Risk Of Misstatement Research Articles

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.

Analysis of Financial Statement and Prewarning of Audit Risks Based on Artificial Neural Network

The marketization of social capital has resulted in frequent audit failures, and financial statement frauds. One of the key steps of auditing is the identification of material misstatement risk of financial statement. However, there is no unified analysis framework or quantitative method for identifying this risk. Therefore, this paper aims to analyze financial statement and prewarn audit risks in an accurate manner. Firstly, the items of financial statement were analyzed in three aspects of the target enterprise: balance statement, income statement, and cash flow statement. Next, the authors probed deep into the core indices of the post audit risk verification and evaluation of the business process, constructed a scientific evaluation index system for audit risks of financial statement, and quantified the 89 tertiary indices, 21 secondary indices, and 3 primary indices. After that, an audit risk prediction model for financial statement was established based on neural network. Experimental results show the effectiveness of the proposed model for audit risk prewarning, and applicable to other tasks of financial auditing.

Analyzing earnings management preferences from business strategies

Purpose This study aims to examine the preference for earnings management (EM) strategies according to business strategies, namely, cost leadership strategies and differentiation strategies, Design/methodology/approach This study analyzed 262 samples of manufacturing and service companies listed on the Indonesia Stock Exchange for the period 2019. Logistic regression analysis is used to test the company’s EM strategy preferences based on the applied business strategy. Findings The results prove that business strategy has a significant effect on EM strategy preferences. Companies that implement a cost leadership strategy tend to use an accrual form of EM rather than a real form of EM. Conversely, companies that implement a differentiation strategy tend to use a real form of EM. Research limitations/implications Theoretically, this study confirms that contingency theory can explain EM practice preferences based on business strategy. Practically, this study helps auditors and financial statement analysts in assessing the quality of financial statements, as well as the risk of financial misstatement based on the business strategy adopted by the companies. Originality/value Based on prior literature, research studies on the analysis of EM strategy preferences based on business strategy have been limited.

Учет основных средств и капитальных вложений как ключевой вопрос аудита отчетности

The article is devoted to the issues of accounting of fixed assets in organizations, whose securities are circulated by the organizers of trade on the securities market. These organizations include public joint stock companies, which are subject to mandatory audit. In the auditor's reports issued to such organizations, in accordance with the requirements of ISA 701 "Key Audit Matters", key audit matters should be disclosed. Very often, auditors choose such key issues as "fixed assets" and "capital investments", especially on the eve of the entry into force from January 1, 2022 of the new accounting standards - FSBU 6/2020 "Fixed assets" and FSBU 26 / 2020 "Capital investments". The article discusses the features of accounting for fixed assets and capital investments, due to which auditors assess the risk of misstatement of accounting (financial) statements as increasing and conduct audit procedures to identify such prerequisites for the formation of statements as the valuation of fixed assets and rights to them belonging to the reporting organization.

Does Corporate Citizenship Influence Auditors’ Perceptions of the Credibility of Management in Relation to Financial Reports?

This paper examines whether the distributional fairness dimensions of corporate citizenship influence auditors’ assessments of source credibility in relation to financial reporting, as reflected in audit fees. Grounded in the traditional view of corporate citizenship as social contributions that reflect distributional fairness, the analysis uses three measures that are not widely considered in the corporate social responsibility literature: tax fairness, wage fairness and philanthropy. We obtain robust evidence that tax fairness and philanthropy, and some evidence that wage fairness, are negatively related to audit fees. It appears that the philanthropy effect may be dominated by domestic philanthropy. Overall, the results are consistent with the proposition that auditors attach more credibility (or less risk of misstatement) to management assertions when a corporation demonstrates a higher level of corporate citizenship in terms of distributional fairness.

Internal Audit in ERP Systems Context

Through this paper, the authors wanted to highlight how important and useful are ERP systems for any company that requires internal auditing. ERP - Enterprise Resource Planning systems are intelligent software that can be adapted to the needs of each company allowing the combination of all business processes in a single database. They are also a way of internal control over the data entered and employees. From an internal audit perspective, these systems can be considered an appropriate solution because they provide an opportunity to more effectively manage internal and external audit risks. The main objective of this paper is to demonstrate the satisfaction of internal audit needs with the help of integrated systems. These systems facilitate the operation of data and their security. Another objective was to analyse how much these systems can reduce certain risks. The risks of significant misstatement may be mitigated by these systems, and any operation introduced may be analysed, verified and approved / disapproved. Therefore, a quantitative research was conducted, using the questionnaire as an analysis tool. Based on the answers received, the profile of the respondents was outlined and at the same time a statistical analysis was performed. The results obtained demonstrate that respondents appreciate ERP systems’ utility. They perceive a reduction in financial and operational risk but also an increase in technical risk. Of course, these technical risk issues can be mitigated by the internal audit department's ability to assess and manage any issues that may arise. However, respondents also emphasize the need of training employees in using the system and understanding the data generated by it. Without well-trained employees, performance at the company level, as well as at the internal audit level would not be achieved. It is essential to have training at employees’ level who manage data in an ERP system. This training is also valid for internal auditors who can recommend this system to reduce audit risks.

Do Stronger Wise‐Thinking Dispositions Facilitate Auditors' Objective Evaluation of Evidence When Assessing and Addressing Fraud Risk?*

ABSTRACTThe objective evaluation of evidence is imperative for audit effectiveness and the proper exercise of professional skepticism. However, numerous studies suggest that auditors fail to evaluate evidence objectively when assessing or addressing the risk of material misstatement due to fraud. We develop theory to predict that auditors do evaluate evidence objectively but only when they have stronger wise‐thinking dispositions (WTDs), a construct that is new to the audit literature. We define WTDs as the tendency of individuals to naturally engage in the balanced revision of beliefs and doubts about target phenomena by thinking openly and reflectively about evidence. We report prediction‐consistent results from two experiments that measure the strength of participants' WTDs and manipulate whether the underlying evidence is less or more indicative of fraud. The experimental results also document that auditors vary considerably in WTD strength and collectively demonstrate the reproducibility of audit judgment‐quality benefits of stronger WTDs. We further validate the WTD construct in auditing using confirmatory bi‐factor analyses to show that it has one higher‐order general factor along with several subfactors. Overall, our theory and results advance the literature by identifying WTDs as a determinant of auditors' ability to objectively evaluate evidence. In addition, our findings have implications for standard setters and audit firms as quality control standards and audit working paper review processes might benefit from revisions that take into account that auditors do not objectively evaluate evidence unless they have stronger WTDs.

Audit committee strength and auditors' risk assessments: The moderating role of CEO narcissism

This paper examines the impact of two elements of the client's control environment on auditor's assessment of the risk of material misstatement: audit committee strength and CEO narcissism, the latter of which is a component of management philosophy, operating style, and tone at the top. We predict and find that auditors' risk assessments are adequately responsive to both elements; however, importantly, a strong audit committee decreases perceived risk assessments only when the client has a CEO with less narcissistic characteristics. In other words, our findings suggest that the presence of narcissistic CEOs' attitudes weakens the perceived audit committee effectiveness, leading auditors to rely less on a strong audit committee. Our findings contribute to the auditing literature by exploring auditors' responses to the complex dynamics between management boards and those charged with governance. From a practical perspective, our results suggest that auditing standards and practice guidance should consider making such complexities and the role of management attitudes and styles even more explicit.

COVID-19 AND THE ACCOUNTING PROFESSION

This is the first large-scale academic study evaluating the impact of COVID-19 on the accounting profession. We find that physical restrictions and economic hardships resulting from COVID-19 impeded accountants’ productivity, ability to perform their work, ability to maintain relationships with clients and co-workers, and ability to sell future services to prospective clients. Auditors believe COVID-19 will reduce the effectiveness of clients’ internal controls and make it more difficult for auditors to determine the effectiveness of internal controls. Auditors additionally believe that COVID-19 will make it more difficult to determine the going concern status of their clients. Tax professionals do not agree with the notions that COVID-19 will lead to increased difficulty in reporting taxable income, an increase in aggressive tax reporting, or an increase in attempted tax evasion. Results herein are of importance to accountants, educators, legislators and all users of financial statements. “Face-to-face discussions with client personnel is very important in evaluating controls and risk of fraud and material misstatement. These meetings allow the auditor to pick up non-verbal clues and are a more comfortable environment for open discussions with client personnel. These can be performed in other ways but, in my opinion, none will be as effective as face-to-face meetings.” - Anonymous Respondent

Auditor Response to Estimated Misstatement Risk: A Machine Learning Approach

SYNOPSISWe investigate whether misstatement risk estimated using advanced machine learning techniques—hereafter, estimated misstatement risk (EMR)—approximates auditors' risk assessments in practice. We find that auditors price EMR and auditor turnover is more likely to occur when EMR increases, indicating that EMR is associated with auditors' risk assessment. We also find evidence that EMR is positively and significantly associated with audit fees and auditor switching for companies with Big N auditors but not for other companies, suggesting that Big N auditors are more responsive to risks captured by EMR. Additional analyses reveal that companies switching auditors when EMR increases are more likely to engage non-Big N auditors. Surprisingly, we find little evidence that the association between audit quality and EMR differs by auditor type. Our findings are consistent with the notion that the documented association between audit fees and EMR primarily reflects a risk premium in our setting.

The impact of client use of blockchain technology on audit risk and audit approach—An exploratory study

Blockchain is claimed to disrupt the external audit function by enhancing the reliability of both external and internal audit evidence. This study examined the impact of client use of blockchain technology on audit risk and audit approach. It referred to the Australian Auditing Standard ASA 315 Identifying and Assessing the Risks of Material Misstatement and van Buuren et al.'s continuum of audit approaches to frame semi‐structured interviews with 28 blockchain stakeholders including audit partners. The study found that blockchain clients are perceived to be riskier than other clients and that inherent and control risks are amplified. The audit approach is not definitive with two likely approaches: a combination of direct, indirect, account‐level and entity‐level evidence and an increase in indirect and entity‐level evidence. This study's findings are useful for audit practitioners, standard setters and regulators.

Determining a typology of behavioral traits indicating the inclination to material misstatement risk among those charged with financial reporting

Subject. We typified persons charged with financial reporting, who are more than inclined to misstatement risk due to fraud. Objectives. We herein develop a methodological framework for determining types of people charged with financial reporting. The typification is based on behavioral traits of the inclination to material misstatement risk. Methods. We applied multivariate statistical methods of factor and cluster analyses on the basis of empirical data we gathered in the survey of 515 employees charged with financial reporting. Results. As we found, if a person charged with financial reporting has some behavioral traits admitting the possibility of taking risk and an expectation of remaining unpunished and a pathological monetary type in case of legislative illiteracy, these signs mean the inclination to material misstatement risk due to fraud. Such people account for nine percent of the sample. One third of the sample is made up of people who are not inclined to risk at all. The neutral group in terms of the above risk comprises slightly more than one third. The remaining people (about 23 percent) can be qualified as suspicious in terms of their inclination to the above risk, which should be a reason for additional auditing procedures. Conclusions. Being not very difficult, the proposed methodological framework helps improve the efficacy of risk assessment procedures during audits. From perspectives of the inclination to business risk, determining types of employees charged with financial reports allows to decide on the necessity of additional auditing procedures when setting up the audit strategy and planning to cushion the material misstatement risks due to fraud.

Challenges Faced By Auditors When Estimating Fair Values. An Experiment in an Emerging Economy

Abstract Risks related to fair value (FV) estimates and their impact on the audit process represent a crucial topic in accounting and audit literature. Therefore, this paper focuses on one of the influential factors of FV estimation and related risks in audit missions, i.e. the valuation process performed (provider and measurement). In doing so, it addressees a less analysed FV level of estimation – level 3 according to IFRS 13, ’the models’, for the case of tangible assets. An experiment is conducted on a group of auditors, members of the Romanian audit professional body. The results reveal that, if the internal control quality is high, auditors differentiate between FV providers in the case of: FV measurement, i.e. income valuation approach versus cost approach, which implies additional effort for verification and risk of misstatement, when the estimation is provided by a third party instead of management. These findings could be related to the volatility of the investigated economic context and the respondents’ level of knowledge and expertise. We infer that respondents have a moderate understanding of valuation logic and methodology while excessively relying on their own valuator.

The effects of disclosing critical audit matters and auditor tenure on nonprofessional investors’ judgments

In an effort to provide more meaningful information to financial statement users, the Public Company Accounting Oversight Board (PCAOB) recently adopted sweeping changes to the audit report, requiring the audit firm to disclose whether or not it identified a critical audit matter (CAM) and its tenure with the client. To our knowledge, ours is the first study to explore how nonprofessional investors’ judgments are influenced by (1) the relative effects of a CAM disclosure versus a disclosure that the auditor did not identify a CAM, and (2) the disclosure of the audit firm’s tenure. We find that, relative to disclosing that no CAMs were identified, disclosing a CAM reduces investment intentions. We do not find a significant effect of tenure disclosure on investment intentions, despite evidence that participants attended to and understood the tenure manipulation. Concerning investors’ cognitive processes, we find that perceptions of both risk of material misstatement and management disclosure credibility mediate the effect of CAM disclosure on investment intentions, while perceived audit quality suppresses this effect. Our contributions include furthering the understanding of cognitive mechanisms through which CAM disclosure influences investment intentions, identifying a relatively unique setting in which perceptions of management disclosure credibility and audit quality move in opposite directions, and providing evidence that auditor tenure disclosure does not appear to affect investment intentions. Our findings should be of interest to regulators, auditors, issuers, and investors.

Application of visualization methods of audit risk assessment in developing an audit strategy

Objectives This study aims to formalize developing a risk-based audit strategy and planning effective and rational audit procedures that reduce the risks of material misstatements and formalize these in a sufficiently detailed and understandable form to ensure the audit engagement high quality. The applicability of different materiality levels to parameterize the significance of risks of material misstatement is substantiated. A scenario mechanism for sufficient auditor actions in response to specific characteristics of the risk factor based on the risk heat map was developed. Methodology The new method of the risk complex visualization – spectrum analysis of the assessed risk factors of material misstatement to develop an audit strategy was proposed. Contribution The usefulness of the study results is to develop and test on a specific example of the audit engagement the risk-oriented approach that allows the most rational use of the audit organization resources. The methodology is also applicable for managing the risks of material misstatement in the internal audit.

Are top executives important for earning management and firm risk? Empirical evidence from selected Chinese firms

PurposeThis study examines the role of the observable and unobservable characteristics of top management on earning management and firm risk in China.Design/methodology/approachThe authors used manager-firm matched panel for 104 non-financial firms listed on the Shanghai Stock Exchange between 2010 and 2018. The authors also trace the persistence of managerial financial styles and their active role across two different firms between which managers switched during the sample period.FindingsThe results show that managers' financial styles indeed influence earning management and firm risk and that this influence differs across different managers. These findings are robust when tested for the persistence and active role of managers. Furthermore, individual characteristics such as age, gender, qualification and experience influence managers' financial styles.Practical implicationsGiven their findings, the authors propose that financial analysts and potential investors should not only depend on quantitative data but also consider the individual characteristics of managers when evaluating firms.Social implicationsThe findings of this study carry serious implications for managers, policymakers and potential investors. The findings assist the external auditors in measuring the risk of material misstatement, the various regulatory bodies to assess the quality of financial reporting and the users of financial statements to evaluate the earnings and make further investment decisions considering not only the quantitative data but also the individual characteristics of top managers.Originality/valueThe current study examines the observable and unobservable characteristics of top management on firm risk and earnings management in Chinese context.

Аналитические процедуры оценки рисков существенного искажения отчетности вследствие недобросовестных действий аудируемого лица

Th e article substantiates the choice of non-fi nancial indicators used in analytical procedures for assessing the risk of unfair misstatement of reporting, which can be used along with fi nancial indicators, but which (unlike fi nancial indicators) are diffi cult to manipulate. A set of control ratios has been developed, including non-fi nancial indicators for organizations of various types of activities.

Accounting Policy Changes and Misstatement Risk

We examine how various types of accounting policy changes affect financial misstatement risk and the ways auditors mitigate that risk. We find greater misstatement risk for both idiosyncratic and industry-wide accounting policy changes and that auditors play an important role in mitigating these risks in some situations but not others. Higher quality auditors appear to mitigate the misstatement risk from industry-wide changes, but not idiosyncratic changes. Misstatement risk is also mitigated when auditors communicate accounting policy changes through explanatory paragraphs and preferability letters and when they identify material weaknesses. Our evidence suggests that accounting policy changes are associated with a heightened risk of misstating the financial statements and auditors do not fully mitigate these risks in their audits.

Поведенческие характеристики руководства аудируемой организации как детерминанты риска фальсификации финансовой отчетности

Th e author’s methodology for assessing the propensity to the risk of material misstatement of fi nancial statements due to fraudulent actions by those charged with preparation of the fi nancial statement of the audited organization is proposed on the basis of two behavioral characteristics − tolerance to violations of legislation and pathological monetary personality type. On the basis of a specifi ed econometric bivariate probit model, calculations are made on empirical data from a survey of employees of the audited companies conducted by the authors. Using the results in the working audit documentation at the stage of preliminary planning of the audit will assess the likelihood of the propensity of the organization’s management to economic risk.

Auditors' Susceptibility to Affective Bias via Repeated Client Email Exchanges with Mixed Evidence

While auditors used email to communicate with clients before COVID-19, the pandemic has caused firms to increase their reliance on email to facilitate remote client service delivery. Thus, auditors are relying more on email to establish relationships and gather audit evidence. This reliance could result in skewed judgments based on client email content and tone. We conduct a 2x2 within-subjects experiment that manipulates client affect (positive vs. neutral) and evidence consistency (whether the client’s response is consistent or inconsistent with audit evidence). We find auditors’ judgments are positively skewed by positive affective tones used across repeated email correspondences. Importantly, the affective response is engaged, and persists, only once participants are exposed to statements inconsistent with audit evidence. Our results are pervasive across several significant judgments including reliability, risk of material misstatement, skepticism, and trust. Our results inform firms redesigning audit methodologies to ensure audit quality in a remote audit environment.