enforced through their intellectual property policies. Recognition of these issues may be helpful in identifying both opportunities and pitfalls as “business method” intellectual property protection continues to evolve.
The Auditor's Reporting Model: A Literature Overview and Research Synthesis
Authors: Church Bryan K. , Davis Shawn M. , McCracken Susan A.
Published: March 2008

This article examines academic research to contribute to the Public Company Accounting Oversight Board's (PCAOB) project on the auditor's reporting model. We develop a framework to organize our discussion of the literature in light of key questions raised at two Standing Advisory Group (SAG) meetings. We trace the historical development of the auditor's report and then delve into relevant research that focuses on the auditor's reporting decision and the content of the auditor's report. Throughout the article, we offer recommendations for future study. Last, we provide a brief recap and summarize the key findings.
Negotiation Research in Auditing
Authors: Brown Helen L. , Wright Arnold M.
Published: March 2008

Investor confidence is the cornerstone of the capital markets, and reporting quality depends on the proper resolution of contentious accounting and disclosure matters that surface during the audit process. As our overview of the auditor-client negotiation process portrays, the negotiation literature depicts this process as consisting of three stages: pre-negotiation, negotiation, and negotiation outcomes. These stages are influenced by characteristics of the auditor, the client, and the environment. A unique aspect of auditor-client negotiations is the very rich, complex set of environmental factors such as nature (complexity) of the issue, litigation, corporate governance, and the multiperiod relationship between the auditor and the client. We identify the major findings of this emerging body of work, recommend promising avenues for future research, and suggest implications for practice.
A “Close Reading” Protocol to Identify Perception-Fashioning Rhetoric in Web Site Financial Reporting: The Case of Microsoft®
Authors: Craig Russell , Garrott Lucia , Amernic Joel
Published: March 2008

This paper describes a protocol by which to conduct a “close reading” critique of financial reporting on a corporate web site. The proposed protocol helps identify the rhetorical and metaphorical features of web sites and draws attention to their potential to influence social cognition. The paper complements and extends the “close reading” example provided by Amernic (1998) and is influenced by the approach to deconstruction outlined by Martin (1990). Application of the protocol is demonstrated through a “close reading” of aspects of the financial reporting on the Microsoft Corporation web site. The “close reading” reveals some of the benefits that are likely to emerge from arousing a greater consciousness of the subtle and persuasory nature of the hypertools used to effect Internetbased financial reporting.