Risk Of Misstatement Research Articles

Transformation of ISA 315 as a response to the changing operating environment and the introduction of digital technologies

Subject. This article examines the revised requirements and recommendations of the current ISA 315 Standard – Identifying and Assessing the Risks of Material Misstatement, and compares them with the provisions of the previous redrafted Standard – Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment. Objectives. The article aims to analyze the new edition of the ISA 315 Standard, which reflects important changes that have been made in response to the changing operating environment of the organization and the use of information technology and financial reporting structure. Methods. For the study, we used classification, synthesis, and induction and deduction. Results. The article identifies the most important changes made to the revised ISA 315 Standard and describes a case of an internal control system assessment based on the relationship between the control environment, risk assessment process, information system, control activities and control procedures. Conclusions. The article concludes that the improvements and clarifications provided by the current ISA 315 Standard – Identifying and Assessing the Risks of Material Misstatement, help auditors to apply audit risk models in identifying and assessing risks of material misstatement.

THE CHALLENGES IN AUDITING FINANCIAL STATEMENTS AT FAIR VALUE CONCEPT (FVC) IN DEVELOPING ECONOMIES: THE CASE OF REPUBLIC OF SERBIA

Some balance sheet items are the result of judgments, including fair value estimates, so the relevant evidence is very complicated to collect by auditors, thus the risk of misstatements in financial statements is inevitably greater. The research objective of this paper is to: a) highlight the problems encountered by auditors from developing countries when auditing FV accounting estimates; b) identify the challenges that auditors from Serbia face in auditing FV accounting estimates; c) consider the possibility of adequately responding to these audit challenges in Serbia. The research confirmed that the problems of auditors in Serbia in the audit of FV estimates are generated by inefficient capital markets, and that they are primarily in the field of FV assessment which are connected to the impossibility of applying the market model and higher volatility of FV financial statements, as well as those in the field of auditing techniques used in providing assurance on the objectivity of FV assessments in various business activities, which requires additional training of auditors. Thus, the research confirmed the similarity of the problems in Serbia with the problems in the auditing FV estimates in developing countries.

Mitigating the Effects of Auditors' First Impressions of Client Personnel: The Importance of Audit Supervisors' Preference for Effectiveness

ABSTRACT Fraud perpetrators realize the importance of conveying a positive first impression to others. We examine how auditors' first impressions of client personnel interact with supervisors' preferences for audit effectiveness or efficiency to influence auditors' risk judgments. We argue that auditors are typically focused on efficiency and, therefore, in an intuitive mindset that makes them susceptible to first impression biases. Thus, we expect a positive (negative) first impression to decrease (increase) auditor objectivity and cause auditors to become less (more) sensitive to misstatement risk. We predict that supervisors' preferences for effectiveness (over efficiency) will lead auditors to adopt an analytical mindset and mitigate the effects of first impressions. Our 2 × 2 experiment with 124 practicing auditors manipulates both first impression (positive versus negative) and supervisor preference (effectiveness versus efficiency) and supports our predictions. These findings build on first-impression research in psychology suggesting first impressions are subconscious and difficult to mitigate.

Does extended auditor disclosure deter managerial bad-news hoarding? Evidence from crash risk

We examine how the mandatory adoption of extended auditor's reports (EARs) affects managerial bad-news hoarding through the lens of stock price crash risk. Relying on the UK's auditing standard change in 2013 as a quasi-natural experiment, we document a crash risk reduction for firms that were required to adopt EARs, relative to firms that were not so required. The crash risk reduction is related to EARs' disclosure of risks of material misstatement in revenue recognition. The negative effect of EARs adoption on crash risk is more pronounced for firms with scant public information and firms with non-Big-4 or non-industry-specialist auditors. EARs adoption induces firms to disclose more smaller pieces of negative information without changing firms' accruals management. Taken together, our results suggest that EARs adoption dampens bad-news hoarding by managers.

Explainable Artificial Intelligence (XAI) in auditing

Artificial Intelligence (AI) and Machine Learning (ML) are gaining increasing attention regarding their potential applications in auditing. One major challenge of their adoption in auditing is the lack of explainability of their results. As AI/ML matures, so do techniques that can enhance the interpretability of AI, a.k.a., Explainable Artificial Intelligence (XAI). This paper introduces XAI techniques to auditing practitioners and researchers. We discuss how different XAI techniques can be used to meet the requirements of audit documentation and audit evidence standards. Furthermore, we demonstrate popular XAI techniques, especially Local Interpretable Model-agnostic Explanations (LIME) and Shapley Additive exPlanations (SHAP), using an auditing task of assessing the risk of material misstatement. This paper contributes to accounting information systems research and practice by introducing XAI techniques to enhance the transparency and interpretability of AI applications applied to auditing tasks.

Effects of Government Regulations on Under-Reporting of Carbon Emission Transfers by Enterprises in Supply Chains

In low-carbon environments, asymmetric carbon information causes the enterprises in a supply chain to face the risk of misstatements about carbon emissions. Such misstatements could affect the decisions about carbon emission transfers in the supply chain. To optimize carbon emission transfers among supply chain enterprises, this study formulates a supplier-led Stackelberg game model incorporating the government’s initial carbon emission allowances and fines. The study also examines the mechanism of the behaviors of enterprises in low-carbon supply chains, the proportions of initial quotas, the impact of government fines on carbon transfers, and the influence of the supply chain and carbon emission transfers on related supply chain decisions and profits. The main findings are as follows. First, the proportion of the government’s initial quota has a positive effect on the carbon emission transfer quantity of the supplier, while government fines and misstatement factors have a negative effect. Second, the carbon emissions of the unit product of the supplier decrease as the under-reporting factor and carbon emission transfer quantity of the supplier increase. The under-reporting factor has a stronger effect on the carbon emissions of the unit product. Third, in a carbon-free market, carbon emission transfers negatively affect the disclosed profits of the supply chain, whereas in a perfect carbon market, the carbon trading price has a certain endogenous regulation mechanism for the suppliers’ operational decisions. Fourth, the supplier’s wholesale price order quantity is negatively correlated with the supplier’s carbon emission transfer quantity, but positively correlated with the initial carbon quota ratio.

TÜRKİYE’DE BAĞIMSIZ DENETÇİLERİN İÇ DENETÇİ ÇALIŞMALARINDAN FAYDALANMASI ÜZERİNE BİR ARAŞTIRMA

Uluslararası Denetim Standartları kapsamında bağımsız denetim risk odaklı bir yaklaşım ile yürütülmektedir. Bu anlayış çerçevesinde iş süreçlerinde finansal tablolarda önemli yanlışlığa sebep olabilecek yapısal riskler belirlenir, işletmenin bu riskleri yönetebilmek için geliştirdiği kontroller tespit edilir ve bu kontrollerin test edilmesi suretiyle de önemli yanlışlık riski değerlendirilmiş olur. Bağımsız denetçinin uygulayacağı müteakip denetim prosedürlerinin kapsam ve içeriği belirlenmiş olan önemli yanlışlık riskine göre şekillenir. Uluslararası İç Denetim Standartları çerçevesinde yürütülen bir iç denetim çalışmasında da iş süreçlerindeki riskler ve ilgili kontroller değerlendirilir, mevcut ve potansiyel riskler için öneriler geliştirilir ve bu değerlendirme sonucunda denetim planındaki öncelikli alanlar belirlenir. Farklı bakış açılarıyla yürütülüyor olmasına rağmen, her iki denetimde de risk odaklı bir denetim anlayışı vardır ve özellikle iş süreçlerinin incelenmesi, risklerin ve kontrollerin belirlenerek test edilmesi aşamalarında benzer çalışmalar yürütmektedirler. Dolayısıyla, bağımsız denetçi ve iç denetçi arasındaki işbirliği, verimliliği artıracak, kaynak israfını önleyecektir. Bağımsız denetim standartları, bağımsız denetçilerin iç denetçi çalışmalarından faydalanmaları konusunda gerekli düzenlemeleri yapmıştır. Bu çalışma ile Türkiye’de denetim şirketleri üzerinden bir anket çalışması yapılarak bu işbirliğinin ne düzeyde olduğu, bağımsız denetçilerin iç denetçi çalışmalarından denetim sürecinin hangi aşamasında ve ne kapsamda faydalandığı ortaya konmaya çalışılmıştır.

Do Different Data Analytics Impact Auditors' Decisions?

SUMMARYGlobal stakeholders have expressed interest in increasing the use of data analytics throughout the audit process. While data analytics offer great promise in identifying audit-relevant information, auditors may not use this information to its full potential, resulting in a missed opportunity for possible improvements to audit quality. This article summarizes a study by Koreff (2022) that examines whether conclusions from different types of data analytical models (anomaly versus predictive) and data analyzed (financial versus non-financial) result in different auditor decisions. Findings suggest that when predictive models are used and identify a risk of misstatement, auditors increase budgeted audit hours more when financial data are analyzed than when non-financial data are analyzed. However, when anomaly models are used and identify a risk of misstatement, auditors' budgeted hours do not differ based on the type of data analyzed. These findings provide evidence that different data analytics do not uniformly impact auditors' decisions.

Research on the Mechanism of Blockchain Technology Investment's Impact on Audit Fees

This paper selects the financial data of China's A-share listed companies from 2016 to 2020, and analyzes the impact of blockchain technology investment on company audit expenses. The results show that there is a significant positive correlation between the blockchain technology investment and the company's audit expenses, that is, the more the company invests in blockchain technology, the higher the audit expenses will be. This is because the application of blockchain technology in listed companies will make auditors face higher risk of significant misstatement and audit risks, and then increase the related audit procedures, thus increasing the audit expenses. Conclusion The above results are still valid after robustness test and endogenous treatment. In this paper, the research on blockchain technology investment from the perspective of audit fees will help the theoretical circle to fully understand the potential effects of blockchain technology investment on social and economic development.

THE ROLE OF HUMAN CAPITAL ON REMOTE AUDIT THROUGH A QUALITY AUDIT APPROACH

The condition of the prolonged Covid-19 pandemic entering its third year, requiring the fulfillment of health protocols and social distancing policies, including the work from home policy, is very influential in the implementation of audits, which should be the largest portion in field activities. Management and supervision as a function of controlling the rotation of the business wheel, is a link in terms of the responsibility for governance of business management to prepare and present financial statements and other relevant disclosures based on the best judgment and analysis of the latest facts and events after the reporting date that can predictable. Reliable human resources in driving the pace of change and change from various sides as part of the company's adaptive response to the prolonged Covid-19 pandemic conditions in the supervision department and audit system in business organizations are very key in maintaining audit quality and obtaining audit evidence. sufficient and appropriate to support the audit opinion through procedures for gathering audit evidence, revising the process for identifying and assessing the risks of material misstatement, and changing planned audit procedures or performing alternative or follow-up audit procedures as appropriate. The role of reliable human resources is part of the company's wealth ( human capital ) in collaborating with information technology and investing in technology as a solution to facilitate communication between the auditor department and business management using remote audit potential or known as remote audit while maintaining audit quality and optimizing the supervision and control of the business wheel. The implementation of remote auditing requires auditors to improve the ability to use technology, it is necessary to have human resource competencies that can always be improved through adequate training and education, so that increasing competencies will improve audit quality, in line with increasingly qualified human capital will affect the process. audit and is directly proportional to improving audit quality. Keywords: Covid-19 pandemic, remote audit , human capital , information technology

Auditors' response to management confidence and misstatement risk

Corporate managers display varying degrees of confidence, but investors appear to have difficulty distinguishing when management's high confidence is warranted (i.e., when it signals accuracy and/or future positive outcomes). Archival research finds that the managers associated with proxies for high confidence are actually “overconfident” because their choices ultimately resulted in personal and shareholder losses, on average. Auditors are experienced in evaluating management and are trained to be professionally skeptical, and users rely on them to reduce the information risk around noisy signals in financial reporting. Therefore, we investigate whether and how management confidence impacts auditors' response to the risk of material misstatement (RMM). Audit standards are explicit that auditors should increase testing and acquire more reliable evidence as RMM increases. Accordingly, we conduct an experiment, varying management confidence in their explanations about an accounting estimate and RMM at the client. We find, consistent with the thought-suppression literature, that although auditors universally believe relying on management's explanations without corroboration is inappropriate and that high confidence signals management's desire to induce auditor reliance, they do not distinguish their response to RMM when management confidence is high. When management confidence is low, auditors appropriately perform more testing for clients where RMM is higher than lower. Auditors' testing judgements moderate their likelihood of pursuing inquiry evidence for higher than lower risk clients when management confidence is high versus when it was low. Our finding is troublesome because deceitful managers can readily manipulate confidence and influence the explanations and inquiry evidence presented to auditors. Thus, our research offers evidence that auditors' tendency to be influenced by high management confidence can play a contributing role in the observed association between high management confidence and biased financial reporting.

AUDITOR INDEPENDENCE, AUDITOR ETHICS, AUDITOR EXPERIENCE, AND DUE PROFESSIONAL CARE ON AUDIT QUALITY

Public accountants are exceptionally important to give certainty to clients that the financial statements introduced by the organization can be trusted, but the risk of misstatement will in any case exist despite the fact that it has been evaluated by a Public Accounting Firm. This study expects to analyze the components that influence audit quality that can lessen the risk of misstatement in the presentation of financial statements, specifically auditor independence, auditor ethics, auditor experience, and due professional care. The subject in this study were employees who worked as auditors at the Tangerang’s Public Accounting Firms. This type of research is a causal study with a convenience sampling method. The research period was completed during the Coronavirus pandemic from March to June 2020. The hypothesis test method used in this research is multiple regression analysis. The results of this study are auditor independence does not affect audit quality, auditor ethics does not affect audit quality, auditor experience has positive effect on audit quality, and due professional care has positive effect on audit quality. This research is expected to be a reference in making decisions by auditors based on audit considerations possessed by an auditor to improve audit quality, especially from the experience and due professional care of the auditor.

The Power of Words: An Empirical Analysis of the Communicative Value of Extended Auditor Reports

We examine the communicative value of extended auditor reports in the United Kingdom (UK), where ISA 700 (UK and Ireland) requires auditors to disclose the risks of material misstatement that had the greatest effect on the audit – key audit matters (KAM). By using methods from computational linguistics, we find that different proxies for communicative value (i.e., readability, evaluative content, visual aids, and specificity) improve in post-ISA 700 periods. Cross-sectional tests show that the improvement differs across audit firms and audit clients as well as KAM disclosure characteristics. Finally, broadly consistent with concurrent studies, we find no evidence that several proxies for communicative value are informative to investors. However, we find initial evidence that a more specific description of KAM is significantly and positively associated with capital market reactions, suggesting that investors value precise information. Overall, this study directly responds to the call for more research on how KAM are worded.

Using the International Standard of Auditing 315 “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment” in the Auditing Practice

The article contains results of a study focused on practical issues of the application of the International Standard of Auditing (ISA) 315 “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment”. It is argued that by using provisions of ISA 315 at the phase of planning of an auditing engagement, managers of an auditing entity have to assess sectoral, regulatory and other external factors with impact on the financial reporting process, including the involved conceptual framework. The characteristics of an auditing entity to be analyzed by the auditor are determined: nature of business, pattern of ownership and corporate management, types of investment, structure and methods of financing. The auditor’s analysis of these issues has to result in his/her conclusion about the inherent risk, which is the risk of client’s business. When planning audit for small firms, an auditor can make use of the so called economies of scales. It means that small firms can minimize the measures of control through introducing components of the control environment in a way different from other business entities classified as large by activity scopes. Auditing procedures pertaining to components of the control environment should be initiated through inquiries, observations, reviews of documents and/or risk assessment procedures. A systematization of business risks and measures of control over audit customers, conditions and events that may signal the existence of risks of significant material misstatement in financial statements is made.

The joint effect of supervisor influence and investor perspective: unintended consequences on assessing accounting estimates

PurposeThe purpose of this paper is to examine the joint effect of supervisor influence and investor perspective on novice auditors’ assessments of accounting estimates.Design/methodology/approachThe experiment used a 2 × 2 between-subjects design, randomly assigning proxies of novice auditors among four conditions. The authors manipulated the supervisor’s level of emphasis on evidence that suggests accounting estimate adjustment and whether auditors are prompted to take an investor perspective. Participants were asked to assess the misstatement risk of the allowance for doubtful accounts of the client company.FindingsThe authors find that auditors assign a higher (lower) risk of misstatement when their supervisor places high (low) emphasis on evidence suggesting accounting adjustment. The authors also find that contrary to the belief that taking the perspective of investors could enhance objectivity and independence, investor perspective leads to a decrease (rather than an increase) in auditors’ perceived risk of misstatement when the supervisor places low emphasis on evidence suggesting accounting adjustment.Originality/valueThis study provides early evidence on the efficacy of investor perspective and is one of the first to document an unintended consequence of asking auditors to take an investor perspective.

Big Data Analysis and Its Contribution to Remote Audit

The COVID-19 pandemic has brought about a change in the audit process. Remote audit process is the best alternative that can be applied. Strategies to anticipate pandemic conditions with all their limitations must be carried out starting from the audit assignment process which usually includes planning, checking documents, field work, interviews, testing, and completing audits, especially to verify critical business functions. On the other hand, Big Data is needed not only to help understand the information contained in the data but also to help identify the data that is most important for current and future business decisions. This makes it easier for people to get the data and information they want. Entities must react quickly to increased capacity of information reporting systems and data analysis. This makes it easier for people to get the data and information they want. The Covid-19 pandemic for Public Accounting Firms in Central Java has also led to changes in giving initial consideration to the risks of material misstatement identified in management's assertions in the financial statements. For this reason, the auditors of the Public Accounting Firm in Central Java need to make changes by carrying out alternative audit procedures to obtain sufficient and adequate audit evidence during the pandemic. Auditors are required to be able to respond to disturbances caused by the Covid-19 pandemic and provide correct information on financial reports. The auditor must be able to modify the audit procedures performed, collect audit evidence and assess the risk of material misstatement, perhaps even provide alternatives to perform audit procedures in accordance with current conditions.

Shaping an audit strategy based on mapping and spectral risk analysis

Subject. This article deals with the practice of forming an audit strategy in conditions of uncertainty of parameterization of probability and significance of risks of material misstatement of financial statements. Objectives. The article aims to substantiate a risk-based audit strategy construction using the risk heat map tool and determining the necessary and sufficient actions of the auditor in response to the assessed risks. Methods. For the study, we used a content analysis, systematization, classification, and the abstract-logical and data visualization graphical methods. Results. Based on the content analysis of the revised ISAs that regulate audit risk, the article clarifies the aspects of risk identification, assessment, and fixing, the parameters of positioning and visualization of risk factors depending on their likelihood and significance. The article introduces a scenario mechanism for sufficient appropriate actions of the auditor in response to specific risk factor characteristics. It develops and presents a method of spectral analysis of a complex of assessed risk factors of material misstatement of reporting in order to build up an audit strategy. Conclusions and Relevance. The developed models of the audit risk heat map and the generalized map of the spectral risk analysis are the most rational tools for the formation of a scientifically based audit strategy with emphasis on the high-risk areas. The results of this article can be used in the practical activities of auditors and audit organizations, as well as internal auditors seeking to plan control measures using digital methods most effectively.

Scoring to estimate the financial statement fraud risk during the audit

Subject. This article assesses the propensity for material misstatement risk due to unfair actions of persons charged with the financial statements preparation, based on their behavioral traits. Objectives. The article aims to develop a scoring type methodology for identifying the propensity for material misstatement risk due to unfair actions of persons charged with the financial statements preparation. Methods. For the study, we used a multidimensional statistical method of discriminant analysis based on empirical data from an author-conducted survey of 515 employees charged with the financial statements preparation in companies. Results. The article presents a two-stage methodology that helps estimate whether a person has traits associated with a hyperpropensity for financial statements fraud risk. Conclusions and Relevance. The developed methodology for detecting the fraud risk is easy to use. It gives the result in binary form and does not violate the principles of audit ethics. The estimated material misstatement risk due to unfair actions makes it possible to justify the need for appropriate audit procedures when developing a strategy and audit plan.

Does Susceptibility to the Numerosity Heuristic Impact Juror Assessments of Auditors' Liability?*

ABSTRACTWe provide evidence that regulatory guidance aimed at improving audit efficiency and effectiveness—allowing auditor reliance on a multi‐location client's competent and objective internal audit function (IAF)—can unintentionally increase auditors' litigation risk. Our research is important in demonstrating how client characteristics and juror cognitive processing, such as the number of client locations and jurors' susceptibility to the numerosity heuristic, factors beyond auditors' control, can exacerbate their litigation exposure. Consistent with theoretical predictions, we find that susceptibility to the numerosity heuristic contributes to jurors assessing an increased likelihood of misstatement on multi‐location compared to single‐location audits. Furthermore, these assessments of higher misstatement risk on multi‐location audits lead jurors to perceive that auditor reliance on the client's IAF in multi‐location audits is less appropriate (i.e., not normal). Accordingly, jurors judge that auditors are more negligent when they rely on the IAF during multi‐location audits than when they do not, but IAF reliance does not impact auditor negligence on single‐location audits. Our results suggest auditor reluctance to use a qualified IAF, despite client pressure and regulatory allowance, can provide potential benefits to firms in terms of reduced litigation exposure. Thus, we demonstrate the legal regime can undermine the objectives of regulators' guidance to enhance audit efficiency and corporate governance.

On Controlling for Misstatement Risk

SUMMARYEx ante misstatement risk confounds most settings relying on misstatements as a measure of audit quality, but researchers continue to debate how to effectively control for this construct. In this study, we consider a recent approach that involves controlling for prior period misstatements (“Lagged Misstatements”). Using a controlled simulation and a basic archival analysis, we show that a lagged misstatement control can significantly bias coefficient estimates. We demonstrate this bias using audit fees as a variable of interest but also show the same issue manifests for other measures that respond to the restatement of misstated financial statements (i.e., internal control material weaknesses and auditor changes). We conclude by discussing alternative approaches for controlling for ex ante misstatement risk and providing guidance for future research.Data Availability: All data used are publicly available from sources cited in the text.JEL Classifications: M40; M41; M42.