Risk Of Misstatement Research Articles

Audit and accounting considerations on cryptoassets and related transactions

Introduction. The rapid rise and volatility of cryptoassets have led to increased global interest by governments, investors, regulators. In 2020, the market capitalization of cryptocurrencies increased to USD 758.06 billion by expert estimations. Each of the cryptoassets has its own unique features and characteristics which makes their accounting and auditing challenging. The lack of official accounting and auditing guidance for cryptoassets and related transactions impose additional audit risks that should be measured properly before the client-acceptance stage and planning audit procedures. We developed a model which links financial statement assertions, identified cryptoassets’ risks that should be considered during the audit, and related controls in response to such risks. The purpose of this paper is to identify cryptoassets framework for audit planning and gathering audit evidence to support management assertions regarding their financial statements. Methods. This paper adopts an empirical research approach with application of auditing and analytical procedures. In a comprehensive analytical overview of trends in cryptoassets market capitalization, the authors have used statistical methods and structural analysis, the selected sample includes daily data of cryptoassets market capitalization during January 2016 - February 2020. Results. According to the conducted research, the auditors have to consider whether to accept or continue an audit engagement when an entity has engaged in material cryptocurrency transactions; the auditors have to identify and assess risks of material misstatement in financial statements related to cryptoassets transactions and balances. We suggested a possible substantive audit procedures for cryptoassets and related transactions, such as: inspection of the wallets and verification the balances on them; confirmation by a third party (traders); inspection of documents supporting ownership of the asset (white papers, agreements with crypto-traders); testing client internal controls system and controls that are implemented to ensure the security of the private key of crypto-wallet. Conclusions. It is becoming common for financial statements to show cryptoassets balances and reflect the results of cryptoassets transactions, however, many auditors may have little or no experience with cryptoassets and therefore may not fully appreciate the challenges that auditing these items may present. The auditors need to identify and assess risks of material misstatement throughout the process of obtaining an understanding of the entity and its control environment, and evaluate the potential effect of that risks on financial statements.

Bitcoin and Blockchain: Audit Implications of the Killer Bs

ABSTRACTThis case examines auditing implications of Bitcoin and blockchain, and is intended for either undergraduate or graduate auditing and assurance courses. Students are asked to engage in aspects of planning and risk assessment for the audit of an online retailer. The case provides an interesting setting in which to achieve the learning objectives of: (1) identifying risks of material misstatement, (2) linking risks of material misstatement to relevant financial statement assertions, (3) explaining changes in audit procedures for responding to risks, (4) understanding a financial statement auditor's use of service auditor reports, and (5) understanding management specialists and the role they play in an audit. The modular case can be used for in-class discussion or as an out-of-class assignment and requires minimal advance preparation by the instructor. The case may be assigned in part or in its entirety. Student responses indicate the case is interesting and offers a positive learning experience.

The Forewarning Effect of Critical Audit Matter Disclosures Involving Measurement Uncertainty*

ABSTRACTWe present experimental evidence suggesting that critical audit matter (CAM) disclosures in the auditor's report involving areas of high measurement uncertainty forewarn users of misstatement risk. Specifically, in our first study with MBA students, financial analysts, and attorneys, we find that CAMs (i) lower premisstatement assessments of confidence in the financial statement area disclosed as a CAM, and (ii) lower assessments of auditor responsibility for a subsequently revealed misstatement in a CAM‐related area. In our second study with student participants proxying as mock jurors, we find that the responsibility‐mitigating effect of CAM disclosure is driven by CAM disclosures involving measurement uncertainty, as opposed to CAM disclosures involving categorical determinations. Combined, our findings help reconcile mixed evidence from prior research, supporting the view that the forewarning effect of CAM disclosures involving measurement uncertainty could mitigate perceived auditor responsibility for CAM‐related material misstatements.

ФОРМУВАННЯ КРИТЕРІЇВ ДОВІРИ АУДИТОРА ДО НЕЗАЛЕЖНОГО ОЦІНЮВАЧА ПІД ЧАС АУДИТУ ОБЛІКОВИХ ОЦІНОК

The article is devoted to the issue of taking into account the instructions of ISA 620 "Using the work of an auditor’s expert" when auditing the public financial statements of Ukrainian enterprises. Methodological tools have been developed in order to identify audit risks of material misstatement and non-disclosure during the audit of the valuation of assets and liabilities of the enterprise, performed by an independent appraiser. Recommendations are provided, the use of which will allow to valuate the compliance of the independent appraiser's goals with the auditor's goals when checking the objectivity of the assessment of accounting objects under conditions of sustainable development and in the presence of signs of violation of the principle of business continuity.

How do auditors respond to low annual report readability?

We show that increased audit effort is associated with lower annual report readability to compensate for a perceived increase in the risk of financial misstatement for United States (US) firms. In particular, we find that lower annual report readability is associated with longer audit delays and higher audit fees for Form 10-K for US auditors, suggesting that auditors spend more effort auditing clients when annual reports have lower readability. We also find that low readability increases the likelihood of auditors using more explanatory language in unqualified audit reports.

Systems-Thinking in Complex Audit Situations

SUMMARYThis article summarizes three academic studies (Brewster 2011; Brewster 2016; Bucaro 2019) that investigate the effects of a specific form of critical thinking, systems-thinking, on audit judgments. Systems-thinking emphasizes taking a holistic “big picture” perspective and understanding how parts of complex processes interact and function. Collectively, the three studies find that systems-thinking can lead to auditors better understanding the risk of material misstatement through improved risk assessment and information processing. Ultimately, these improvements in critical thinking also increase the likelihood of identifying incorrect management explanations and incorporation of comprehensive information into audit decisions. Importantly, these studies find that systems-thinking can be instilled through short tutorial sessions, which may be embedded directly into the audit process.

Do Firms Respond to Auditors’ Red Flags? Evidence from the Expanded Audit Report

We investigate the impact of the expanded audit report on firm disclosure, focusing on auditors’ mentions of goodwill impairment as a risk of material misstatement. Using a sample of U.K. Premium listed companies with goodwill on their balance sheets, we identify instances where goodwill impairment is (versus is not) flagged as a risk and contrast firms’ disclosure level on goodwill impairment. We find that managers increase goodwill impairment disclosure when auditors initiate the mention of this risk but do not react to the elimination of the mention. The increase in disclosure is stronger when firms are perceived to be riskier, and firms make more timely goodwill impairment decisions when auditors mention goodwill impairment as a risk. Overall, this paper establishes the role of the expanded audit report as a credible channel for revealing corporate financial reporting risks to financial statement users, as well as a trigger of enhanced corporate disclosure.

Key Audit Matters and the Pricing of Audit Services: Evidence from Hong Kong

Auditors identify, assess, and respond to risks of material misstatement in the financial statements of the clients they audit. This study examines whether textual features of key audit matters (KAMs) disclosed in the audit reports of Hong Kong publicly-listed firms are reflected in the pricing of audit services. We find that audit fees are increasing in the length, complexity, and litigious or weak tone of KAM disclosures and decreasing in the similarity of KAMs to industry peers. Separating the textual content of KAM risk descriptions and auditor responses, we find that audit fees load on the complexity, litigiousness and similarity of risk descriptions and the length and weak tone of auditor responses. In addition, we find that indications of control risk concerns in risk descriptions are incrementally informative for audit fees. Results are robust to controlling for the textual features of the footnote disclosures referenced in KAMs. Finally, we show that our results are insignificant for the Chinese state-owned firms in our sample, indicating that KAM disclosures have limited value in the absence of strong demands for high audit quality.

Risk of Material Misstatement in the Stage of Audit Planning: Empirical Evidence from Vietnamese Listed Enterprises

Risk of Material Misstatement in the Stage of Audit Planning: Empirical Evidence from Vietnamese Listed Enterprises

Research into behavioral traits of the susceptibility to the risk of significant financial misstatements

Subject. The article identifies behavioral signs of the susceptibility to the risk of material misstatements through the expert survey of professional auditors. Objectives. We do empirical research into the impact five behavioral traits have, which we discovered through the two parameter risk assessment model, i.e. tolerance to violation of laws, money pathology, susceptibility to high risk, aspiration of impunity and legislative illiteracy in finance. Method.s We performed the expert survey of professional auditors to discover what determines the susceptibility to fraud among those charged with financial reporting. The expert group was made on the basis of an unbiased approach and documentation. We applied the Rasch model to rank personal traits. The collected data were processed with methods of descriptive statistics and multivariate statistical analysis. Results. Carrying out the statistical analysis of experts’ opinions, we found that their significantly correlated. Personal traits were sorted by their impact on risk assessment. Money pathology, susceptibility to high risk, aspiration of impunity and legislative illiteracy in finance were acknowledged as the most influential factors in terms of the susceptibility to misstatements of financial reporting. Conclusions and Relevance. We empirically proved the importance of factors influencing the propensity to risk of misstating financial reports. We used our own theoretical concept. The findings can be useful to auditing forms to detect the customers’ propensity to the risk of manipulating financial reporting.

The Inherent General Risk Issues

The risk of significant misstatement (RDS) is the risk that the financial statements are significant misstated prior the audit. It consists of two components, namely the inherent risk (IR), which refers to the susceptibility of an assertion about a class of transactions, account balance or presentation to be materially misstated, either individually or in aggregate with other misstatements, before taking into account any checks related control risk (CR), which is the risk that a misstatement that could occur at the level of claims on a class of transactions, account balance or presentation could be material, either individually or aggregated with other misstatements, will not be prevented or detected and corrected on time by the entity's internal control. Evaluation based on evidence of the inherent general risk is carried out below.

How Do Look-Back Analyses and Evidence Specificity Affect Auditors' Planning Judgments?

ABSTRACTDuring a look-back analysis, auditors review prior-period evidence to understand estimation inaccuracies and assess the reliability of management's estimation process. We find that evidence specificity moderates the relation between the consistency of an estimation inaccuracy with management's incentives and auditors' reliability assessments. The direction of an estimation inaccuracy has no effect on auditors' reliability assessments when the prior-period evidence is less specific. When prior-period evidence is more specific, auditors report the highest (lowest) reliability assessments of management's estimation process when an estimation inaccuracy is inconsistent (consistent) with management's incentives. Auditors' low reliability assessments in the more specific, consistent condition, however, do not translate to high risk assessments. Instead, specificity has a main effect on auditors' risk assessments. A follow-up experiment reveals, though, an inverse relation between auditors' reliability and risk assessments when auditors are provided procedures to address various levels of assessed misstatement risk.

The Regulatory Observer Effect: Large-Sample Evidence from SEC Investigations

Drawing on financial reporting, institutional, and social psychology theories, we consider whether awareness of SEC scrutiny affects the extent to which managers exercise financial reporting discretion. Because there is a higher probability that the SEC will detect misconduct and impose penalties on firms under investigation, we predict that managers will change their behavior during periods of increased scrutiny. We test our predictions using novel data on all Division of Enforcement (DoE) investigations completed during the 2000-2016 period. The evidence we present offers three insights. First, our results suggest that managers perceive the SEC will be more concerned, and potentially more punitive, with firms that employ discretion through accruals rather than real activities. Second, the actions taken by managers appear to reflect improvements in accounting misstatement risk, reductions in accounting irregularities, and increases in conservatism. Third, firms investigated by the SEC, but not ultimately subject to an enforcement action, exhibit decreased R&D and capital expenditures and increased likelihoods of CEO turnover, comment letter receipt, earnings restatements, and class-action lawsuits. The implications of our study should be of interest to academics, investors, and regulators in understanding how heightened regulatory monitoring over financial reporting can affect both accounting practices and operating decisions.

“Internet+”, Entrepreneurs’ Investment and Audit Fee

In the Internet era, the real economy and the internet are deeply integrated, and the “Internet+” business model comes into being. Under the modern risk-oriented theory, the risk of customer material misstatement becomes an important factor that auditors focus on, and also becomes the starting point of audit execution and audit pricing. Investment behavior is certainly a factor that auditors need to mainly focus on when assessing the risk of material misstatement. Based on the background of the enterprise’s implementation of the internet business model and drawing on the existing research results at home and abroad, this paper takes the non-state-owned listed companies in 2013-2018 as the research sample, and uses the modern audit risk-oriented theory. The investment behavior is divided into two parts—the financial investment and long-term equity investment to research the impact of the two types of investment on the audit fees from the theoretical and empirical perspectives. Besides, we also analyze the adjustment effect of “Internet+” on the relationship between investment behavior and audit fees. Studies have shown that the level of enterprises’ investment will significantly increase audit costs. Further research shows that “Internet+” strengthens the relationship between corporate investment behavior and audit fees.

Risk of material misstatement of organizations reporting for 2020 on the example of operations with non-repayable loan

Risk of material misstatement of organizations reporting for 2020 on the example of operations with non-repayable loan

Does Audit Firm Hiring of Former PCAOB Personnel Improve Audit Quality?

The so-called “revolving door” for employees moving from the Public Company Accounting Oversight Board (PCAOB) to the accounting firms it regulates has received heightened scrutiny recently. Hendricks, Landsman, and Pena-Romera (HLP) (2019) document that large audit firms exhibit improved inspections performance after hiring PCAOB personnel, consistent with an “inspections expertise” hypothesis that these hires help in managing inspection risk. We extend HLP (2019) by examining whether these individuals also bring “technical expertise” that enhances hiring firms’ audit quality. Using a sample of large auditors’ engagements from 2010 to 2016, we document positive associations between audit firms’ employment of former PCAOB employees and multiple audit quality proxies. These associations are stronger for higher misstatement risk clients. The precision of internal control audit opinions also improves in the presence of these individuals. These results suggest that former PCAOB employees are beneficial to firms’ audit quality particularly in areas emphasized by the regulator.

Corporate employment, red flags, and audit effort

U.S. regulatory agencies and congressional oversight committees have expressed concerns that auditors often neglect red flags embedded in the operating characteristics of firms that misstate their financial reports. This study examines whether labor employment decisions, a major part of a firm’s operations, help predict accounting improprieties and consequently play a role in audit planning and pricing. We find that negative abnormal employment changes are associated with a higher likelihood of subsequent financial restatements, accounting irregularities, and lawsuits related to accounting fraud, and generally require greater effort from auditors as manifested by higher audit fees and longer audit report lags. Positive abnormal employment changes are associated with subsequent restatements and longer audit report lags, but not associated with fraud or audit fees. Taken together, the results are consistent with auditors recognizing the individual misstatement risks pertaining to companies’ employment decisions. These results suggest that standard setters, regulators, and practitioners should devote more attention to operational statistics to identify potential red flags.

The identification of risks of material misstatement based on key audit matters in line with International Standard on Auditing 701

The purpose of this paper is to determine what key audit matters (KAM) have been identified by statutory auditors from various audit firms in companies from various industries, which assertions appeared most often in the audit reports, and what the links were between the auditing company, KAM, the assertion and the market sector. The research sample consisted of 317 companies listed on the Warsaw (158 companies) and London (159 companies) stock exchanges. The analysis was divided into companies from the following ten market sectors: construction, chemicals, energy, mining, IT, media, automotive, real estate, oil & gas and food. The research was executed based on the analysis of annual financial statements (annual reports) and independent auditor reports that were published by in-scope entities for the latest twelve-month period available as at the date of the research (the twelve-month periods ended on December 31, 2017, and March 31, 2018). The auditors of the tested companies identified a total of 793 unique KAMs. Based on their detailed descriptions, they were then divided into 36 categories (including the cate-gory ‘none’), and they were finally mapped with a total of 2,094 assertions from 7 types. All analyses and developed charts were supported by the Microsoft Power BI data analysis tool.

How do Risk-Based Inspections Impact Auditor Behavior? Experimental Evidence on the PCAOB's Process

ABSTRACT I provide theory-based causal evidence on the effects of risk-based regulatory inspections, modeled after the PCAOB's, on auditor behavior in a multi-client setting where clients with relatively higher misstatement risk (“higher-risk” clients) have a higher risk of being inspected than clients with relatively lower misstatement risk (“lower-risk” clients). I predict and find that inspections increase auditor effort, but only for higher-risk clients. Inspections also impair auditors' decision performance for lower-risk clients relative to a regime without inspections and relative to higher-risk clients within an inspections regime, ceteris paribus. Theory-based process model results show that inspections increase auditors' perceived inspection risks, which increase auditor effort for higher-risk clients, but also increase auditors' task-related anxiety, resulting in decreased decision performance for lower-risk clients. Notwithstanding the previously identified benefits, this study identifies potential unintended consequences of risk-based regulatory inspections.

Multicriteria analysis of internal controls in a Brazilian banking operation with focus on accounting information systems

The objective of the present study is to understand how the preparers of accounting information systems elect in the midst of stream of internal control procedures to mitigate the risk of material misstatement in financial statements. In effect, what renders some controls unnecessary and other prioritized, and what impacts do such attitudes create in the operational results. Therefore, this study consists of a multicriteria analysis on the exercise of internal controls in a Brazilian banking operation with a focus on Accounting Information Systems (AIS). We interviewed seven employees from different functions of an organisation, who currently hold positions in the Operations, Accounts Payable, Information Technology and Finance. Results show that the multicriteria analysis of internal control which leads to relegating certain controls to secondary place and others prioritised are as a result of a) management do not understand in its entirety the relative importance of certain controls; b) management give importance to certain controls by overriding some in order to be efficient, knowing fully well that the lower relative importance controls are ostensibly less important; c) the control environment masterminds controls to suite managerial style by focusing resources toward high strategic risk; and d) resources are scarce in particular in SMEs where AIS are underused so as to comply with every control procedures. Overall, results also demonstrate that issue of multicriteria of internal control lies within human factors of managing scarce resources when measuring relative importance of controls in AIS.