The Effects of Decision-Aid Design on Auditor Performance in Internal Control Evaluation Tasks

2017 ◽  
Vol 32 (2) ◽  
pp. 95-113 ◽  
Author(s):  
Uday S. Murthy ◽  
Patrick R. Wheeler
Keyword(s):  
Task Performance ◽  
Internal Control ◽  
Decision Aid ◽  
Decision Aids ◽  
Dilution Effect ◽  
Data Availability ◽  
Directed Search ◽  
The Public ◽  
Public Company ◽  
Control Evaluation

ABSTRACT Independent auditors evaluate internal controls (IC) using internal control questionnaires (ICQs). The Public Company Accounting Oversight Board (PCAOB) recommends that rather than using generic ICQs, auditors should consider using ICQs customized for each audit client. Based on Silver's (1988, 1990) decision-aid design principles and dilution effect research, we hypothesize that the presence of irrelevant task cues in an ICQ decision aid will negatively affect auditors' task performance and that task performance will be positively affected by an ICQ decision aid in which task cues are presented one at a time (directed search) rather than all together (non-directed). We conduct an experiment with practicing auditors as participants who complete an ICQ decision-aid with either few or many irrelevant questions presented all at once or a question at a time. We find partial support for the PCAOB's recommendation, in that participants were more accurate with a directed versus non-directed search ICQ decision aid. Irrelevant cues did not affect accuracy. Although the participants with directed search ICQ decision-aids were more accurate evaluating IC, they were less accurate assessing the overall strength of the IC system and recommending additional testing of IC and transaction details. These findings have important implications for the design and use of decision aids. Data Availability: Contact the authors.

scholarly journals Audit Partners' Judgments and Challenges in the Audits of Internal Control over Financial Reporting

2020 ◽  
Vol 39 (4) ◽  
pp. 57-85
Author(s):  
Jeffrey R. Cohen ◽  
Jennifer R. Joe ◽  
Jay C. Thibodeau ◽  
Gregory M. Trompeter
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Data Availability ◽  
Audit Committees ◽  
Structured Interviews ◽  
Material Weakness ◽  
The Public ◽  
National Office ◽  
Evaluation Task ◽  
Public Company

SUMMARY Internal control over financial reporting (ICFR) audits have been the subject of intensive examination by the Public Company Accounting Oversight Board (PCAOB) and researchers but the process through which auditors make ICFR judgments is largely a “black box.” To understand ICFR judgments, we conducted semi-structured interviews with 20 audit partners. Common themes in our interviews suggest that the subjectivity inherent in the ICFR evaluation task contributes to resistance against ICFR audit findings and cougnterarguments from management. Moreover, auditors perceive that their judgments are being second-guessed by PCAOB inspectors. Auditors believe that managers have difficulty accepting that material weaknesses can exist without a detected error, that management's reflexive reaction is to deny/avoid a material weakness finding, and managers routinely claim that management review controls (MRCs) would have caught the detected control deficiency. Auditors cope with management's defenses by consulting with their national office and leveraging support from strong audit committees. Data Availability: Requests for the data should be accompanied by a description of intended uses.

The Effect of Auditing Standard No. 5 on Audit Report Lags

2015 ◽  
Vol 29 (3) ◽  
pp. 507-527 ◽  
Author(s):  
Santanu Mitra ◽  
Hakjoon Song ◽  
Joon Sun Yang
Keyword(s):  
Internal Control ◽  
Extended Period ◽  
Data Availability ◽  
Audit Report ◽  
Audit Process ◽  
Top Down ◽  
The Public ◽  
Audit Efficiency ◽  
Public Company ◽  
The Impact

SYNOPSIS Auditing Standard No. 5 (AS5) introduced by the Public Company Accounting Oversight Board (PCAOB) in June 2007 requires a top-down risk-based approach in auditing and is expected to improve audit efficiency and make the overall auditing process timelier by reducing audit report lags. We investigate the impact of AS5 on audit report lags over an extended period from 2006 to 2011 and find that audit report lags are lower in the AS5 years (2007–2011) relative to the AS2 years (2006–2007). But this reduction is evident mostly for the firms with clean SOX 404 opinions. The presence of material internal control weaknesses (ICW) significantly increases audit report lags, but AS5 does not have any incremental moderating effect on report lags and the ICW relationship. Tests for the firms with company-level and account-specific ICWs demonstrate identical results. Additional analyses show that the learning curve effect takes place rapidly in the early part of the AS5 period and audits continue to remain efficient in terms of reduced report lags in the latter part of the AS5 period relative to the AS2 period. The year-to-year change analyses for the AS5 period further corroborate this result. Overall, our study demonstrates that the top-down, risk-based approach under AS5 makes the audit process more efficient and timelier by decreasing audit report lags. Data Availability: Data are available from public sources identified in the paper.

The Search for Order in Municipal Administration: Herman A. Metz and the New York City Experience, 1898–1909

2020 ◽  
Vol 47 (1) ◽  
pp. 55-74
Author(s):  
Ryan P. McDonough ◽  
Paul J. Miranti ◽  
Michael P. Schoderbek
Keyword(s):  
New York ◽  
New York City ◽  
Internal Control ◽  
York City ◽  
Internal Controls ◽  
Data Availability ◽  
Financial Reports ◽  
The Public ◽  
Operational Activities ◽  
The City

ABSTRACT This paper examines the administrative and accounting reforms coordinated by Herman A. Metz around the turn of the 20th century in New York City. Reform efforts were motivated by deficiencies in administering New York City's finances, including a lack of internal control over monetary resources and operational activities, and opaque financial reports. The activities of Comptroller Metz, who collaborated with institutions such as the New York Bureau of Municipal Research, were paramount in initiating and implementing the administrative and accounting reforms in the city, which contributed to reform efforts across the country. Metz promoted the adoption of functional cost classifications for city departments, developed flowcharts for improved transaction processing, strengthened internal controls, and published the 1909 Manual of Accounting and Business Procedure of the City of New York, which laid the groundwork for transparent financial reports capable of providing vital information about the city's activities and subsidiary units. JEL Classifications: H72, M41, N91. Data Availability: Data are available from the public sources cited in the text.

Hiring Auditors with a Part II Quality Control Report: An Opportunity for Increased Earnings Management or Lower Audit Fees?

2020 ◽  
Vol 5 (1) ◽  
pp. 73-93
Author(s):  
Jared Eutsler ◽  
D. Kip Holderness ◽  
Megan M. Jones
Keyword(s):  
Quality Control ◽  
Audit Quality ◽  
Audit Fees ◽  
Data Availability ◽  
Fiscal Year ◽  
The Public ◽  
Audit Firms ◽  
Public Company ◽  
General Demand ◽  
Systemic Quality

ABSTRACT The Public Company Accounting Oversight Board's (PCAOB) Part II inspection reports, which disclose systemic quality control issues that auditors fail to remediate, signal poor audit quality for triennially inspected audit firms. Auditors that receive a Part II inspection report typically experience a decrease in clients, which demonstrates a general demand for audit quality. However, some companies hire auditors that receive Part II inspection reports. We examine potential reasons for hiring these audit firms. We find that relative to companies that switch to auditors without Part II reports, companies that switch to auditors with Part II reports have higher discretionary accruals in the first fiscal year after the switch, which indicates lower audit quality and a heightened risk for future fraud. We find no difference in audit fees. Our results suggest that PCAOB Part II inspection reports may signal low-quality auditors to companies that desire low-quality audits. Data Availability: Data are available from the public sources cited in the text.

How Internal Control Protects Shareholders' Welfare: Evidence from Tax Avoidance in China

2020 ◽  
Vol 19 (2) ◽  
pp. 19-39
Author(s):  
Hsihui Chang ◽  
Xin Dai ◽  
Yurun He ◽  
Maolin Wang
Keyword(s):  
Control Systems ◽  
Internal Control ◽  
Agency Costs ◽  
Tax Avoidance ◽  
Positive Association ◽  
Data Availability ◽  
Corporate Tax ◽  
Controlling Shareholders ◽  
The Public ◽  
Prior Literature

ABSTRACT This paper investigates how effective internal control protects shareholders' welfare in the context of corporate tax avoidance. Prior literature documents a positive association between internal control weakness and low tax avoidance. In this paper, we re-examine this association and complement prior research by finding that the direction of the association between internal control and tax avoidance depends on the level of tax avoidance. Specifically, for firms with low (high) levels of tax avoidance, internal control quality is positively (negatively) associated with tax avoidance. In additional analyses, we further explore how internal control mitigates agency costs for state-owned enterprises and tunneling activities. We show that for state-owned enterprises, which have lower incentives to avoid tax, effective internal control prevents managers from paying more taxes to cater to the controlling shareholders' interests. We also find that the association between tax avoidance and tunneling is reduced by effective internal control systems. Data Availability: Data are available from the public sources cited in the text.

scholarly journals Integration of Internal Control and Financial Statement Audits: Are Two Audits Better than One?

2018 ◽  
Vol 94 (2) ◽  
pp. 53-81 ◽  
Author(s):  
Lori Shefchik Bhaskar ◽  
Joseph H. Schroeder ◽  
Marcy L. Shepardson
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Audit Quality ◽  
Internal Controls ◽  
Data Availability ◽  
Financial Statement ◽  
Auditor Judgment ◽  
Public Company ◽  
Better Than

ABSTRACT The quality of financial statement (FS) audits integrated with audits of internal controls over financial reporting (ICFR) depends upon the quality of ICFR information used in, and its integration into, FS audits. Recent research and PCAOB inspections find auditors underreport existing ICFR weaknesses and perform insufficient testing to address identified risks, suggesting integrated audits—in which substantial ICFR testing is required—may result in lower FS audit quality than FS-only audits. We compare a 2007–2013 sample of small U.S. public company firm-years receiving integrated audits (accelerated filers) to firm-years receiving FS-only audits (non-accelerated filers) and find integrated audits are associated with higher likelihood of material misstatements and discretionary accruals, consistent with lower FS audit quality. We also find evidence of (1) auditor judgment-based integration issues, and (2) low-quality ICFR audits harming FS audit quality. Overall, results suggest an important potential consequence of integrated audits is lower FS audit quality. Data Availability: Data are publicly available from the sources identified in the text.

Gathering Evidence through Enquiry: A Process Improvement Focus

2012 ◽  
Vol 24 (2) ◽  
pp. 153-175 ◽  
Author(s):  
Guoping Liu
Keyword(s):  
Process Improvement ◽  
Decision Aid ◽  
Decision Aids ◽  
Field Research ◽  
Financial Statements ◽  
Data Availability ◽  
Planning Theory ◽  
Based Instruction ◽  
The Cost

ABSTRACT As financial statements continue to contain more estimates and audit programs rely more on enquiry-based evidence, there is an increasing need to understand whether the process of enquiry can provide more reliable evidence. Prior research in other disciplines indicates enquiry process improvement is a first step in the direction of improving the quality of evidence obtained from management enquiry. This study explores which type of decision aid—a simple cognitive planning theory-adapted instruction or a detailed checklist developed from auditing field research—is more likely to improve junior auditors' planning for collecting enquiry-based evidence about a specific accounting issue. An experiment was conducted using 154 participants with an average of 12 months of auditing experience. The results show participants receiving the theory-based instruction, in contrast to those receiving no decision aids, planned to pose a greater number of questions and inquire of a larger and more diverse set of client personnel in areas relevant to the accounting issue. Further, these participants planned to corroborate evidence obtained from management enquiry with an increased number of audit procedures other than enquiry. The practice-based checklist resulted in similar overall effects, albeit at the “cost” of having to deal with a more complex aid and with less focus on corroboration by means other than enquiry. This study suggests that both decision aids can lead junior auditors to improve their planned approach to enquiry, and if these plans are executed appropriately, they could lead to more reliable audit evidence generated from enquiry of management. Data Availability: Contact the author.

The Effects of Employer and Client Identification on Internal and External Auditors' Evaluations of Internal Control Deficiencies

2012 ◽  
Vol 31 (1) ◽  
pp. 39-56 ◽  
Author(s):  
Chad M. Stefaniak ◽  
Richard W. Houston ◽  
Robert M. Cornell
Keyword(s):  
Internal Control ◽  
Audit Quality ◽  
Data Availability ◽  
Internal Auditor ◽  
Internal Auditors ◽  
External Auditors ◽  
Audit Efficiency ◽  
Public Company ◽  
External Auditor ◽  
Internal Control Deficiencies

SUMMARY The Public Company Accounting Oversight Board's (PCAOB) Auditing Standard No. 5 (AS5) encourages external auditors to rely on internal auditors to increase the efficiency of lower-risk internal control evaluations (PCAOB 2007). We use post-SOX experimental data to compare the levels and effects of employer (client) identification on the control evaluations of internal (external) auditors. First, we find that internal auditors perceive a greater level of identification with the evaluated firm than do external auditors. We also find some evidence that, ceteris paribus, internal auditors are less lenient than external auditors when evaluating internal control deficiencies (i.e., tend to support management's preferred position to a lesser extent). Further, while we support Bamber and Iyer's (2007) results by finding that higher levels of external auditor client identification are associated with more lenient control evaluations, we demonstrate an opposite effect for internal auditors—higher levels of internal auditor employer identification are associated with less lenient control evaluations. Our results are important because we are the first to capture the relative levels of identification between internal and external auditors, as well as the first to compare directly internal and external auditor leniency, both of which are important in light of AS5. That is, we provide initial evidence that external auditors' increased reliance on internal auditors' work, while increasing audit efficiency, also could improve audit quality by resulting in less lenient internal control evaluations, due, at least in part, to the effects of employer and client identification. Data Availability: Contact the first author.

scholarly journals The Effect of an Auditor Identity Disclosure Requirement on Audit Quality: An Experimental Examination Incorporating the Incremental Effect of a Signature Requirement

2019 ◽  
Vol 38 (4) ◽  
pp. 17-29 ◽  
Author(s):  
Allen D. Blay ◽  
Eric S. Gooden ◽  
Mark J. Mellon ◽  
Douglas E. Stevens
Keyword(s):  
Audit Quality ◽  
Social Norm ◽  
Data Availability ◽  
The Public ◽  
Audit Market ◽  
Incremental Effect ◽  
Public Company ◽  
Identity Disclosure ◽  
Disclosure Requirement ◽  
Higher Sensitivity

SUMMARY After considering a proposal to require the engagement partner's signature on the audit report (PCAOB 2009), the Public Company Accounting Oversight Board chose instead to only require the disclosure of the engagement partner's name (PCAOB 2015). We make predictions regarding the effects of the two proposed requirements using insights from social norm theory, and test those predictions using an experimental audit market setting found in the literature. We find that both requirements reduce misreporting when compared to a control setting with neither requirement present. We also document that the signature requirement generates an incremental reduction in misreporting when added to the disclosure requirement. Finally, we provide evidence that these effects are driven by participants with higher sensitivity to social norms. This theory and evidence supports the new identity disclosure requirement at the PCAOB and helps explain the existence of signature requirements in many non-U.S. countries. Data Availability: Experimental data are available from the authors upon request.

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