Auditor Expertise and the Estimation of Dollar Error in Accounts

A major task that auditors undertake in formulating their audit opinion is to estimate the dollar error that might exist in accounts in light of their evaluation of internal control strengths and weaknesses. The research that has been undertaken to evaluate the quality of auditor performance on this task, however, has produced mixed results. The current study tries to overcome some theoretical limitations and measurement limitations that have undermined prior studies. Forty practising auditors rated their abilities on fourteen characteristics derived from a model of expertise. They then undertook an experiment where they judged the extent of dollar error that might exist in the inventories of a manufacturing company. They based their judgments on working papers provided to them that contained, among other information, an evaluation of the company's internal control system. An estimate of the 'true' dollar error in the inventories was calculated using a program that simulated the company's internal control and accounting system. This estimate was then used to calculate the accuracy of the auditors' judgments. Their ratings on the expertise characteristics were not related to their judgment accuracy. Their ratings were related, however, to their confidence in their judgment accuracy. Auditors who considered themselves more expert at the task were more confident in their judgment accuracy but they were, in fact, no more accurate than auditors who considered themselves to be less expert at the task.     

Machine‐independent audit trail analysis—a tool for continuous audit assurance

This paper reports the results of a research project which examines the feasibility of developing a machine‐independent audit trail analyser (MIATA). MIATA is a knowledge‐based system which performs intelligent analysis of operating system audit trails. Such a system is proposed as a decision support tool for auditors when assessing the risk of unauthorized user activity in multi‐user computer systems. It is also relevant to the provision of a continuous assurance service to clients by internal and external auditors. Monitoring user activity in system audit trails manually is impractical because of the vast quantity of events recorded in those audit trails. However, if done manually, an expert security auditor would be needed to look for two main types of events—user activity rejected by the system's security settings (failed actions) and users behaving abnormally (e.g. unexpected changes in activity such as the purchasing clerk attempting to modify payroll data). A knowledge‐based system is suited to applications that require expertise to perform well‐de?ned, yet complex, monitoring activities (e.g. controlling nuclear reactors and detecting intrusions in computer systems). To permit machine‐independent intelligent audit trail analysis, an anomaly‐detection approach is adopted. Time series forecasting methods are used to develop and maintain the user pro?le database (knowledge base) that allows identi?cation of users with rejected behaviour as well as abnormal behaviour. The knowledge‐based system maintains this knowledge base and permits reporting on the potential intruder threats (summarized in Table I). The intelligence of the MIATA system is its ability to handle audit trails from any system, its knowledge base capturing rejected user activity and detecting anomalous activity, and its reporting capabilities focusing on known methods of intrusion. MIATA also updates user pro?les and forecasts of behaviour on a daily basis. As such, it also ‘learns’ from changes in user behaviour. The feasibility of generating machine‐independent audit trail records, and the applicability of the anomaly‐detection approach and time series forecasting methods, are demonstrated using three case studies. These results support the proposal that developing a machine‐independent audit trail analyser is feasible. Such a system will be an invaluable aid to an auditor in detecting potential computer intrusions and monitoring user activity. Copyright © 2004 John Wiley & Sons, Ltd.     

Toward a better expert system for auditor going concern opinions using Bayesian network inflation factors

We develop an analytical model intended as the first stage in the development of expert systems to improve auditor knowledge in, and assist in the decision process of, Going Concern Opinions (“GCOs”). Our approach is consistent with a design science approach to developing information systems, resulting in an initial artifact, the mathematical model, which can, through iterative design science and behavioral research, inform a technology-based expert system. Based on Bayesian networks, our model provides insights about auditors’ revision, or inflation, of the probability to issue a GCO based on the interrelationship that forms with the incremental existence of one, two, or three publicly observable financial statement risk factors – net operating loss, negative cash flows from operations, and negative working capital. We calculate the revised probabilities using empirical data of GCOs from 2004 to 2015. Results reveal that the incremental relationship (one, two, or three factors present) effectively models expert auditors’ decisions to issue a GCO, and suggests the existence of these measurable inflation factors that represent situational and auditor-specific factors. We also find that Non-Big Four auditors inflate these factors differently than Big Four auditors to arrive at a decision to issue a GCO.     

Decision‐making capabilities of a hybrid system applied to the auditor's going‐concern assessment

The purpose of this study is to evaluate a hybrid system as a decision support model to assist with the auditor's going‐concern assessment. The going‐concern assessment is often an unstructured decision that involves the use of both qualitative and quantitative information. An expert system that predicts the going‐concern decision has been developed in consultation with partners at three of the Big Five accounting firms. This system is combined with a statistical model that predicts bankruptcy, as a component of the auditor's decision, to form a hybrid system. The hybrid system, because it combines the use of quantitative and qualitative information, has the potential for better prediction accuracy than either the expert system or statistical model predicting separately. In addition, testing of the system provides some insight into the characteristics of firms that experience problems, but do not necessarily receive a going‐concern modification. Further investigation into those firms that have problems could reveal factors that may be incorporated into decision support systems for auditors, in order to improve accuracy and reliability of these decision tools. © 2001 John Wiley & Sons, Ltd.     

The effects of decision aid structural restrictiveness on cognitive load,perceived usefulness,and reuse intentions

As accounting environments become increasingly automated through information technology support systems, the underlying systems are increasingly restrictive in an effort to direct user behavior and decision making. However, consistent with the theory of technology dominance, restrictive systems have been found to dominate users' decision processes and to have a detrimental effect when decisions require knowledge from outside the system's capability. This study expands upon this research through an examination of users' preferences for more (less) restrictive systems based on their own level of domain knowledge. Incorporating theory on task technology fit, we theorize that users with less knowledge will prefer to be dominated by the system, while users with greater levels of knowledge will prefer a system that provides the user with a level of control over the decision process rather than submitting entirely to the decision aid's control. These theorizations are empirically tested through an experimental design that varies the level of systems restrictiveness across groups of novice and experienced participants. The results confirm that novice (experienced) participants find a highly restrictive system substantially (minimally) reduces cognitive load, increases (decreases) usefulness of the decision aid, and strengthens (weakens) the intention to reuse the system in the future. The results add an important piece to understanding the effect of restrictive systems in that the users that are most susceptible to dominance by decision aids are the users most willing to adopt a restrictive system that reduces the effort they must put forth and in turn reduces the knowledge they accrue from using the system.     

Is the objectivity of internal audit compromised when the internal audit function is a management training ground?

We conduct an experiment with 74 internal auditors to examine the effects of using the internal audit function as a training ground for future senior managers. Specifically, we investigate internal auditors' willingness to resist current management's aggressive revenue recognition policies, assuming that internal auditors expect to move into senior management positions in the future. We also examine whether increasing the power of the board of directors can reduce threats to internal auditors' objectivity. This is the first study to empirically examine whether training grounds influence internal auditors objectivity. Results of our study indicate that internal auditors are less objective (i.e. they are more likely to side with management's aggressive revenue recognition policies) when they expect to move into senior management positions, relative to when internal auditing is not used as a training ground. We also find that empowering the audit committee further decreases the objectivity of internal auditors. These results suggest that board power can have unintended consequences on the behaviour of internal auditors and that board empowerment does not guarantee improved governance or improved oversight of financial reporting.     

External auditors’ reliance on internal audit: the impact of sourcing arrangements and consulting activities

This study examines the impact of internal audit outsourcing and involvement in consulting on external auditors’ reliance on the work of internal audit. We test whether these factors influence reliance on internal audit work already undertaken and the use of internal auditors as assistants, distinguishing between control evaluation and substantive testing. Involvement in consulting impacts reliance on work undertaken and the use of internal auditors as assistants for control evaluation. External auditors make greater use of internal auditors as assistants for substantive testing when internal audit is provided in‐house. Overall, external auditors use internal audit more for control evaluation tasks.     

Consideration of the social context of auditors’ reliance on expert system output during evaluation of loan loss reserves

Auditors are accountable for judgments made within the social context of the accounting firm. Tetlock (1985) states that decision makers often use the acceptability heuristic to cope with accountability. According to this heuristic, individuals make decisions which they are reasonably confident will be acceptable by others to whom they are accountable. When auditors form judgments with the aid of expert system output, they must determine the appropriate level of reliance on the expert system output. Since the expert system output is based on the input of experts, auditors may decide the output is ‘acceptable‘ and overrely on the output. In addition, because of the conservative nature of the accounting firm, expert system output which is negative may be viewed as more acceptable than positive output leading to greater overreliance. The results indicate that auditors do overrely on expert system output and rely to a greater degree on output which is negative versus output which is positive. Copyright © 1999 John Wiley & Sons, Ltd.     

An exploration of the mediating effects of auditor experience and position in internal accounting control evaluation

This study is an exploration of the effects of auditor background on internal accounting control judgements. A series of control evaluation cases were mailed to experienced auditors. These subjects were asked to rate the described control systems against three control objectives.No hypotheses were tested. Rather, the objectives of the study reported here were (1) to determine which, if any, background variables were associated with differences in auditor ratings and (2) to posit reasonable explanations, grounded in actual data, for any differences detected. Such differences were found for subjects grouped according to firm affiliation, auditor rank/years of experience, and control evaluation experience.These differences are discussed and related to several possible explanations, which focus on learning and goal orientation effects in decision making. The explanations are viewed as potential topics for further research.     

The impact of political pressure on novice decision makers: are auditors qualified to make going concern judgements?

Over the past decade, the public accountancy profession has been the subject of broad criticism for its failure to adequately prepare third parties for the impending failure of client organizations. Many potential causes of auditors’ failure to issue opinions reflecting client organization’s ability to remain a going concern have been put forth, including primarily poor judgement and/or client pressures to issue a clean opinion. In this paper, we argue that the uncertainty in the decision-making process may be compounded by a relatively low level of knowledge, making the auditor’s end decision more susceptible to socio-political pressure. The paper is divided into five sections. The introductory section of the paper focuses on the widespread criticism of the accountancy profession for its inability to issue going concern opinions for questionable clients who fail shortly after the audit report is issued. In the second section of the paper, we provide an overview of extant studies that have examined how auditors accumulate and process data used to make going concern judgements in a politically sensitive environment. In the third section, we contrast this environment and the approach used by auditors in making going concern judgements with the environment and approach used by insolvency practitioners in dealing with companies in financial distress. A multi-year study in building and using a computerized model of insolvency decision processes is used as the basis for understanding the approach used by insolvency practitioners. Even though the nature of the problems faced in going concern judgements and insolvency practice are very similar, striking differences in the environment, evidence and decision processes used by the two groups of accounting experts are noted. The fourth section reports the results of a field study conducted with insolvency novices and specialists in an effort to elicit the differences in their respective decision processes. The interaction with insolvency specialists from 10 different discussion sessions reveals that senior insolvency practitioners perceive that the decision strategies of auditors is very similar to junior (novice) insolvency practitioners and that the going concern decision, as currently made, fails to include the specialized knowledge of expert decision makers. The fifth and concluding sections discuss implications of these results on auditors’ susceptibility to socio-political pressures and explores the difficulties in addressing the problems identified.     

The effects of tone at the top and coordination with external auditors on internal auditors’ fraud risk assessments

Prior research suggests that internal auditors’ judgements are subject to management influence resulting in compromised risk assessments. This study investigates the effects of the tone at the top and coordination with external auditors on internal auditors’ fraud risk assessments. Results of an experiment involving 64 internal auditors indicate that when the tone at the top is poor, rather than favouring management, internal auditors report a higher risk of intentional misstatements and that coordination with external auditors can further reduce expectations of the incidence of intentional misstatements.     

The impact of perceived ethical intensity on audit-quality-threatening behaviours

Although there has been significant interest among researchers in audit-quality-threatening behaviours (QTBs), the decision process through which staff auditors engage in those behaviours has received relatively little attention. It seems likely that the ethical intensity of the behaviours perceived by auditors may play an important role in that process; to date, this has not been tested. This study examines the mediating role of perceived ethical intensity in the relationship between perceived ethical culture of the firm and the auditors' ethical evaluation of, and intention to engage in, three different forms of QTBs. A multi-item measure of ethical intensity is developed and the findings provide the first empirical evidence of a direct relationship between perceived ethical intensity and ethical decision-making regarding QTBs. Moreover, the findings show that perceived ethical intensity fully mediates the relationship between perceived ethical culture and ethical decision-making. Implications of the findings for accounting firms and for researchers are discussed and areas for future research on the mediating role of perceived ethical intensity are suggested in the paper.     

An Empirical Investigation of the Interface Between Internal and External Auditors

Professional standards place specific responsibilities on auditors for the discovery of material mis-statements in reports of corporate financial performance. Certain factors have been shown to increase the likelihood of fraudulent financial reporting. One warning sign is the potentially pervasive effect of a weak internal control environment consistent with a weak internal audit group. This study investigates the impact of internal audit department quality differences on auditors ‘willingness to place reliance on the work performed by internal auditors. The study also gives consideration to auditors’ recent experiences with material errors and irregularities and examines the influence of two previously untested individual auditor differences on audit judgment decisions: (1) conflict management style and (2) perception of internal/external auditor communication barriers. The results indicate that auditors attend to internal audit department quality differences and that individual auditor differences exhibit significant influence over auditor judgments. Implications for audit practice are considered and directions for future research are suggested.     

The illusion of no control: management control systems facilitating autonomous motivation in university research

Autonomous motivation, a fundamental factor influencing research success, can be undermined when people feel pressured, managed or controlled. So how do universities – which are under increasing external pressure to manage research activities to produce outcomes – exert management control without threatening the autonomous motivation of their researchers? We address this question through an exploratory case study of the management control systems used in two university faculties. Our results confirm the importance of autonomous motivation in driving researchers’ activity and show how incentives, performance evaluation and cultural–administrative structures can be designed to not only preserve, but also enhance and leverage this motivation.     

The effect of audit documentation format on data collection

This study considered the impact of three different methods of documenting internal accounting control systems (internal control questionnaire, flowchart, and narrative memorandum) upon the quantity and type of data collected during the auditor's preliminary review of internal control. The effect of experience upon data collection was also considered. Fifty-five auditors participated in a laboratory experiment in which they collected data about a client's control system, and recorded it in one of the three formats. Results indicated that subjects using an internal control questionnaire collected far more data than did other subjects. When using a questionnaire or flowchart, seniors collected more data than less experienced auditors. The type of data collected was shown to be associated strongly with documentation format but not with experience. Evidence that selective perception was induced by documentation format was particularly strong for the questionnaire subjects.     

The influence of judges' attitudes on liability assessments related to failed audits exhibiting significant audit team over-time or significant use of off-shore auditors

This study provides evidence on how audit firms' decisions to use offshore (outsourced) auditors or to assign on-site (local) auditors extensive overtime affect judges' evaluation of auditor legal liability I conduct a behavioral experiment in which actual judges responded to a hypothetical audit lawsuit. The results suggest auditors may be penalized during the litigation process depending on the extent of overtime or off-shoring and judges' attitude toward the public accounting profession. Judges with a positive attitude toward public accounting assessed more liability for an audit firm that used offshore (outsourced) auditors than for the use of extensive overtime for on-site auditors or a control condition. However, judges with a negative attitude toward the auditing profession assessed higher liability for auditors except when on-site auditors bore significant overtime in the final weeks of the audit.     

External auditors' evaluation of the internal audit function: An empirical investigation

Evaluation of the strength of the client's internal audit function by the external auditor (EA) has taken on increased significance due to stronger regulation around the evaluation of internal controls after SOX (2002). However, research examining how this evaluation occurs in practice is mixed and inconclusive. In this study, we examine empirically whether the Desai et al. (2010) theoretical model is reflective of how auditors make judgments about the strength of their client's internal audit function in practice. Specifically, we present external auditors with evidence about internal auditor work performance, competence and objectivity in a manner consistent with the structure of evidence evaluation implied by the Desai et al. (2010) model. We then compare the auditors' actual strength judgments to the strength levels predicted by the model and evaluate similarities and differences. Results indicate that no one factor dominates the strength judgment in all cases. In addition, EAs do not weigh negative evidence as heavily as does the model. When the evidence about the three factors is conflicting, external auditors have difficulty incorporating them in a consistent way into the calculation of their overall strength judgment. Finally, we find results consistent with prior research indicating auditors tend to be more sensitive to negative than positive evidence. Also, it is harder to move auditors' beliefs away from a negative position with positive evidence than to move those beliefs away from a positive position with negative evidence. Results suggest that additional training and use of a decision aid structured according to the Desai et al. (2010) model would be especially useful when evidence about internal auditors' work performance, competence and objectivity is conflicting.     

An evaluation of root cause analysis use by internal auditors

The objective of this study is to increase understanding of internal auditor use of root cause analysis (RCA). The IIA’s Practice Advisory 2320–2: Root Cause Analysis (IIA 2011) states that RCA should be a core competency for internal auditors to provide insight and add value within organizations. However, little is known about internal auditor use of RCA in a profession where normative problem-solving theory and RCA frameworks potentially conflict with professional demands for independence and objectivity. We conduct in-depth interviews with 21 high-level internal auditors with RCA experience to understand use within the profession. The results suggest several overarching themes that have implications for policymakers, researchers, and practitioners. First, we find that internal auditors in practice believe that RCA is a very important tool within the profession. Second, although internal auditors generally claim to understand RCA, we find considerable variation in the ways they approach the construct and implement prescribed processes in practice. Finally, the results indicate that while RCA use is reasonably prevalent among internal auditors, knowledge constraints, resource limitations, and concern about independence and objectivity create considerable variation in terms of RCA approach, rigor, and efficacy within organizations.     

SEC ESG Noncompliance: Where the Rubber Meets the Road

This article begins by discussing the findings of a recent study that suggests widespread corporate SEC noncompliance in the reporting of ESG issues. Second, it discusses the SEC rules on internal control systems and argues that full compliance with these SEC rules can significantly limit the SEC ESG noncompliance problem. Third, it highlights certain SEC noncompliance liabilities for corporate management, audit committees, and independent auditors arising from SEC ESG noncompliance. Fourth, the author discusses problems with enterprise software systems as a cause of the SEC ESG noncompliance problem. Fifth and last, the article highlights recent regulatory and market developments that may encourage compliance, and concludes with comments about the relationship of the SEC internal control system rules to Integrated Reporting.