Showing papers on "Audit published in 2004"

Audit Committee Characteristics and Restatements

Abstract: This study addresses the impact of certain audit committee characteristics identified by the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (BRC) on the likelihood of financial restatement. We examine 88 restatements of annual results (without allegations of fraud) in the period 1991–1999, together with a matched pairs control group of firms of similar size, exchange listing, industry and auditor type. We find that the independence and activity level (our proxy for audit committee diligence) of the audit committee exhibit a significant and negative association with the occurrence of restatement. We also document a significant negative association between an audit committee that includes at least one member with financial expertise and restatement. To test the robustness of the results we also consider a sample of 44 fraud and no‐fraud firms and arrive at largely similar findings. Our results underscore the importance of the BRC's recommendations as a means of strengthen...

The Effect of Audit Committee Expertise, Independence, and Activity on Aggressive Earnings Management

Abstract: This study investigates whether the expertise, independence, and activities of a firm's audit committee have an effect on the quality of its publicly released financial information. In particular, we examine the relationship between audit committee characteristics and the extent of corporate earnings management as measured by the level of income‐increasing and income‐decreasing abnormal accruals. Using two groups of U.S. firms, one with relatively high and one with relatively low levels of abnormal accruals in the year 1996, we find a significant association between earnings management and audit committee governance practices. We find that aggressive earnings management is negatively associated with the financial and governance expertise of audit committee members, with indicators of independence, and with the presence of a clear mandate defining the responsibilities of the committee. The association is similar for both income‐increasing and income‐decreasing earnings management, suggesting that audit com...

What do we know about audit quality

Abstract: This paper reviews empirical research over the past 25 years, mainly from the United States, in order to assess what we currently know about audit quality with respect to publicly listed companies. The evidence indicates that outright audit failure rates are infrequent, far less than 1% annually, and audit fees are quite small, less than 0.1% of aggregate client sales. This suggests there may be an acceptable level of audit quality at a relatively low cost. There is also evidence of voluntary differential audit quality (above the legal minimum) along a number of dimensions such as firm size, industry specialization, office characteristics, and cross-country differences in legal systems and auditor liability exposure. The evidence is very positive although there is some indication that audit quality may have declined in the 1990s, in which case there could be merit in recent reforms such as the Sarbanes-Oxley Act of 2002 in the US. However, we do not know from research the optimal level of audit quality and therefore whether we currently have ‘too little’ or ‘too much’ auditing? Despite this lacuna we are entering an era of more mandated auditing in response to high-profile corporate governance failures including the Enron–Andersen affair. Finally, while recent reforms have scaled back the scope of non-audit services due to independence concerns, a case can be made that audit quality will always be somewhat suspect if other services are provided that are perceived to potentially compromise the auditor's objectivity and skepticism. For this reason public confidence in audit quality may be increased by proscribing all non-audit services for audit clients. Recommendations are also proposed with respect to legal liability reform and changes in partner compensation arrangements.

Auditor Independence, Non‐Audit Services, and Restatements: Was the U.S. Government Right?

Abstract: Do fees for non-audit services compromise auditor's independence and result in reduced quality of financial reporting? The Sarbanes-Oxley Act of 2002 presumes that some fees do and bans these services for audit clients. Also, some registrants voluntarily restrict their audit firms from providing legally permitted non-audit services. Assuming that restatements of previously issued financial statements reflect low-quality financial reporting, we investigate detailed fees for restating registrants for 1995 to 2000 and for similar nonrestating registrants. We do not find a statistically significant positive association between fees for either financial information systems design and implementation or internal audit services and restatements, but we do find some such association for unspecified non-audit services and restatements. We find a significant negative association between tax services fees and restatements, consistent with net benefits from acquiring tax services from a registrant's audit firm. The significant associations are driven primarily by larger registrants.

The ethical, social and environmental reporting‐performance portrayal gap

Abstract: The purpose of this article is twofold. First, it assesses in detail the extent to which corporate reporting on ethical, social and environmental issues reflects corporate performance in case study company Alpha. This “reporting‐performance” portrayal gap is a key measure of the extent to which an organisation is accountable to its stakeholders. Alpha's disclosures concerning its ethical, social and environmental performance for the years 1993 and 1999 were compared with information obtained on Alpha's performance from other sources. Two different pictures of performance emerged leading to the conclusion that, in the case of Alpha, reports do not demonstrate a high level of accountability to key stakeholder groups on ethical, social and environmental issues. Of particular concern is the lack of “completeness” of reporting. Second, the article assesses the potential of recent standards or guidelines developed by the Global Reporting Initiative (GRI) and the Institute of Social and Ethical AccountAbility (AccountAbility) as well as the industry's own “responsible care” initiative to reduce this “reporting‐performance” portrayal gap and improve corporate accountability. The conclusions point to the need for other measures to improve accountability including mandatory reporting guidelines, better developed audit guidelines, a mandatory audit requirement for MNCs and a radical overhaul of corporate governance systems.

Litigation Risk and the Financial Reporting Credibility of Big 4 versus Non‐Big 4 Audits: Evidence from Anglo‐American Countries

Abstract: Prior research suggests that Big 4 auditors provide higher quality audits in the U.S. in order to protect the firm's brand name reputation and to avoid costly litigation. In this study, we examine whether the perceived higher quality of a Big 4 audit is related to auditor litigation exposure or to reputation concerns. Specifically, we utilize an estimable proxy for financial reporting credibility—the ex ante cost of equity capital—to examine whether Big 4 auditors are perceived as providing higher quality audits (relative to non‐Big 4 auditors) in the U.S., and in the less litigious (but economically similar) environments in other Anglo‐American countries during the 1990–99 period. We find that a Big 4 audit is associated with a lower ex ante cost of equity capital for auditees in the U.S. but not in Australia, Canada, or the U.K. Our findings suggest that it is litigation exposure rather than brand name reputation protection that drives perceived audit quality.

Audit Firm Tenure and Fraudulent Financial Reporting

Abstract: The Sarbanes‐Oxley Act (2002) required the U.S. Comptroller General to study the potential effects of requiring mandatory audit firm rotation. The General Accounting Office (GAO) concludes in its recently released study of mandatory audit firm rotation that “mandatory audit firm rotation may not be the most efficient way to strengthen auditor independence” (GAO 2003, Highlights). However, the GAO also suggests that mandatory audit firm rotation could be necessary if the Sarbanes‐Oxley Act's requirements do not lead to improved audit quality (GAO 2003, 5). We examine the relation between audit firm tenure and fraudulent financial reporting. Comparing firms cited for fraudulent reporting from 1990 through 2001 with both a matched set of non‐fraud firms and with the available population of non‐fraud firms, we find that fraudulent financial reporting is more likely to occur in the first three years of the auditor‐client relationship. We fail to find any evidence that fraudulent financial reporting is more lik...

The corporate governance mosaic and financial reporting quality

Abstract: The purpose of this paper is to review research on corporate governance and its impact on financial reporting quality This review will serve three purposes: (1) to suggest a corporate governance mosaic(ie, the interactions among the actors and institutions that affect corporate governance) that encompasses a broader view of governance than has been considered in prior accounting research; (2) to provide an overview of the principal findings of prior research; and (3) to identify important gaps in the research that represent promising avenues for future study

Does Auditor Quality and Tenure Matter to Investors? Evidence from the Bond Market

Abstract: We examine the relation between auditor characteristics (quality and tenure) and the cost of debt financing. Consistent with the hypothesis that audit characteristics are important to the capital markets, we find that (1) auditor quality and tenure are negatively and significantly related to the cost of debt financing, (2) the relation between auditor characteristics and the cost of debt is most pronounced in firms with debt that is noninvestment grade, and (3) both the insurance and information role of audits are economically significant to the cost of debt. Overall, our results suggest that, through their dual roles of providing information and insurance, auditor quality and tenure matter to capital market participants.

Board Composition and Corporate Fraud

Abstract: The study reported here examined how various characteristics of the board of directors and other governance features affected the occurrence of U.S. corporate fraud in the 1978–2001 period. The findings suggest that board composition and the structure of a board's oversight committees are significantly correlated with the incidence of corporate fraud. In the sample, as the number of independent outside directors increased on a board and in the board's audit and compensation committees, the likelihood of corporate wrongdoing decreased.

Building an Encrypted and Searchable Audit Log.

Abstract: Audit logs are an important part of any secure system, and they need to be carefully designed in order to give a faithful representation of past system activity. This is especially true in the presence of adversaries who might want to tamper with the audit logs. While it is important that auditors can inspect audit logs to assess past system activity, the content of an audit log may contain sensitive information, and should therefore be protected from unauthorized

Earnings Manipulation Risk, Corporate Governance Risk, and Auditors' Planning and Pricing Decisions

Abstract: This paper investigates auditors' assessments of earnings manipulation risk and corporate governance risk, and their planning and pricing decisions in the presence of these identified risks. To conduct this investigation, we use engagement partners' assessments of their existing clients made during the participating public accounting firm's client continuance risk assessment process. We find that auditors plan increased effort and billing rates for clients with earnings manipulation risk, and that the positive relationships between earnings manipulation risk and both effort and billing rates are greater for clients that also have heightened corporate governance risk. These findings provide evidence that auditors assess situations involving both an aggressive management and inadequate corporate governance, and that there is a relationship between those assessments and auditors' planning and pricing decisions.

Self-Selection of Auditors and Audit Pricing in Private Firms

Abstract: Prior research has examined audit pricing for publicly held firms and provided some evidence of a Big 8 premium in pricing. We investigate audit pricing among private firms, and provide evidence that private firms do not pay such a premium on average. The relatively greater degree of dispersion in auditor choice (between Big 5 and non‐Big 5 auditors) in our large sample of privately held audit clients allows us to predict the auditor choice for each firm and to control for potential self‐selection. We reject the null hypothesis that clients are randomly allocated across Big 5 and non‐Big 5 auditors. Using standard OLS regressions, we document a Big 5 premium; however this premium vanishes once we control for self‐selection bias. Moreover, we find that client firms choosing Big 5 auditors generally would have faced higher fees had they chosen non‐Big 5 auditors, given their firm‐specific characteristics. Our results are consistent with audit markets for private firms being segmented along cost‐effective li...

The risk management of everything

Abstract: I recently decided that there was no longer space to store 20 years worth of Accountancy and Accountancy Age. Prior to disposal I reviewed all the back issues for articles of particular note worth saving. In the course of this process, a number of things were striking. First, articles on financial reporting were conspicuous in the 1980s, and in the 1990s it was auditing which seemed to be the main object of discussion. Second, risk and risk management begin to receive regular exposure only from about the mid‐1990s onwards. In particular, the late 1990s reveal an increasing commentary on practice management and risks to professional partnerships.

Validity of the alcohol use disorders identification test in college students.

Abstract: Background: High-risk alcohol use among college students is associated with accidents, partner violence, unwanted sexual encounters, tobacco use, and performance issues. The identification and treatment of high-risk drinking students is a priority for many college campuses and college health centers. The goal of this study was to test the psychometric properties of the Alcohol Use Disorders Identification Test (AUDIT) in college students. Methods: A convenience sample of students coming into a college health clinic was asked to complete the 10-question AUDIT and then participate in a research interview. The interview focused on assessing students for alcohol abuse and dependence by using the Composite International Diagnostic Interview Substance Abuse Module and timeline follow-back procedures to assess a 28-day drinking history. Results: A total of 302 students met the eligibility criteria and agreed to participate in the study. The sample consisted of 185 females (61%) and 117 males (39%), with a mean age of 20.3 years. Forty students were abstinent, 88 were high-risk drinkers, and 103 met criteria for a 12-month history of dependence. Receiver operator curves demonstrated that the AUDIT had the highest area under the cure for detecting high-risk alcohol use (0.872) and the lowest for identifying persons with a lifetime history of alcohol abuse or dependence (0.775). An AUDIT cutoff score of 6 or greater demonstrated a sensitivity of 91.0% and a specificity of 60.0% in the detection of high-risk drinkers. Conclusions: The AUDIT has reasonable psychometric properties in sample of college students using student health services. This study supports the use of the AUDIT in this population.

Audit Firm Industry Specialization and Client Disclosure Quality

Abstract: This paper provides evidence that clients select auditors as part of their overall disclosure strategy. We hypothesize that in addition to higher quality audits, industry-specialist audit firms assist clients in enhancing disclosures. We also posit that the choice of an industry-specialist auditor signals a client’s intention to provide enhanced disclosures. However, we predict that industry-specialist audit firms are less important in regulated industries where enhanced disclosures add little value. Consistent with our hypotheses, we document a positive association between industry-specialist audit firms and analysts’ rankings of disclosure quality in unregulated industries, but no relation in regulated industries.

Former Audit Partners and Abnormal Accruals

Abstract: Audit clients often employ a former partner of their present auditor as an officer or a director. This “revolving door” practice presents a potential threat to auditor independence. Using the Jones (1991) model to calculate abnormal accruals for firms in 1998 and 1999, we find that firms employing former partners as officers or directors report larger signed and unsigned abnormal accruals than other firms, after controlling for other factors that plausibly affect abnormal accruals. To ensure that the results are not driven by performance characteristics of the former partner firms, we construct a performance‐matched control sample and obtain consistent results. We also observe a disproportionately higher (lower) proportion of former partner firms than expected just meeting (missing) analysts' earnings forecasts.

Commission for Healthcare Audit and Inspection

Abstract: Presentation by Barry Tennison to the South East and South West Public Health Network Learning Set on 28th January 2004.

Auditor Industry Specialization, Client Bargaining Power, and Audit Pricing

Abstract: 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 com...

Accounting Professionalism—They Just Don't Get It!

Abstract: INTRODUCTION I realize that my title contains two ambiguous pronouns--"they" and "it." After reading this commentary, I hope you will be able to identify who is "they" and what it is that they don't get. The accounting profession has been beaten up badly in the media over the last few years, and with some justification. The forces at work were numerous and complex and different investigators place emphasis on a variety of phenomena that created the environment in which Arthur Andersen disappeared and the reputation of the entire profession was tarnished. Some of these forces were not new, such as: * corporate and individual greed, * delivering services that acted to impair independence, * becoming too cozy with clients, and * participating actively in finding ways to avoid the provisions of accounting standards. What was new is that the profession's historical defenses to combat these forces proved ineffective. The bottom line is that the profession--indeed, society as whole--has paid a high price for the accounting profession's failure to meet the expectations of investors, creditors, and other users of financial statements. This commentary attempts to identify the core of the problem. I will also make some suggestions on how the profession can prevent a recurrence of the recent bad times, and how educators may better prepare entrants to the profession. My observations are based upon observing the profession's evolution over the past 50 years and participating actively in it for nearly 40 years. My comments will frequently refer to Arthur Andersen, since that is the only firm with which I had substantive experience. Those comments are not intended to be praiseworthy, apologetic, or critical of Andersen. Rather, they merely will help illustrate the world as I saw it over a good many years. PAST EMPHASIS ON PROFESSIONALISM Some historical perspective helps set the stage for understanding how accounting professionalism gradually lost significance in the 1980s and 1990s. In the 1940s, even the large accounting firms were not very big entities. When I graduated from college, Andersen was the 12th largest firm--in Chicago--and had about 30 partners. Andersen was a part of the Big 8 by the mid-1960s, and it was probably seventh in size, with about 350 partners around the world. Accounting education in the 1950s and 1960s focused more on professionalism and the accounting code of ethics. Nearly all entrants to the large firms were recent college graduates whose courses in auditing focused on professional responsibilities and the importance of ethical behavior. The apprenticeship approach inherited from the United Kingdom was a thing of the past, and the hiring of experienced individuals with diverse business backgrounds had not appeared on the scene. The American Institute of Certified Public Accountants (AICPA) was mostly a professional organization whose senior committees developed the professional standards that guided accounting decisions and auditing approaches. Jack Carey was the Institute's most significant spokesman, and his focus over the years was on heightening the awareness of the importance of ethical professional behavior. Only later did the AICPA become, in effect, a trade association with only limited impact on matters of professionalism and ethical behavior. The large firms were headed by a leading accounting professional, often one who had risen to the top of the firm based upon acknowledged know-how, exposure to diverse accounting issues, and honed technical skills. These individuals were often well known in the broad business community and were active outside their firm. The firm leaders used articles and speeches to articulate the nature of the profession and its importance to our business and commercial system. They spoke out forcefully on the issues of the day, often without regard to whether one or more clients might find their remarks objectionable. …

Equity Audits: A Practical Leadership Tool for Developing Equitable and Excellent Schools

Abstract: Persistent achievement gaps by race and class in U.S. public schools are educationally and ethically deplorable and, thus, need to be eliminated. Based on their research on schools and districts that haven arrowed these gaps, the authors have developed a simplified reconceptualization of equity auditing, a concept with a respected history in civil rights, in curriculum auditing, and in some state accountability systems. This reconceptualized equity auditing is a leadership tool that can be used to uncover, understand, and change inequities that are internal to schools and districts in three areas—teacher quality, educational programs, and student achievement.

Client size, auditor specialization and fraudulent financial reporting

Abstract: This study examines the effect that client size has on the relation between industry‐specialist auditors and fraudulent financial reporting. Most of the major accounting firms have organized their audit practices along industry lines, reflecting a belief that industry specialization leads to higher quality audits. Furthermore, regulatory bodies and extant research suggests that larger clients have greater bargaining power and are more likely to be able to convince the auditor to acquiesce to aggressive accounting. Also, it may be more difficult for an auditor to possess industry expertise for larger clients who are likely to be more complex and operate in more than one industry. Consistent with previous research, we generally find a significant negative relation between auditor industry specialization and client financial fraud. Also, as expected, the negative relation between auditor industry specialization and financial fraud is weaker for larger clients. This study provides evidence that the positive benefits of auditor industry specialization in deterring financial fraud is affected by client size.

The Impact of Audit on Social Work Practice

Abstract: Public sector services in all developed economies have had to meet new demands for accountability and transparency, leading to the creation of complex audit systems. This article examines the way that this has been done in relation to social work practice in the UK. Auditing is a dynamic process and the aim of the Audit Commission is to be a driving force in improving services. However, it is argued that social work presents particular challenges because of the nature of its knowledge base. Improvement in services to users cannot be achieved just by managerial changes but requires rigorous research to increase our understanding of what works. The process of making social work ‘auditable’ is in danger of being destructive, creating a simplistic description of practice and focusing on achieving service outputs with little attention to user outcomes. Alternatively, however, if it is linked to research methods, it could be highly constructive, producing reliable evidence not only on efficiency but on effectiveness.

Corporate Governance and Accounting Scandals

Abstract: This paper empirically examines whether certain corporate governance mechanisms are related to the probability of a company restating its earnings. We examine a sample of 159 U.S. public companies that restated earnings and an industry-size matched sample of control firms. We have assembled a novel, hand-collected dataset measuring corporate governance characteristics of these 318 firms. We find that several key governance characteristics are unrelated to the probability of a company restating earnings. These include the independence of boards and audit committees, and the provision of non-audit services by outside auditors. We find that the probability of restatement is lower in companies whose boards or audit committees have an independent director with financial expertise; it is higher in companies where the CEO belongs to the founding family. These relations are statistically significant, large in magnitude, and robust to alternative specifications. Our findings are consistent with the idea that independent directors with financial expertise are valuable in providing oversight of a firm's financial reporting practices.

The corporate governance effects of audit committees

Abstract: Arguments associated with the promotion of audit committees in many countries are premised on their potential for alleviating weaknesses in corporate governance. This paper provides a synthesis and evaluation of empirical research on the governance effects associated with audit committees. Given recent policy recommendations in several countries aimed at strengthening these committees, it is important to establish what research evidence demonstrates about their existing governance contribution. A framework for analyzing the impact of audit committees is described, identifying potential perceived effects which may have led to their adoption and documented effects on aspects of the audit function, on financial reporting quality and on corporate performance. It is argued that there is only limited and mixed evidence of effects to support claims and perceptions about the value of audit committees for these elements of governance. It is also shown that most of the existing research has focused on factors associated with audit committee existence, characteristics and measures of activity and there is very little evidence on the processes associated with the operation of audit committees and the manner in which they influence organizational behaviour. It is clear that there is no automatic relationship between the adoption of audit committee structures or characteristics and the achievement of particular governance effects, and caution may be needed over expectations that greater codification around factors such as audit committee members' independence and expertise as the means of “correcting” past weaknesses in the arrangements for audit committees. The most fundamental question concerning what difference audit committees make in practice continues to be an important area for research development. For future research we suggest (i) greater consideration of the organizational and institutional contexts in which audit committees operate; (ii) explicit theorization of the processes associated with audit committee operation; (iii) complementing extant research methods with field studies; and (iv) investigation of unintended (behavioural) as well as expected consequences of audit committees.

Accountability, completeness, credibility and the audit expectations gap.

Abstract: This article deals with two concerns in achieving greater accountability in social reports: the lack of completeness of reporting, and the lack of credibility of reports. The article focuses, in particular, on the role of social audits in improving the completeness and credibility of reporting, thereby reducing the audit expectations gap. We suggest that this gap arises due to an over-emphasis on the validity of performance data at the expense of addressing completeness and credibility, both of which, we argue, require stakeholder involvement. The article reviews recent guidelines aimed at ensuring that companies produce reports that are complete in all material respects including those produced by the Global Reporting Initiative and the Federation des Experts Comptables Europeens, focusing particularly on AccountAbility’s AA1000 Standard and AA1000S Assurance Standard. Finally, the article considers the development of a practical approach to social audit following principles increasingly being incorporated into developing assurance guidelines aimed at reducing the audit expectations gap. ● Social auditing ● Accountability ● Audit expectations gap

Globalization and the coordinating of work in multinational audits

Abstract: This paper examines how the processes of coordinating a multinational audit impacts, and is effected by, the structuration of globalization. Using a detailed field study of an audit involving multiple locations, we argue that the coordination of work in multinational firms links the local and the global in a dialectical manner. In particular, we analyze the relationship between the global and the local through an examination of two key coordinating mechanisms used by audit firms––inter-office instructions and the firm's risk based audit methodology. In so doing, we discuss the local appropriation of global systems, as well as the importance of trust and professional identity in the coordination and management of the multisite audit. Our study suggests two key globalizing tendencies associated with reflexivity in audit––the increased risk of litigation and the commercialization of the audit industry. These changes are intimately linked at the work practice level to changes in documentation, new technologies and methodologies, and a diversification in business advisory services requiring new skills and client relationships. We discuss the implications of these changes for the future of auditing, audit work and large audit firms.

The Effectiveness of Alternative Risk Assessment and Program Planning Tools in a Fraud Setting

Abstract: This study examines the impact of alternative risk assessment (standard risk checklist versus no checklist) and program development (standard program versus no program) tools on two facets of fraud planning effectiveness: (1) the quality of audit procedures relative to a benchmark validated by a panel of experts, and (2) the propensity to consult fraud experts. A between-subjects experiment, using an SEC enforcement fraud case, was conducted to examine these relationships. Sixty-nine auditors made risk assessments and designed an audit program. We found that auditors who used a standard risk checklist, structured by SAS No. 82 risk categories, made lower risk assessments than those without a checklist. This suggests that the use of the checklist was associated with a less effective diagnosis of the fraud. We also found that auditors with a standard audit program designed a relatively less effective fraud program than those without this tool but were not more willing to seek consultation with fraud experts. This suggests that standard programs may impair auditors' ability to respond to fraud risk. Finally, our results show that fraud risk assessment (FRASK) was not associated with the planning of more effective fraud procedures but was directly associated with the desire to consult with fraud specialists. This suggests that one benefit of improved FRASK is its relation with consultation. Overall, the findings call into question the effectiveness of standard audit tools in a fraud setting and highlight the need for a more strategic reasoning approach in an elevated risk situation.