Corporate Audit Research Articles

Extreme Estimation Uncertainty and Audit Assurance

SUMMARYThe overall uncertainty inherent in financial statements has increased in recent decades, but the related reports and required level of audit assurance have changed very little. In our study, “Extreme Estimation Uncertainty in Fair Value Estimates: Implications for Audit Assurance” (Christensen et al. 2012a), we examine estimates reported by public companies and find that estimates based on management's subjective models and inputs contain estimation uncertainty that is many times greater than typical audit materiality. We do not question the value that audits provide to the marketplace or the ability of auditors to deploy up-to-date auditing techniques. Rather, we suggest that the convergence of relatively recent events is placing an increasingly difficult and perhaps, in some cases, unrealistic burden on auditors. We discuss potential changes to financial reporting and auditing standards that may improve the information provided to users, and also address the concerns raised in our study.

Differences in Auditors’ Materiality Assessments When Auditing Financial and Non-Financial Reports

With increased interest in voluntary sustainability reports from investors and other stakeholders, more companies are having these reports assured. The issue of what is considered material in these assurance engagements is important and yet research on materiality has focused only on financial statement audits. This paper reports the results of an experiment where auditors assess the materiality of audit differences of the same magnitude for both a financial audit and a sustainability (water) assurance engagement. Two factors, the risk of breaching a contract and community impact, are manipulated between-subjects. We find that auditors assess the materiality of an audit difference significantly higher for a financial case than for a water case. This difference is significantly greater when there is no risk of breaching a contract than when there is a risk of breaching a contract. For the water case, risk of breaching a contract has a stronger effect on auditor's materiality assessments when there is no community impact than when there is a community impact.

Corporate Social Responsibility (CSR) and Audit Fees: A Dual Perspective of CSR Performance and CSR Reporting

Corporate Social Responsibility (CSR) and Audit Fees: A Dual Perspective of CSR Performance and CSR Reporting

Qualitative audit materiality and earnings management

This study investigates auditors’ propensity to rely on quantitative materiality thresholds to the exclusion of qualitative materiality thresholds. Specifically, we examine whether auditors are more likely to allow earnings management that is less than typical quantitative materiality thresholds but that nonetheless is qualitatively material. We use changes in tax expense as a proxy for earnings management. Our results indicate that companies with pre-managed earnings that would have missed the consensus analyst forecast are more likely to decrease their tax expense when the magnitude of the decrease is less than quantitative audit materiality thresholds. The results also indicate that firms are more likely to meet or beat the forecast when the amount of earnings management necessary to meet the analyst forecast is less than quantitative materiality. These results are consistent with auditors relying on quantitative materiality thresholds to the exclusion of qualitative materiality thresholds, i.e., the importance of meeting or beating the analyst forecast. Finally, we find that the ability to use tax expense reduction within quantitative materiality to meet or beat analysts’ consensus forecasts was significantly reduced by the SEC’s guidance on materiality in SAB-99 and by the passage of the Sarbanes–Oxley Act.

Corporate Governance Mechanism, Audit Quality and Accrual Quality (Indonesia Manufacturing Company Evidance)

Abstract – This study examines the influence of implementation of corporate governance mechanism and audit quality toward accrual quality of the corporation. The implementation of corporate governance mechanism uses three measures: the effectiveness of the audit committee, board effectiveness and family ownership structure. For audit quality the measurements uses two approaches: amount of audit fee and grouping the company into two groups (audited by the auditor big-4 and audited by auditor non big-4). The study was conducted among selected manufacturing companies in Indonesia, during the period 2007-2009. Based on the results of the study, we find that only the board of Commissioners and grouping the company into two group (audited by the auditor big-4 and audited by auditor non big-4 experience) as a proxy of audit quality significantly improved quality of accrual. Keywords - Corporate governance mechanism, audit quality, accrual quality

The Audit Committee: A Gatekeeper for Effective Corporate Governance

In recent years, much attention has focused on the role of the corporate audit committee within corporate governance in the wake of several high profiles corporate financial debacles, such as Maxwell, Polly Peck and BCCI Bank in the UK, Enron and WorldCom in the US, and Parmalat in Italy. The value of strong corporate governance has assumed a critical role in organisations since these highly publicised corporate scandals. Regulations have been introduced in most countries around the world to enhance the functioning of audit committees as a device for strengthening good corporate governance to avoid future accounting fiascos. This paper posits that arguably only an audit committee that is independent (e.g., comprised solely of outside directors), active (e.g., meeting frequently) and with members possessing financial expertise can contribute to effective corporate governance.

Qualitative Perspective of Audit Materiality: Empirical Evidence in Mexico and Colombia

Qualitative Perspective of Audit Materiality: Empirical Evidence in Mexico and Colombia

Spotlight on the Design of European Audit Committees: A Comparative Descriptive Study

In this study we shed light on the design of audit committees in continental Europe by analysing the contents of the Eighth EU Company Law Directive, European codes of governance, and corporate audit committee charters. Our results show substantial cross‐national differences in the scope of responsibilities to be addressed by audit committees, in the competences required of committee members, and the proportion of independent committee members. The extent of differentiation comes as a surprise in light of prevailing pressures for isomorphism in the design of audit committees. A closer analysis of publicly available audit committee charters shows that compulsory disclosure requirements can increase the effectiveness of coercive isomorphism, but, consistent with prior literature, can also increase the percentage of unoriginal content in corporate documents. Our results contribute to the scant knowledge about audit committees outside the Anglo‐Saxon domain and inform practice about implementing audit committee design standards in the EU.

Driven to perfection

Driven to perfection QHow do you ensure that the service you are providing is being monitored? AWe carry out both internal and corporate audits on a weekly or monthly basis, which reflect the Care Quality Commission (CQC) outcomes 16 and 21. A member of the clinical governance team for the company visits each month to carry out their own unannounced audit, which they compare against the outcomes of internal audits. The regional director visits the home on an unannounced inspection each month as part of the provider’s visit. The home also has regular meetings with social services and local NHS trusts to discuss service provision and ways of improving the care and support provided.

Voluntary formation of audit committees in non-listed companies: The case of Morocco

The aim of this study is to observe the circumstances that led to small and medium enterprises to voluntarily adopt audit committees. The study of audit committees has been widely discussed in the literature, although most studies have focused on listed companies in the Anglo-Saxon environment. In contrast, corporate governance in small and medium enterprises has not been the subject of much attention by researchers, and even less so the voluntary formation of audit committees. This paper applies a logistic regression to data collected from a questionnaire sent to all businesses that have established strategic alliances between Spain and Morocco. The results were that the younger companies in which the directors have a lower stake, whose boards of directors have no institutional presence, but a higher proportion of non-executive directors, are more likely to voluntarily create audit committees. This paper provides a better understanding of the mechanisms of control adopted by small and medium enterprises in an emerging economy. In particular, it shows that these companies recognize the benefits of voluntary formation of audit committees in improving corporate governance. Key words: Corporate governance, audit committee, small and medium enterprise(SME), non-listed companies, Morocco.

Mitigating Transfer Pricing Risk Proactively in an Uncertain Global Economy

Transnational corporations have long considered transfer pricing as a key tax concern. If stability in transfer pricing is a necessary condition for dynamic cross-border trading, then recent financial reporting changes, updated transfer pricing guidelines, and new reporting requirements for uncertain tax positions are destabilizing influences that must be addressed by companies in order to mitigate their transfer pricing-related exposures and risk. This study reports the results of a survey of tax executives from four countries and seeks to explain what TNCs are doing in today’s volatile environment to proactively manage their transfer pricing risks, and if their actions are successful. Findings include contradictory evidence between audit risk reduction strategies recommended by tax authorities and the ability of those strategies to actually reduce corporate audit risk. The expected relationship between APAs and audit risk reduction was not supported. There was no significance attached to APA status and the likelihood of a TP-related audit, or the outcome of that audit. This was a surprising result, given that tax authorities and consulting firms with TP expertise tout APAs as the best way to mitigate TP audit risk. At best, are APAs neutral relative to audit risk? At worst, are tax authorities using APAs as a source of confidential data to be tucked way for possible future use in non-TP audits? The latter possibility gained traction with TNC tax executives when the IRS Schedule UTP was released. Few TNC executives fully believe the IRS’s declarations that a policy of restraint is in place regarding Schedule UTP data. Only a study in hindsight of the next few years’ audits looking for connections between the audits and APA-related data, and/or Schedule UTP-related data, will answer these questions.

Commercial legislation and the emergence of corporate auditing in France, 1856–1935

Enacted in 1856, the Joint-Stock Limited Partnerships Act was the first legislation in France to require joint-stock companies to establish a stewardship mechanism, the so called ‘conseil de surveillance’. Subsequent legislation passed in 1867 partially harmonised the auditing regime for all joint-stock companies until the Decree Law of 1935 strengthened it even further. The creation of new audit and stewardship and monitoring mechanisms within companies was the subject of debate among a number of interested groups including elected officials, entrepreneurs, jurists and the courts. The study demonstrates that, as well as being technical disciplines, accounting and auditing represent a space for social conflict, where their functioning is called into question in the context of political change, financial scandals and ideological shifts.

Reform der europäischen Abschlussprüfung – Stresstest auch für die genossenschaftliche Prüfung

Zusammenfassung Die gesetzliche Prüfungspflicht der Geschäftsführung der Genossenschaften wurde in Deutschland bereits mit dem Genossenschaftsgesetz von 1889 eingeführt, seit 1934 ergänzt durch die Pflichtmitgliedschaft in einem Prüfungsverband. Erst Unternehmenszusammenbrüche im Zuge der Weltwirtschaftskrise von 1929 waren Anlass für die Schaffung des Berufsstands der Wirtschaftsprüfer im Jahr 1931, die die jährliche Abschlussprüfung von Aktiengesellschaften durchführen sollten. Bilanzskandale ziehen seither regelmäßig Rufe nach Reformen der Abschlussprüfung nach sich. Als Folge der jüngsten Finanzmarktkrise nimmt nun der europäische Gesetzgeber die Regulierung der Abschlussprüfung erneut und umfassend ins Visier. Der Beitrag untersucht, ob die Lehren, die die EU-Kommission aus der Finanzmarktkrise zieht, auf das genossenschaftliche Prüfungssystem übertragbar sind.

Corporate Social Responsibility (CSR) and Audit Fees: A Dual Perspective of CSR Performance and CSR Reporting

Corporate Social Responsibility (CSR) and Audit Fees: A Dual Perspective of CSR Performance and CSR Reporting

Corporate environmental responsibility and audit risk

PurposeThe purpose of this paper is to examine the relationship between and corporate environmental responsibility (CER) and audit risk.Design/methodology/approachA survey participation request was mailed to 5,008 US auditors at random. The request provided a link to an electronic survey. The final sample consists of anonymous responses from 163 auditors.FindingsThe authors find that auditors, on average, do not perceive a significant relationship between corporate environmental strengths and audit risk; however, they do perceive an increase in audit risk among firms with corporate environmental concerns. Use of CER in the risk assessment process also varies across types of CER: 15 per cent of auditors use corporate environmental strengths to assess audit risk, while 43 per cent of auditors use corporate environmental concerns to assess audit risk. Perception of the CER/audit risk relationship is a significant determinant of CER use. Finally, both types of CER are found to have average usefulness in the risk assessment process.Research limitations/implicationsThe findings are limited to US auditors; results may not be transferable to other countries.Originality/valueStudies involving the impact of CER on earnings generally involve archival data. By examining the impact of CER on audit risk, using a unique dataset, the authors present a different and timely setting to study the CER/earnings relationship. To the best of the authors' knowledge, this is the first paper to document the relationship between CER and audit risk.

Early Evolution of Corporate Control and Auditing: The British East India Company (1600-1643 CE)

The purpose of this paper is to examine the emergence of auditing in a sixteenth century business organization and to link these developments to the evolution of the organizational structure and accounting. More specifically, the paper introduces into the debate material, which documents the evolution of the auditing practice over a period of 40 years in a single case of the English East India Company (EIC).During the first stage of the organization’s development (1600–1640), auditing in the EIC evolved from ex ante to ex post verification of transactions, and from volunteer to paid shareholder auditors. At the beginning, the company was organized into as a series of separate, terminable stock, and the oral from of ex ante verification by volunteer auditors picked from shareholders was enough to secure the latter’s interests. When the increasing number, size and complexity of the EIC’s transactions rendered the ex ante approach insufficient, ex post verification of the financial transactions was added. This called for more work than volunteers were willing or able to perform. With clearer separation of ownership and control at the time of introduction of permanent joint stock the audit function gradually evolved towards a more professional form by shareholders who began to be compensated for their work.

Legal Expertise on Corporate Audit Committees and Financial Reporting Quality

ABSTRACT Recent trends in corporate board composition indicate an increase in the appointment of directors with legal expertise. Using two financial reporting quality measures, accruals quality and discretionary accruals, we find—for a sample of Russell 1000 firms in 2003 and 2005—that the presence (and proportion) of directors with legal backgrounds on the audit committee is associated with higher financial reporting quality. These results obtain after controlling for accounting expertise on audit committees. Also, supplementary tests indicate a positive association between changes in legal expertise and changes in financial reporting quality, suggesting that legal expertise serves as a monitor rather than as a signal of financial reporting quality. Further, the two forms of expertise interact —i.e., the presence of directors with both forms of expertise enhances financial reporting quality, beyond the contribution of the individual forms of expertise. Additional tests suggest that the positive effects of legal expertise are greater in the post-SOX period compared with a pre-SOX year.

Materiality in the context of audit: the real expectations gap

PurposeThis paper seeks to focus on the issue of materiality judgements and the need for public disclosure of materiality levels. Insights about the concept of materiality are drawn from the words of users of audited financial reports, auditee managements, suppliers to the market for audit services and auditing standard setters and regulators.Design/methodology/approachThis paper reports findings arising from face‐to‐face office interviews with individuals representing identified groups of stakeholders in the market for audit services about the issue of “materiality” as this concept is applied in auditing. The interviews canvassed many issues related to audit as part of a larger project entitled “The future of audit”.FindingsIn general, stakeholders perceive that the concepts involved in audit materiality are not well understood and they point to the difficulty in providing educative materiality about it, especially in relation to qualitative materiality, to retail investors in particular. There are mixed views as to whether the actual level of tolerable error, as per one of the meanings of materiality in the audit space, should be disclosed, with some feeling that it might be detrimental or dangerous.Practical implicationsIf incremental information about materiality is to be disclosed, the issue of where, what to whom, by whom and when arise. Various suggestions are made by stakeholders in respect of these questions.Originality/valueThe paper concludes by drawing from the insights gained by the authors through the comments of participant stakeholders to make recommendations that deal with the issue of audit materiality.

Enhancing Information Usefulness by Line Managers’ Involvement in Cross-Unit Activities

Organization and management scholars have long advocated that efficient use of information is critical for firms to compete successfully in the modern marketplace. This study examines whether the use of managerial cross-unit involvement in an organization enhances managers’ propensity to use useful information provided by a functionally related unit in the organization. Senior line managers in a major global bank participated in our study in which they provided information related to their information processing and assessments of the usefulness of corporate audit information. We analyse the effect of line managers’ prior involvement with Corporate Audit using Throughput Modeling. This model allows us to understand how line managers’ cross-unit involvement influenced the way they process information received from Corporate Audit. Our results show that managers’ cross-unit involvement positively influences their assessment of information from Corporate Audit in a way that influences their propensity to use information from that unit. The results indicate that cross-unit involvement is more than an effective means of transmitting information — it can also be used as a means of building boundary-spanning capabilities in managers.

Corporate audits and how to fix them

Auditors are supposed to be watchdogs, but in the last decade or so, they sometimes looked like lapdogs -- more interested in serving the companies they audited than in assuring a flow of accurate information to investors. The auditing profession is based on what looks like a structural infirmity: auditors are paid by the companies they audit. An old German proverb holds: Whose bread I eat, his song I sing. While this saying was originally meant as a prayer of thanksgiving, the old proverb takes on a darker meaning for those who study the auditing profession. This paper begins with an overview of the practice of audits, the auditing profession, and the problems that auditors continue to face in terms not only of providing audits of high quality, but also in providing audits that investors feel comfortable trusting to be of high quality. It then turns to a number of reforms that have been proposed, including ways of building reputation, liability reform, capitalizing or insuring auditing firms, and greater competition in the auditing profession. However, none of these suggested reforms, individually or collectively, severs the agency relation between the client management and the auditors. As a result, the conflict of interest, although it can be mitigated by some of these reforms, continues to threaten auditors' independence, both real and perceived. In conclusion, I'll discuss my own proposal for financial statements insurance, which would redefine the relationship between auditors and firms in such a way that auditors would no longer be beholden to management.