Client Acceptance Decisions Research Articles

Decision Making in a Public Accounting Firm: An Instructional Case in Risk Evaluation, Client Continuance, and Auditor Independence within the Context of the Sarbanes-Oxley Act of 2002

The purpose of this case, loosely based on an actual auditor-client situation, is to study decision making by auditors in public accounting firms regarding risk management (business, engagement, and audit risk), client continuance, and auditor independence. Audit partners often face difficult decisions for which they must balance the business objectives of the firm with their professional objective of satisfying the public interest. While most studies and cases focus on client-acceptance decisions (e.g., Johnstone 2000; Gendron 2002; Knapp and Knapp 2004), an equally important decision for public accounting firms in the Sarbanes-Oxley era is whether to keep a current client. This case encourages students to consider the decision with respect to client continuance, auditor independence, and risk evaluation.

Resignations by the Big 4 and the Market for Audit Services

Following enactment of the Sarbanes-Oxley Act (SOX) of 2002, Big 4 auditors claimed to have a more conservative policy regarding client retention and acceptance decisions. In this paper, we examine the resignations of Big 4 audit firms in periods before and after SOX. We find that Big 4 audit firms resigned from more audit clients in 2003 than in 2001, and that the 2003 group of clients had significantly lower measures of financial stress. Our results are robust to adjustments for differences in bankruptcy probability between 2003 and 2001. We also find that the relative increases in fees charged by the Big 4 successor following the resignation of a Big 4 predecessor are higher in 2003 than in 2001; for clients with a non-Big 4 successor firm following a Big 4 resignation, we find a significant fee discount in 2001 but not in 2003. Overall, the results support the view that auditors are much more conservative in the post-Enron/SOX period than in the immediately preceding period.

Toward Understanding Chinese Auditors' Structuring of Audit Approaches, Client Acceptance Decisions, Risk Assessment, and Stringency of Imposed Reporting Standards

This study seeks insights into determinants of Chinese audit firms' ability to ensure high quality financial reporting. Its scope of investigation encompasses the extent to which Chinese audit firms employ structured audit processes, their evaluation of potential clients, factors that impact their risk assessment, and the stringency of the reporting standards that they seek to impose on clients. The factors investigated include ones suggested as being important by extant research, as well as unique characteristics of the Chinese setting (e.g., the importance of interpersonal relationships [“guanxi”] and most listed companies' origins as state-owned enterprises). Structured interviews and questionnaire surveys are used to solicit quantitative and open-ended responses from 102 Chinese auditors at the partner, manager, and senior levels of Big 4 affiliates and local public accounting firms.

The effect of non-audit services on client risk, acceptance and staffing decisions

The Sarbanes Oxley Act of 2002 prohibited auditing firms from providing certain non-audit services to audit clients and left open the possibility that other currently non-prohibited services could also be banned. This prohibition hinges, in part, on regulatory concerns that auditors were willing to accept prospective higher risk clients in order to obtain more profitable non-audit service engagements. Accounting firms rejected this claim. Given the prospect that more non-audit services could be prohibited, we revisit this debate by examining these competing claims in an experiment in which we manipulate risk and the potential to sell non-audit services and then observe the impact of these variables on auditors’ client acceptance and subsequent staffing decisions. Specifically, audit partners received client information and were asked to make an acceptance decision and propose a staffing plan for a potential engagement. We find that a higher (lower) level of risk decreased (increased) the likelihood of acceptance and this relation did not vary with the potential to provide non-audit services. These results do not support the regulators’ claims but are consistent with the firms’ claims. Further, we found that more experienced auditors were assigned to the prospective client whose management had lower integrity. This staffing plan is consistent with a risk adaptation strategy for the client with lower integrity. The prohibition of certain non-audit services has been justified on the grounds that auditors might engage in systematic opportunistic behavior. However, our results do not find such behavior which should inform the current PCAOB deliberation over whether additional services should be banned. Alternatively, different justification must be found for the prohibitions.

Towards Understanding the Current State of Auditing Practices in China: Client Acceptance Decisions, Structuring of Audit Approaches, and the Stringency of Imposed Reporting Standards

This study explores factors potentially related to the ability of Chinese audit firms to ensure a high level of integrity in Chinese business enterprises' financial reporting. Its scope of investigation encompasses how Chinese audit firms evaluate potential clients, how they structure the audit process and to what extent the audit procedures are different from the international audit practices. It also considers the effects of a wide range of factors on auditors' risk assessment and the stringency of the reporting standards to which they hold clients. These factors include those suggested as important by extant research, as well as unique characteristics of the Chinese setting (e.g., the importance of interpersonal relationships (guanxi) and most listed companies' origins as state-owned-enterprises). The major difficulties encountered by Chinese auditors in the course of an audit also are explored. Structured interviews and questionnaire surveys are used to solicit quantitative and open-ended responses to the above questions from 102 auditors at partner and manager levels of Big 4 and large and medium-sized domestic audit firms.

Audit Firm Portfolio Management Decisions

ABSTRACTWe examine client acceptance and client continuance decisions of a large audit firm to provide empirical evidence on the extent and nature of risk avoidance that the firm uses to purposefully manage its client portfolio. Our results support several key new inferences regarding audit firm portfolio management decisions. First, the results show that this firm is shedding the riskier clients in its portfolio, consistent with the risk avoidance theory of audit firm portfolio management. Second, the results show that the firm's newly accepted clients are less risky than its continuing clients. Although results of both the client continuance and client acceptance decisions imply a less risky portfolio emerging over time, there are greater differences in risk between continuing and discontinued clients than between continuing and newly accepted clients. Third, we find that audit risk factors are more important in audit firm portfolio management decisions than are financial risk factors. Finally, we find no evidence that audit pricing affects the client acceptance and continuance decisions of this firm, controlling for risk and other client characteristics.

Risk Management in Client Acceptance Decisions

This paper examines whether risk-management strategies (specifically, the use of specialist personnel and higher billing rates) moderate the effect of risk on client acceptance decisions, thereby assisting auditors in bringing prospective client relationships to acceptable risk/return levels. We propose a conceptual model of the client acceptance decision process, and use archival data on one firm's actual client acceptance decisions to test the model. Our results demonstrate the selective use of risk-management strategies in the client acceptance decision, based on the nature of the risks present for each particular client. Specifically, plans to charge a higher billing rate are associated with a reduction in the negative relationship between client acceptance likelihood and both going-concern risk and public trading status, and plans to assign specialist personnel are associated with a reduction in the negative relationship between client acceptance likelihood and both fraud risk and error risk. Therefore, we provide evidence that while risky clients are less likely to be accepted overall, the application of particular risk-management strategies to particular risks increases the likelihood of accepting such clients.

On the role of the organization in auditors’ client-acceptance decisions

The objective of this research is to better understand the role that the accounting firm organization plays when auditors make difficult client-acceptance decisions in the midst of conflicting influences—specifically between the professional and commercial “logics of action”. The investigation was conducted via a field study at three Big Six firms located in Canada. The main argument that is developed in the paper is that the firm sets the stage for auditors’ decision-making by making its formal organizational components (e.g., the firm's partner-compensation scheme and decision-making policies) more reflective of one of the two logics, thereby establishing and helping reproduce certain patterns of order and consistency within the firm. However, the firm's organizational components are also to some extent reflective of the other logic, thereby providing decision-makers with a legitimizing space to influence the decision process differently. I present fieldwork data that is consistent with the paper's argument.

The Difficult Client‐Acceptance Decision in Canadian Audit Firms: A Field Investigation*

AbstractAuditing is often depicted in scientific and professional literature as being subject to conflicting forces, such as mechanization versus flexibility, and professionalism versus commercialism. This paper examines how auditors actually make the client‐acceptance decision in the midst of these forces. The investigation was conducted via a field study at three Big 6 firms located in Canada.The results show that in all firms the client‐acceptance decision process in action is largely flexible, being characterized by a high degree of informal communication and the adaptation of the client‐acceptance written policies and decision aids to circumstances. Furthermore, while commercialism in one firm (A) has a significant influence on the decision process, in the two other firms (B and C) the decision process is mostly consistent with professionalism. This result conflicts with the concerns that North American regulators have recently expressed about auditors' professionalism.

The Difficult Client-Acceptance Decision in Canadian Audit Firms: A Field Investigation

Auditing is often depicted in scientific as well as professional literature as a practice subject to conflicting influences, such as mechanisation vs. flexibility, and professionalism vs. commercialism. This paper examines how auditors actually make the client-acceptance decision in action, in the midst of these conflicting influences. The investigation was conducted via a field study at three Big Six firms located in Canada. The results show that in all firms the decision processes are largely flexible, being characterised by a high degree of informal communications and the adaptation of the firm's rules and decision aids to circumstances. Furthermore, while commercialism exerts in one firm a significant influence on the decision processes, in the two other firms the decision processes are mostly consistent with professionalism. This finding seems to contradict the deprofessionalisation claims that are often made vis-a-vis the auditing profession within the academic literature: in the majority of the firms, professionalism appears to be significantly influential when auditors make client-acceptance decisions.

A Framework for Determining the Influence of the Corporate Board of Directors in Accounting Studies

Accounting, auditing, and tax professionals constantly evaluate the integrity, competence, and financial performance of clients as factors in practice that influence both client acceptance decisions and the manner in which professional services are rendered. Yet, from an accounting perspective, previous research investigating the corporate board of directors as a governance mechanism has focused only on the representational role of board members. Moreover, many of these studies resulted in conflicting findings according to these attributes. Other disciplines address the particular influence of the board with respect to overall corporate performance, but arrive at little agreement on either the effect of or the most critical of board attributes. This literature review synthesizes the existing research to provide a framework in which to evaluate the effect of the board of directors in accounting settings and, in particular, when conducting future research that employs elements of corporate governance as dependent or independent variables in accounting studies.

Client-Acceptance Decisions: Simultaneous Effects of Client Business Risk, Audit Risk, Auditor Business Risk, and Risk Adaptation

Little is known about how audit partners make the client-acceptance decision. In this paper, a model is developed and tested that characterizes the client-acceptance decision as a process of risk evaluation and risk adaptation. The model proposes that auditors will evaluate client-related risks (e.g., financial viability, and internal control) and use that evaluation to determine if the audit firm will suffer a loss on the engagement via a lack of engagement profitability or future litigation. The model proposes that auditors will adapt to the client-acceptance risks by using three strategies: (1) screening clients based on their risk characteristics; (2) screening clients based on the audit firm's risk of loss on the engagement; and (3) more proactively adapting using strategies including adjusting the audit fee, making plans about necessary audit evidence, making plans about personnel assignment, and/or adjusting the amount of data collected during the client-acceptance process. To test the model, an experiment was conducted using 137 highly experienced audit partners as participants. The results show that the partners considered the relationships between client-related risks and used their evaluation of those risks to evaluate the audit firm's risk of loss on the engagement. In terms of risk adaptation, partners screened clients based on the clients' risk characteristics and based on the audit firm's risk of loss on the engagement. Contrary to prediction, the partners did not use more proactive risk-adaptation strategies (e.g., adjusting the audit fee, making plans about necessary audit evidence, etc.) to make less “acceptable” clients more acceptable. It appears that avoiding risk, rather than proactively adapting to risk, is descriptive of how audit partners currently make the client-acceptance decision.

The Impact of Legal Liability Regimes and Differential Client Risk on Client Acceptance, Audit Pricing, and Audit Effort Decisions

This study uses experimental methods to examine client acceptance, auditor pricing and effort decisions for clients of varying risk under two legal rules, joint and several liability, and proportionate liability. We predict greater availability of audit services for high-risk clients, lower audit prices, and lower audit effort under proportionate liability relative to joint and several liability. Our experimental evidence does not strongly support predicted prices due to underpricing behavior, but prices do reflect risk differences across client groups for both liability regimes. The results also exhibit some support for the predictions that auditors select low effort for the lowest-risk clients, and a lower effort level under proportionate liability relative to joint and several liability for moderate-risk clients. As predicted for the highest-risk clients, high effort is selected under proportionate liability, and there is some evidence of a substantial reduction in contracting under joint and several liability.

The Trainee Performance Sample: Toward the Prediction of Habilitation Costs for Severely Handicapped Adults

Severely handicapped adults have often been excluded from vocational rehabilitation programs because they were not seen as feasible for ultimate occupational success. Recent training and management research has demonstrated that these adults can be quite successful with appropriate training, and a practical basis for selecting and placing them in training programs is needed. For this reason the Trainee Performance Sample (TPS) was developed to predict time required for vocational training. Preliminary data on the TPS indicate high internal consistency, reliability, and stability of scores over time and trainers. Further, correlations between TPS scores and training time and trials were above .75 in four of seven samples. Although considerably more research is needed, the TPS does appear to be a potentially useful instrument in making client acceptance and placement decisions for severely handicapped adults.