Showing papers in "Auditing-a Journal of Practice & Theory in 2014"
TL;DR: In this paper, the authors re-examine this issue using the incidence of accounting restatements as a measure of audit quality, using a propensity-score matching procedure similar to that used by recent research to control for clients' endogenous choice of auditor.
Abstract: SUMMARY: Recent research suggests that Big 4 auditors do not provide higher audit quality than other auditors, after controlling for the endogenous choice of auditor. We re-examine this issue using the incidence of accounting restatements as a measure of audit quality. Using a propensity-score matching procedure similar to that used by recent research to control for clients' endogenous choice of auditor, we find that clients of Big 4 audit firms are less likely to subsequently issue an accounting restatement than are clients of other auditors. In additional tests, we find weak evidence that clients of Big 4 auditors are less likely to issue accounting restatements than are clients of Mid-tier auditors (Grant Thornton and BDO Seidman). Taken together, the evidence suggests that Big 4 auditors do perform higher quality audits. JEL Classifications: M41, M42 Data Availability: All data are publicly available from sources identified in the text.
209 citations
182 citations
TL;DR: The U.S. and international standard setters have recently proposed changes to the standard audit report, including a requirement to include a critical audit matter (CAM) paragraph.
Abstract: SUMMARY: Both U.S. and international standard setters have recently proposed changes to the standard audit report, including a requirement to include a critical audit matter (CAM) paragraph. We exa...
133 citations
TL;DR: In this paper, the relationship between future financial statement restatements and audit report lags is investigated, defined as the number of days between the fiscal year-end and the audit report deadline.
Abstract: SUMMARY: We investigate the relationship between future financial statement restatements and audit report lags. Audit report lags are defined as the number of days between the fiscal year-end and t...
120 citations
TL;DR: In this paper, the authors reexamine the issue on a sample of clients who have both the incentive and the ability to use discretionary accruals to meet or beat the consensus earnings forecast.
Abstract: SUMMARY: Are high audit fees a signal that the auditor exerted more effort or a signal that the auditor may be losing her independence? Prior literature offers conflicting evidence. In this paper, we reexamine the issue on a sample of clients who have both the incentive and the ability to use discretionary accruals to meet or beat the consensus earnings forecast. We find a negative relationship between the level of abnormal audit fees paid by the client and the likelihood of using discretionary accruals to meet or beat the consensus analyst forecast. The evidence is consistent with the notion that abnormal audit fees are indicative of greater effort on the engagement. In other words, the results suggest a positive relationship between abnormal audit fees and audit quality. We show that the conflicting evidence in prior research was caused by research designs that did not consider the incentives of the manager. JEL Classifications: M42; M41. Data Availability: All data are available from public sources quo...
119 citations
TL;DR: In this paper, the authors compared both pre-and post-policy implementation and, after the implementation of the policy, mandatory long-tenure versus voluntary shorttenure rotation situations and found that audit quality did not significantly change compared with pre-2006 longtenure audit situations and voluntary post-rotation situations.
Abstract: SUMMARY: Using a unique setting in which mandatory audit firm rotation was required from 2006–2010, and in which both audit fees and audit hours were disclosed (South Korea), this study provides empirical evidence of the economic impact of this policy initiative on audit quality, and the associated implications for audit fees. This study compares both pre- and post-policy implementation and, after the implementation of the policy, mandatory long-tenure versus voluntary short-tenure rotation situations. Where audit firms were mandatorily rotated post-policy, we observe that audit quality (measured as abnormal discretionary accruals) did not significantly change compared with pre-2006 long-tenure audit situations and voluntary post-rotation situations. Audit fees in the post-regulation period for mandatorily rotated engagements are significantly larger than in the pre-regulation period, but are discounted compared to audit fees for post-regulation continuing engagements. We also find that the observed incre...
89 citations
TL;DR: In 2002, the peer review auditor program was replaced with independent inspections of audit firms by the Public Company Accounting Oversight Board (PCAOB), which differ from peer review audits.
Abstract: SUMMARY: In 2002, the peer review auditor program was replaced with independent inspections of audit firms by the Public Company Accounting Oversight Board (PCAOB). The PCAOB inspections differ fro...
86 citations
TL;DR: Using publicly traded bank holding company data from 2008 through 2011, the authors found that the proportions of fair-valued assets held by banks are positively associated with audit performance. But they did not find that the proportion of fair valued assets held in banks is positively correlated with audit quality.
Abstract: SUMMARY: Using publicly traded bank holding company data from 2008 through 2011, this paper documents that the proportions of fair-valued assets held by banks are positively associated with audit f...
82 citations
TL;DR: In this paper, the authors examined the effects of workgroup composition factors and organizational climate factors on perceived gender discrimination, along with the impact of perceived discrimination on several critical organizational outcomes.
Abstract: SUMMARY: This paper tests a model of perceived gender discrimination in the audit profession. Using a sample of 234 female auditors employed in public accounting firms, we examine the effects of workgroup composition factors and organizational climate factors on perceived gender discrimination, along with the impact of perceived gender discrimination on several critical organizational outcomes. We find that female auditors report lower levels of gender discrimination when employed (1) in firms with more female partners, (2) in firms with stronger ethical climates, (3) in firms that are more supportive of alternative work arrangements, and (4) in firms that provide higher levels of top management support for the personal well-being of their employees. Further, we find that perceived gender discrimination is associated with lower organizational citizenship behavior and higher turnover intentions. Implications for research and public policy are discussed.
66 citations
TL;DR: A review of cross-cultural differences in auditors' judgment and decision making (JDM) is presented in this paper, where the authors present a framework that categorizes those auditor judgments and decisions most likely affected by cross-culture differences, including confidence, risk and probability judgments, risk decisions, conflict decisions, and ethical judgments.
Abstract: SUMMARY: Motivated by the growing cultural diversity of new hires in audit firms, this paper reviews the literature on cross-cultural differences in auditors' judgment and decision making (JDM). The overarching aim of the review is to summarize the current state of knowledge and compare our understanding of cross-cultural auditors' JDM with the broader cross-cultural JDM research in psychology to stimulate applied research. We develop a framework that categorizes those auditor judgments and decisions most likely affected by cross-cultural differences. The categories include auditors' confidence, risk and probability judgments, risk decisions, conflict decisions, and ethical judgments. We contribute to the cross-cultural audit research in four ways. First, we provide a framework by which future research can be synthesized within auditing and compared with psychology. Second, we recommend specific research questions to respond to both the gaps in extant literature and the changing multicultural environment ...
65 citations
TL;DR: In this article, the authors developed a framework for a continuous data level auditing system and used a large sample of procurement data from a major health care provider to simulate an implementation of this framework, the first layer monitors compliance with deterministic business process rules and the second layer consists of analytical monitoring of business processes.
Abstract: SUMMARY: This study develops a framework for a continuous data level auditing system and uses a large sample of procurement data from a major health care provider to simulate an implementation of this framework. In this framework, the first layer monitors compliance with deterministic business process rules and the second layer consists of analytical monitoring of business processes. A distinction is made between exceptions identified by the first layer and anomalies identified by the second one. The unique capability of continuous auditing to investigate (and possibly remediate) the identified anomalies in “pseudo-real time” (e.g., on a daily basis) is simulated and evaluated. Overall, evidence is provided that continuous auditing of complete population data can lead to superior results, but only when audit practices change to reflect the new reality of data availability. Data Availability: The data are proprietary. Please contact the authors for details.
TL;DR: In this article, the authors investigate the effect of audit partner rotation on financial reporting quality in the U.S. and find evidence of lower reporting quality during the first two years with a new audit partner relative to the final two years of the outgoing partner.
Abstract: SUMMARY: Audit partner rotation has received considerable attention globally and in the U.S. since the Sarbanes-Oxley Act of 2002 accelerated the rotation period from seven to five years and expanded the cooling-off period from two to five years. However, research on the effects of audit partner rotation on financial reporting quality in the U.S. is virtually non-existent, largely due to the absence of publicly available information on audit partners. Using a novel approach to determine audit partner rotation, we investigate the effect of rotation on financial reporting quality in the U.S. We find evidence of lower financial reporting quality following an audit partner change. Specifically, we find lower financial reporting quality during the first two years with a new audit partner relative to the final two years with the outgoing partner. We find the lower financial reporting quality to be more prevalent for larger clients. Further analyses suggest the initial year post-rotation presents audit challenge...
TL;DR: In this article, the authors use the association between audit fees and CEO and CFO equity incentives to infer whether auditors increase audit scope and perceive greater risk as equity incentives increase.
Abstract: SUMMARY: In 2013, the Public Company Accounting Oversight Board (PCAOB) proposed an amendment to Auditing Standard No. 12 (PCAOB 2010) that would require auditors to consider executive compensation in audit planning because of potential fraud risk associated with equity incentives. We use the association between audit fees and CEO and CFO equity incentives to infer whether auditors increase audit scope and perceive greater risk as equity incentives increase. Equity incentives are defined as the sensitivity of the value of executives' equity portfolios to changes in share price (delta incentive) and to changes in return volatility (vega incentive). We find a positive association between audit fees and vega, but not delta. However, when we interact vega with proxies for residual auditor business risk, we find that the fee premiums for risk decrease as vega increases. Our results suggest that auditors do consider executive compensation in audit planning.
TL;DR: In this article, audit fee negotiations conclude with the signing of an engagement letter, typically the first quarter of the year under audit, and investors do not learn the audit fee paid until disclosed.
Abstract: SUMMARY: Audit fee negotiations conclude with the signing of an engagement letter, typically the first quarter of the year under audit. Yet investors do not learn the audit fee paid until disclosed...
TL;DR: In this paper, the authors examined the timeliness implications of office-specific attributes of the audit firm and found that office specific industry expertise, office size, and the importance of the client to the local office are associated with audit delay.
Abstract: SUMMARY: Recent changes in the audit and financial reporting environment have resulted in longer audit report lags and have increased the importance of identifying factors associated with a timely audit. We examine timeliness implications of office-specific attributes of the audit firm. Specifically, we examine whether office-specific industry expertise, office size, and the importance of the client to the local office are associated with audit delay (i.e., the time between fiscal year-end and the audit report date). We explore the sensitivity of our results to various measures and consider the impact of earnings quality. We examine two types of industry expertise and whether the aforementioned audit firm attributes are associated with a propensity to issue an early earnings announcement. We find that office-specific industry expertise is negatively associated with audit delay (for all but the largest quartile of firm offices) while office size and client importance are both positively associated with aud...
TL;DR: The authors empirically tested auditors' responses to CEO/CFO equity incentives in planning and pricing decisions using data from 2002 through 2009, finding that CFO equity incentive is positively associated with audit fees and CEO equity incentives are not statistically related to audit fees, suggesting that auditors perceive heightened audit risk associated with CFO incentive.
Abstract: SUMMARY: The alleged perverse role of managerial incentives in accounting scandals, and the distinctive role of auditors in identifying and intervening in attempted earnings manipulation, highlight the importance of explicitly considering executive incentive plans by auditors in the auditing process. By empirically testing auditors' responses to CEO/CFO equity incentives in planning and pricing decisions using data from 2002 through 2009, we document compelling evidence that CFO equity incentives are positively associated with audit fees and CEO equity incentives are not statistically related to audit fees, suggesting that auditors perceive heightened audit risk associated with CFO equity incentives. Our further analyses reveal that the positive association between CFO equity incentives and audit fees is more pronounced in firms with weak internal controls, indicating heightened risk associated with CFO equity incentives in this setting perceived by auditors. JEL Classifications: G30, G34, M42, M52.
TL;DR: In this paper, the authors extend this literature by focusing on the link between the going concern opinion and the cost of equity capi cation, and find that negative market reaction to going concern opinions is correlated with the stock price.
Abstract: SUMMARY: Prior studies document a negative market reaction to going concern opinions. We extend this literature by focusing on the link between the going concern opinion and the cost of equity capi...
TL;DR: In this paper, the authors investigate the association between auditors' supply chain knowledge and companies' audit quality and audit pricing, and they find that auditors with supply-chain knowledge at the city level are associated with higher audit quality, and lower audit fees.
Abstract: SUMMARY: We investigate the association between auditors' supply chain knowledge and companies' audit quality and audit pricing. Auditor supply chain knowledge is a specialized understanding of information and processes regarding accounting and auditing issues that relates to both a supplier and its major customer, regardless of industry commonalities, that is particularly useful for understanding complexities associated with the revenue cycle. We find that auditors' supply chain knowledge at the city level is associated with higher audit quality and lower audit fees, compared to companies employing auditors with supply chain knowledge at the national level or employing auditors without supply chain knowledge. Such effects are stronger for supplier companies that derive a high proportion of revenue from their major customers, and when the revenue cycle for the supplier companies is more important. We obtain these results while controlling for the usual determinants of audit quality and fees, along with au...
TL;DR: Huang et al. as discussed by the authors investigated whether lowballing exists in new auditor-client relationships in an extended post-SOX environment for the first time and found that Big 4 auditors charged a fee premium on new auditor client relationships in 2006.
Abstract: SUMMARY: On August 16, 2011, the Public Company Accounting Oversight Board (PCAOB) issued a concept release seeking comments on ways to enhance auditor independence. The Board notes that higher failure rates in new audit engagements might be linked to unrealistic pricing. The Board's concern is that a new auditor might be more susceptible to management pressure if initial-year audit fees are set artificially low. Prior to the Sarbanes-Oxley Act (SOX) of 2002, empirical evidence shows that auditors discounted their initial-year audit fees. This practice, known as lowballing, was expected to decrease significantly after the enactment of SOX. Indeed, findings in Huang, Raghunandan, and Rama (2009) seem to confirm that Big 4 auditors charged a fee premium on new auditor-client relationships in 2006. However, it is not clear if more recent post-SOX initial-year audits are free of lowballing. We investigate whether lowballing exists in new auditor-client relationships in an “extended” post-SOX environment for t...
TL;DR: In this paper, the authors examine whether Sarbanes-Oxley (SOX) Section 404 material weakness disclosures are predictive of future financial reporting quality and find evidence that for companies with a history of MW404s, the likelihood of misstatements in financial information continues to be significantly higher for two years after the last MW404 report compared to companies without a history.
Abstract: SUMMARY: This study examines whether Sarbanes-Oxley (SOX) Section 404 material weakness (MW404) disclosures are predictive of future financial reporting quality. I find evidence that for companies with a history of MW404s, the likelihood of misstatements in financial information continues to be significantly higher for two years after the last MW404 report compared to companies without a history of reported MW404s. The magnitude of the effect decreases non-linearly with decreasing speed. The findings further imply that the reason for the misstatement incidences is the unacknowledged pervasiveness of control problems. In particular, it appears that in many cases, the future misstatements are unrelated to the MW types disclosed in the last MW404 report, suggesting that some MW types are unacknowledged and, hence, control problems are even more pervasive than what was identified. Overall, the findings of this study highlight the importance of discovering and disclosing material weaknesses in internal control...
TL;DR: In this article, the authors investigate the role of business risk perspectives in the audit of smaller and medium-sized entities (SMEs) by SMPs, and develop a model that considers a continuum of audit approaches ranging from a substantive-based audit approach to a full-scope business risk audit.
Abstract: SUMMARY: This study investigates the role of business risk perspectives in the audit of smaller and medium-sized entities (SMEs) by small and medium-sized audit practices (SMPs). The research is important, since we have little knowledge of how SMPs utilize business risk factors, and there is a current debate about the need for proportionally applying auditing standards, including standards on business risks, in the audit of SMEs. We conduct 38 interviews with Dutch and German auditors of both small and medium-sized audit practices to capture a variety of different audit environments. We develop a model that considers a continuum of audit approaches ranging from a substantive-based audit approach to a full-scope business risk audit, and observe a limited and heterogeneous application of business risk perspectives by SMP auditors. We find that client complexity, enforcement by audit supervisory authorities, relative emphasis on book-tax alignment in different countries, and investments in audit technology a...
TL;DR: In this paper, the authors analyze whether audit adjustments vary systematically with inherent and control risk factors, based on proprietary data from a large recent sample of audit adjunctive adjuCs.
Abstract: SUMMARY: This paper analyzes whether audit adjustments vary systematically with inherent and control risk factors The analysis is based on proprietary data from a large recent sample of audit adju
TL;DR: Li et al. as discussed by the authors found that the association between fee dependence and the incidence of going-concern opinions (GCO) changed from insignificant in 2001 to positive in 2003, which has been interpreted as evidence that auditors became more conservative after the Sarbanes-Oxley Act (SOX).
Abstract: SUMMARY: Li (2009) found that the association between fee dependence (FEEDEP) and the incidence of going-concern opinions (GCO) changed from insignificant in 2001 to positive in 2003. This finding has been interpreted as evidence that auditors became more conservative after the Sarbanes-Oxley Act (SOX). However, Feldmann and Read (2010) suggested that the year following SOX was not typical due to the intense spotlight directed at the audit profession. We revisit Li (2009) by extending the post-SOX period to 2011, and find robust results of little FEEDEP-GCO association in the years after 2003. Hence, the rise in auditor conservatism identified by Li (2009) likely represented the audit profession's temporary reaction to public scrutiny surrounding the passage of SOX, rather than a sustained movement toward more conservative going-concern reporting. Our study reinforces the notion that the effect of major events and government regulations cannot be adequately assessed based on what transpires in the short r...
TL;DR: In this paper, the authors examined auditor industry specialization effects in Perth, a remote mining town in Australia characterized by a large number of small, homogeneous firms and found no evidence of auditor industry leadership fee premiums accruing to BDO, a result robust to a range of sensitivity tests.
Abstract: SUMMARY: This study examines auditor industry specialization effects in Perth, a remote mining town in Australia characterized by a large number of small, homogeneous firms. We consider the impact of leadership by the non-Big 4 auditor BDO Kendalls (BDO) for a sample of 371 mining development stage entities (MDSEs). After controlling for factors known to determine audit fees, we find no evidence of auditor industry leadership fee premiums accruing to BDO, a result robust to a range of sensitivity tests including the broadening of tests Australia-wide. However, when the dependent variable is redefined to the total “bundle” of services provided by the audit firm (including audit and non-audit fees), the industry leader is shown to earn a fee premium suggesting BDO uses audits as a conduit to supply higher-margin non-audit services. Our findings suggest that strategic pricing by industry leaders may not be confined to Big 4 firms.
TL;DR: Investigation of accounting population error rates and auditor sampling performance for a unique proprietary post-SOX dataset of 160 audit sampling applications for a large auditing firm finds low error rates, evidence that auditors' application of audit sampling is more consistent with the requirements in professional standards than previously reported.
Abstract: SUMMARY: Changes in the accounting and auditing environments since the passage of Sarbanes-Oxley (SOX) and the creation of the Public Accounting Oversight Board (PCAOB) have likely impacted accounting population error rates and audit sampling procedures. We investigate accounting population error rates and auditor sampling performance for a unique proprietary post-SOX dataset of 160 audit sampling applications for a large auditing firm. Compared to previous research, we find that in the post-SOX period, accounting data error rates are significantly lower in magnitude and frequency, sample sizes are significantly larger, and auditor performance has improved in evaluating sample errors. The low error rates suggest criticisms in prior research regarding audit sampling techniques may not be a serious concern for most audit sampling applications. Furthermore, we provide evidence that auditors' application of audit sampling is more consistent with the requirements in professional standards than previously reported.
TL;DR: In this paper, the authors empirically examined the relationship between the external financial statement audit and the method of payment across a sample of Belgian mergers and acquisitions between listed and private firms over the period 1997-2009.
Abstract: SUMMARY: In this paper, we empirically examine the relationship between the external financial statement audit and the method of payment across a sample of Belgian mergers and acquisitions between listed and private firms over the period 1997–2009. We investigate whether a Big N audit (at the target level) reduces the need for a contingent payment resulting from information asymmetry about the target's value. In addition, we analyze whether a Big N audit (at the bidder level) limits incentives for bidders to exploit private information about their own value. Using multivariate ordered probit and binary regression models, we determine that contingent payments are less common when the target is audited by a Big N auditor after controlling for several other deal and firm characteristics. Furthermore, we find that the incentive to use stock payments in periods of stock market overvaluation is lower for acquirers with a Big N auditor. Finally, target shareholders are more likely to accept a contingent offer if...
TL;DR: This article analyzed how investors perceive reported earnings using EERC coefficients from returns-earnings regressions as a proxy for investor perceptions of earnings quality, and found that the ERCs are a good proxy for earnings quality.
Abstract: SUMMARY: Using earnings response coefficients (ERCs) from returns-earnings regressions as a proxy for investor perceptions of earnings quality, we analyze how investors perceive reported earnings w...
TL;DR: In this article, the association between audit quality and the joint provision of audit and non-audit services (NAS) by accounting firms is examined, and it is shown that differences in audit quality between joint and nonjoint NAS conditions can only be assessed if the quality of the NAS service is held constant.
Abstract: SUMMARY: We examine the association between audit quality and the joint provision of audit and non-audit services (NAS) by accounting firms. We argue that differences in audit quality between joint and non-joint NAS conditions can only be assessed if the quality of the NAS service is held constant. Most prior work has not been able to do this because the identity of the NAS provider is unknown unless it is the audit firm itself. Our analysis is based on firms in the property-casualty insurance industry that purchase an actuarial certification of their loss reserves from an external party. The insurance setting is unique because the non-audit service that we examine is purchased by all firms in our sample, and we can identify both the audit and non-audit service provider. This allows us to directly address the NAS separation issue while holding NAS quality constant. We find that when actuarial work is obtained only from Big N firms (NAS quality is constant), audit quality is higher when separate Big N firm...
TL;DR: In this article, the authors examined the effect of an unexpected increase in a client's reputation on audit fees at the office level and found that association with a reputed client will enhance the auditor's reputation and establish a brand name, enabling the auditor to charge higher fees from other clients.
Abstract: SUMMARY: Prior studies have examined the effect of a decline in the auditor's or client's reputation on auditor switching, market shares, and stock prices. We extend these studies by examining the effect of an unexpected increase in a client's reputation on audit fees at the office level. We argue that association with a reputed client will enhance the auditor's reputation and establish a brand name, thus enabling the auditor to charge higher fees from other clients. Using a client's inclusion into the prestigious S&P 500 index as a proxy for the client's change in reputation, we find that the audit fees are discounted for this S&P client when it enters the index. The audit fee for this client increases following its exit from the index. We posit that changes in the audit fees for the S&P 500 clients are attributable to the changes in the reporting quality of these firms following their entry to and exit from the index. We also find increases in the audit fees of non-S&P clients of the audit office aroun...
TL;DR: In this article, the authors focus on the SEC Division of Corporation Finance (DCF) rather than the Division of Enforcement and specifically on DCF's "review and comment" monitoring role and find that the DCF may target companies with strong CEOs and weak monitoring.
Abstract: SUMMARY: Section 408 requires the Securities and Exchange Commission (SEC) to review the filings of all SEC registrants every three years. Our study investigates this SEC monitoring role and differs from past SEC research by focusing on the SEC Division of Corporation Finance (DCF) rather than the Division of Enforcement and specifically on DCF's “review and comment” monitoring role. We rely on past theoretical research in management, finance, and accounting that provides us with arguments suggesting the DCF may target companies with strong CEOs and weak monitoring. Our findings cast light on the power struggle between the board and CEO by suggesting that the CEO's influence over the board may adversely affect board oversight. In addition, our results indicate that the DCF-prompted restatements lead companies to re-evaluate their governance structure.