The Importance Of Inherent Risk Factors: Auditors‘ Perceptions

This research project investigated auditors' perceptions of the importance of inherent risk factors in assessing inherent risk for accounts receivable and inventory. Sixty-eight auditors completed a questionnaire listing 42 inherent risk factors and six control risk factors. The auditors were required to: identify whether each factor was an inherent risk factor; indicate whether the factor affected their assessment of inherent risk at the financial statement or account balance (class of transactions) level; indicate whether the factor was associated with high or low inherent risk; and assess how important the inherent risk factor was in their assessment of inherent risk. In general, the auditors perceived variables pertaining to the characteristics of management and the history of errors to be the major determinants of inherent risk.     

论CPA不确定性审计意见预测——基于重大疑虑事项的持续经营

随着竞争的日趋激烈,企业持续经营不确定性显著增加,注册会计师对持续经营问题的审计也日益受到关注。本文分析我国注册会计师对持续经营问题的审计状况,统计持续经营不确定审计意见中重大疑虑事项的出现频率,并在此基础上构建持续经营不确定审计意见预测模型。     

Improving Experienced Auditors’ Detection of Deception in CEO Narratives

We experimentally study the deception detection capabilities of experienced auditors, using CEO narratives from earnings conference calls as case materials. We randomly assign narratives of fraud and nonfraud companies to auditors as well as the presence versus absence of an instruction explaining that cognitive dissonance in speech is helpful for detecting deception. We predict this instruction will weaken auditors’ learned tendency to overlook fraud cues. We find that auditors’ deception judgments are less accurate for fraud companies than for nonfraud companies, unless they receive this instruction. We also find that instructed auditors more extensively describe red flags for fraud companies and more accurately identify specific sentences in narratives that pertain to underlying frauds. These findings indicate that instructing experienced auditors to be alert for cognitive dissonance in CEO narratives can activate deception detection capabilities.     

Auditors’ Economic Incentives and the Sensitivity of Managerial Pay to Accounting Performance

The use of managerial incentives to manage earnings in order to enhance accounting performance‐based compensation is greater when auditors have economic incentives to compromise their independence. Hence, compensation committees face more difficulties in determining cash compensation when earnings quality declines. This study investigates whether boards of directors can mitigate the agency problems between managers and shareholders by being aware of the opportunistic earnings management encouraged by auditors’ economic incentives and actively adjusting performance‐based compensation for the reduced earnings quality. To this end, it examines how auditors’ economic incentives affect the sensitivity of managerial pay to accounting performance. The findings show a negative association between the client's economic importance to the auditor and the sensitivity of managerial pay to accounting performance, with this association more pronounced for firms that opportunistically inflate earnings, suggesting that boards mitigate agency problems by actively intervening to modify performance‐based compensation schemes for the reduced earnings quality. Additional analyses show that board effectiveness in determining compensation depends on its characteristics. These results suggest the urgent need to oblige companies to establish compensation committees, particularly in countries that lack such a mandatory requirement or where few companies have such committees.     

The Effect of IPO Risks on Auditors’ Decisions: Auditor Designation Case

This study examines the effect of audit risks in the Korean initial public offering (IPO) market on the designated auditors’ decisions. The Korean External Audit Act requires firms to switch from incumbent to new auditors designated by the Securities and Futures Commission after the firm announces a future IPO. This study shows the effects of audit risks by examining if the quality of reported earnings and audit fees significantly differs between IPO‐eligible and IPO‐ineligible firms. Empirical tests first show that discretionary accruals are significantly lower for IPO‐ineligible firms than for IPO‐eligible firms in both the IPO designation period and the following review period. We interpret this result to mean that designated auditors evaluate the IPO‐ineligible (and eventually failed) firms’ listing possibility as low. Second, audit fees are higher for IPO‐ineligible firms in the auditor designation period. This reflects the fact that designated auditors are exposed to future audit risks associated with firms’ post‐IPO financial market troubles if IPO‐ineligible firms attempt to go public. Our study contributes to IPO‐related research by showing the effects of auditors’ risk evaluation on discretionary accruals and audit fees. This study also contributes to accounting policymaking regarding auditor independence.     

Auditors’ going‐concern‐modified opinions after 2001: measuring reporting accuracy

An important change in auditors’ reporting behaviour in the period after the high‐profile corporate collapses in 2001 is that auditors were more likely to issue going‐concern (GC)‐modified audit opinions. Comparing company failure rates subsequent to receiving a first‐time going‐concern (FTGC)‐modified audit opinion in the pre‐ and post‐2001 periods, we find a consistent type 1 error (misclassification) rate (the rate of survival among companies issued an FTGC opinion). Results are indicative of auditors maintaining GC reporting accuracy when comparing the 1995–1996 and 2004–2005 periods. This conclusion is supported after considering the impact of mitigating circumstances surrounding companies that received an FTGC‐modified audit report and survived.     

An Investigation of Auditors’ Judgments When Companies Release Earnings Before Audit Completion

The majority of U.S. public companies release annual earnings prior to the completion of audit fieldwork. We investigate this phenomenon in a controlled experiment with audit partners and senior managers. We find that releasing earnings before completion of the audit pressures auditors to adopt the goals of management, thereby reducing the likelihood of post‐announcement audit‐adjustment recommendations. We also examine the effect of audit committee (AC) strength in improving auditors’ judgments after annual earnings are released. When ACs are actively involved in accounting issues and proactively communicating with auditors—characteristics currently lacking in most ACs—the negative effects on auditors’ judgments are completely mitigated. Our study provides evidence on potential unintended consequences of early release of earnings and the importance of investing in high‐quality ACs to mitigate adverse effects of client pressures on audit judgment and financial reporting quality.     

Auditors’ decision-making under going-concern uncertainties in low litigation-risk environments: Evidence from Hong Kong

This study examines the audit opinions issued by auditors in a low litigation-risk environment at a time of high economic uncertainty – that of Hong Kong in the period immediately after the Asian financial crisis of 1997. Empirical research using United States data has shown that, contrary to professional guidance which restricts the issue of “disclaimer of opinion” only to situations where existing uncertainties prevent the auditor from forming an opinion, auditors tend to use the “disclaimer” report (in the going concern context) to signal more extreme client firm’s distress. In the high litigation-risk environment of the US, researchers have attributed this tendency to the idea that “disclaimer of opinion” reports are used by auditors to provide some protection against potential legal liability. The results of this study provide evidence that, even in the low litigation-risk environment of Hong Kong, auditors still use “disclaimer” reports to signal more extreme client firm financial distress. Thus, the maintenance of a high litigation-risk environment does not appear to be a necessary pre-requisite for high quality audits.     

Auditors’ Liability,Investments, and Capital Markets: A Potential Unintended Consequence of the Sarbanes‐Oxley Act

To restore investors’ confidence in the reliability of corporate financial disclosures, the Sarbanes‐Oxley Act of 2002 mandated stricter regulations and arguably increased auditors’ liability. In this paper, we analyze the effects of increased auditor liability on the audit failure rate, the cost of capital, and the level of new investment. We focus on a setting in which, with imperfect auditing, a firm has better information than investors about its prospects and seeks to raise capital for new investments in a lemons market. The equilibrium analysis derives corporate reporting and investing choices by the firm, attestation opinions by the auditor, and valuation by rational investors. Three empirically testable predictions emerge: although increasing auditor liability decreases the audit failure rate and the cost of capital for new projects, it also decreases the level of new profitable investments.     

New Auditors’ Decisions for Released Firms from the Mandatory Auditor Designation Rule: Evidence From South Korea

This study examines the effect of the mandatory designation rule on audit fees charged and audit hours rendered by auditors for firms released from the mandatory auditor designation rule in the Korean audit market. Under the mandatory auditor designation rule, which took effect in 1991, problematic firms are assigned new auditors by the Financial Supervisory Service. Previous studies suggest that this regulation positively affects the quality of audits by promoting auditor independence. Thus, this study hypothesises that firms that have been subjected to mandatory auditor designation improve the quality of their financial reporting, and that auditors hired after the mandatory designation period account for reduced audit risks when determining audit fees and audit hours. This study shows that audit fees and audit hours of firms released from the mandatory auditor designation rule are lower than those of other initial audit engagements. Taken together, this study's findings reinforce the notion that auditors’ perceptions of changes in audit risk yield corresponding changes in the audit fees they charge and audit hours they render.     

Model Predictions and Auditor Assessments of Going Concern Status

This paper compares the predictions of a bankruptcy prediction model and the assessments of auditors on the going concern status of a sample of 165 bankrupt companies and 165 matched non-bankrupt companies. Data from US companies for the period 1978 to 1985 were used. Probit analysis (with the weighted exogenous sampling maximum likelihood procedure) was applied to estimate the model parameters. The Lachenbruch U method hold-out accuracy rates of the model are 85.45% for bankrupt firms, 100.00% for non-bankrupt firms, and 99.91% overall. The corresponding accuracy rates of the auditors based on their audit reports are 54.37% for bankrupt firms, 100.00% for non-bankrupt firms, and 99.73% overall. The sensitivity of optimal cut-off points to misclassification costs of Type I and Type II errors was also considered. Results of the study suggest that bankruptcy prediction models can be useful to auditors in making going concern assessments. Further, such models can serve as analytical tools and defensive devices.     

Analysts’ Perceptions of Intellectual Capital Information

This study is based on a survey of 324 financial analysts in Japan. The survey concerns analysts’ perceptions of intellectual capital (IC) information and its links to the evaluation of companies. The value relevance of and the access to IC‐related information reveals a large gap on many items. The analysis further shows that the lack of access to information hampers analysts’ use of IC in their evaluation of companies, particularly in their use of human capital measures. Attitudes towards more disclosure and standardisation are mainly driven by perceptions of what generates value in companies.     

Decision Usefulness of Cash and Accrual Information: Public Sector Managers’ Perceptions

This study examines the usefulness of accrual accounting information for internal decision‐making contexts in the Western Australian public sector. Based on questionnaire responses of public sector managers, it was found that accrual accounting is perceived to be more useful than cash accounting in 16 of the 19 decision situations. These results suggest that the perceived usefulness of the accrual accounting system has improved with the passage of time. It may well be that perceptions of the usefulness of information derived from an accounting system will change over time as users gain familiarity and experience with a system.     

An Investigation of Framing and Firm Size on the Auditor's Going Concern Decision

This study investigated the effects of framed information and firm size on the auditor's going concern report modification decision. Framing has been shown to affect individual decision-making in a variety of contexts. Investigations of framing effects in an audit context have reported mixed results. The findings of this study indicate that auditors are susceptible to the effect of framed information. Previous research has reported that auditors from small firms may be less conservative in audit disclosure recommendations than auditors associated with larger firms. This study evaluated the going concern decisions of auditors from three firm sizes: local/regional, a large non-Big Six firm, and a Big Six audit firm. Results indicate that differences in the report issued do exist across firm size. Possible explanations for the reported results are discussed.     

An Empirical Investigation of the Influence of Qualitative Risk Factors on Canadian Auditors’ Determination of Performance Materiality*

This paper presents the results of a field experiment that tested the effects of various qualitative risk factors suggested by auditing standards and prior literature on practicing Canadian auditors’ estimates of performance materiality, a concept introduced by Canadian Auditing Standard (CAS) 320, in the audit of specific accounts in a financial statement audit. Ninety‐four practicing auditors responded to four scenarios and, based on “good” and “bad” versions of six qualitative risk factors, revised or not, as they deemed appropriate, initially established performance materiality for the audit of four different transaction streams/account balances. For all four scenarios, on average, the auditors revised, to a statistically significant degree, performance materiality, downward on the basis of “bad” information and upward on the basis of “good” information. Different combinations of transaction streams/accounts and risk factors were associated with different magnitudes of revision. However, at the level of individual participants, responses were quite varied. Some participants did not revise performance materiality and some even stated that performance materiality should not be revised based on risk‐related information. It may be that the concept of performance materiality as promulgated in CAS 320 and the relationship between overall materiality, performance materiality, and risk requires clarification to provide appropriate guidance for auditors to make performance materiality judgments.     

A reply to Randall E. LaSalle: “The civil justice system and going-concern audit reports: Comments on ‘Auditors’ decision-making under going-concern uncertainties in low litigation-risk environments: Evidence from Hong Kong’ ”

In a dissent from the conclusion reached in Lam and Mensah [Lam, K, Mensah, Y.M., 2006. Auditors’ decision-making under going-concern uncertainties in low Litigation-risk environments: Evidence from Hong Kong. Journal of Accounting and Public Policy, 25 (6), 706–739], Lasalle has proposed a number of alternative plausible explanations for our findings that Hong Kong auditors issued disclaimer of opinions in a manner associated with the eventual outcome to the clients. We examine these explanations and attempt to relate them to relevant empirical evidence in the literature. We find that none of his plausible explanations is consistent with the limited empirical evidence available. Thus, we continue to believe that a high litigation-risk environment is not a necessary pre-requisite for high quality audits.     

The civil justice system and going concern audit reports: Comments on “Auditors’ decision-making under going concern uncertainties in low litigation risk environments: Evidence from Hong Kong”

Lam and Mensah [Lam, K., Mensah, Y.M., 2006. Auditors’ decision-making under going concern uncertainties in low litigation risk environments: Evidence from Hong Kong. J. Account. Public Pol. 25 (6), this issue] provide some valuable insight on auditors’ choice of going concern audit reports in an environment where the civil justice system affords, from the standpoint of the plaintiff, fewer remedies and is more difficult to file a complaint than it is in the US. Hence, from the auditor’s standpoint, this environment can appropriately be described as a “low litigation risk environment”. In this comment, I first question whether a disclaimer of an opinion is any indication of either a quality audit or professionalism. Secondly, three alternative explanations for the empirical regularities are discussed. The Gatekeeper Story suggests auditors are simply not willing to risk reducing their reputational capital by acquiescing to clients that are not likely to survive their own financial distress. The Herding Story suggests that, when auditors are faced with uncertainties or a gap in the authoritative literature, auditors will herd together to form a common response that mimic one-another. The Value of Incumbency Story holds that as the value of incumbency declines with the client’s inability to survive, auditors will have fewer incentives to incur the incremental costs to gather sufficient competent evidential matter necessary to support an unqualified opinion.     

Should Firms Going Public Enjoy Tax Benefits? An Analysis of the Italian Experience in the 1990s

In Italy tax benefits are granted to firms going public. However, does such tax relief really reduce the corporate tax burden? In this study we tackle the issue by considering 21 industrial firms that were listed on the Italian Exchange from 1995 to 1997 and enjoyed a temporary tax rate cut‐off. We find that the increase in the taxable income reported by these firms largely counterbalances the effect of the tax relief. We conclude that a tax rate cut‐off may not necessarily provoke a reduction in the tax burden for newly listed firms, since in the short term they report larger earnings compared with privately‐owned companies. We claim that this ‘induced’ effect is mainly due to: the significant improvement of operating performance in the year of the listing; the reduction of the debt tax shield; an increase in investment and more accounting transparency. Our findings suggest that tax relief for IPO firms does not necessarily mean a loss of revenue for the government.     

中国企业"走出去"的现状与前景

在过去的3年中,中国日益增长的对外直接投资引起了广泛的关注.但是,中资企业在对外投资的过程中还面临着诸多的困难和挑战.这里面有些问题来自于国内和国外政府的相关政策,还有些问题是棘手的商业挑战,如商业策略、融资渠道、品牌发展、信息管理和人力资源等.前不久在IFC和商务部投资促进局共同举办的"中国对外投资研讨会"上,来自政府、金融机构以及企业界的代表就上述问题进行了深入地探讨,其中不乏真知灼见.