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Abstract:
ERP systems have become the system of choice for the majority of publicly traded companies and have radically changed the way accounting information is processed, analyzed, audited, and disseminated. In this study, we examine whether ERP system implementations have impacted the decision usefulness of accounting information. We find that ERP adoptions lead to a trade-off between increased information relevancy and decreased information reliability for external users of financial statements. After implementing the system, firms concurrently experience both a decrease in reporting lag and an increase in the level of discretionary accruals. Contrary to expectations, adopting more ERP modules did not augment these effects. These results should be of interest to financial statement preparers initially adopting or implementing new versions of ERP applications, auditors serving clients with ERP systems, and regulators overseeing the financial markets and consolidation in the ERP industry.

ERP systems, discretionary accruals, implementation, reporting lag

Abstract:
This study examines whether auditors can effectively use nonfinancial measures to assess the reasonableness of financial performance and, thereby, help detect financial statement fraud (hereafter, fraud). If auditors or other interested parties (e.g., directors, lenders, investors, or regulators) can identify nonfinancial measures (e.g., facilities growth) that are correlated with financial measures (e.g., revenue growth), inconsistent patterns between the nonfinancial and financial measures can be used to detect firms with high fraud risk. We find that the difference between financial and nonfinancial performance is significantly greater for firms that committed fraud than for their non-fraud competitors. We also find that this difference is a significant fraud indicator when included in a model containing variables that have previously been linked to the likelihood of fraud. Overall, our results provide empirical evidence suggesting that nonfinancial measures can be effectively used to assess the likelihood of fraud.

analytical procedures, fraud, nonfinancial measures

Abstract:
This study examines whether auditors can effectively use nonfinancial measures to assess the reasonableness of financial performance and, thereby, help detect financial statement fraud (hereafter, fraud). If auditors or other interested parties (e.g., directors, lenders, investors, or regulators) can identify nonfinancial measures (e.g., facilities growth) that are correlated with financial measures (e.g., revenue growth), inconsistent patterns between the nonfinancial and financial measures can be used to detect firms with high fraud risk. We find that the difference between financial and nonfinancial performance is significantly greater for firms that committed fraud than for their non-fraud competitors. We also find that this difference is a significant fraud indicator when included in a model containing variables that have previously been linked to the likelihood of fraud. Overall, our results provide empirical evidence suggesting that nonfinancial measures can be effectively used to assess the likelihood of fraud.

analytical procedures, earnings management, fraud, nonfinancial measures

Abstract:
In complex accounting information system (AIS) environments, the exchange of audit evidence between computer assurance specialists (CAS) and auditors plays a critical role in determining audit quality. This study investigates the effects of CAS competence and auditor AIS expertise on auditor planning judgments in a complex AIS environment. The source competence literature in auditing has typically examined auditors' evaluations of evidence provided by sources with expertise structures similar to their own. However, the natural variation in knowledge structures which occurs between CAS and auditors likely results in a more complex relationship than those previously examined. This study utilizes a quasi-experiment, where CAS competence was manipulated as high and low between auditors and auditor AIS expertise was measured. Consistent with hypotheses, both auditor AIS expertise and CAS competence significantly affected auditor risk assessments in a complex AIS setting. Interestingly, with respect to the planning of substantive procedures, auditors' reactions to CAS competence variation was moderated by their own level of AIS expertise. Under conditions of low CAS competence, auditors with higher AIS expertise expanded the scope of their audit testing beyond the scope set by auditors with lower AIS expertise. No such auditor AIS expertise effect occurred when auditors received evidence from a highly competent CAS. These results suggest that auditors' AIS expertise can play a significant role in complex AIS environments and in their ability to compensate for CAS competence deficiencies.

Accounting information systems, audit risk model, computer assurance specialist, ERP systems, expertise, source competence

Abstract:
The purpose of this study is to develop, assess, and provide uses for a measure of auditor accounting information systems (AIS) expertise. A nine-item measure of AIS expertise is developed from a review of expertise studies and pre-tests with accounting students. An assessment of the measure shows that it possesses a high level of internal consistency and construct validity (i.e., convergent and discriminant validity). Factor analysis results indicate that all nine items satisfactorily load on one factor. Given that the nine items are designed to measure auditor self-assessments of AIS expertise, this factor is labeled "auditor AIS expertise" for the purposes of this study. In addition, the results suggest that auditor AIS expertise is a unique and separate domain of expertise and not simply a by-product of general audit experience. Possible future uses of the measure, such as determining the effects of auditor AIS expertise on the identification of AIS-related control weaknesses and the customization of the measure for IT audit specialists and internal auditors, are discussed. Given the increasing complexity of corporate AIS, this study's measure should provide researchers with a tool to examine how auditors' knowledge of AIS can affect the quality of contemporary audit services.

Accounting information systems, auditor, ERP systems, expertise, measure

Abstract:
SEC rule 33-8644 substantially reduces the 10-K filing period for large accelerated filers and accelerated filers from 90 to 60 and 75 days, respectively, for fiscal years ending on or after December 15, 2006. For many firms and their auditors, this rule has led to a reduction in audit delay, or the length of time from a company's fiscal year-end to the date of the auditor's report. We investigate the potential effects of this legislation by examining if (and how) changes in audit delay have been associated with changes in earnings quality. We find a significant, negative relationship between changes in audit delay and changes in discretionary accrual levels or that reductions (increases) in audit delay are associated with lower (higher) earnings quality. Similar results are found when we split our sample between current SEC mandated audit delay changes and voluntary changes in audit delay. Contrary to expectations, this relationship is not more acute for "busy season" audits. The negative relationship between changes in audit delay and changes in discretionary accruals also appears to be consistent across all three filer types: large accelerated, accelerated, and non-accelerated. These results were found to be robust to using alternative measures of discretionary accruals, a levels (vs. changes) model, and conservatism as an alternative measure of financial reporting quality. Overall, our findings support claims by auditors and preparers that SEC rule 33-8644 has the capacity to reduce the quality of financial information supplied by large accelerated and accelerated filers, and that expansion of the legislation to non-accelerated filers may lead to deleterious effects.

audit delay, discretionary accruals, earnings quality, SEC filings

Abstract:
Audit standards require auditors to conduct brainstorming sessions on every audit so they can discuss the potential for fraud and how to respond to the risk of fraud. The Public Company Accounting Oversight Board (PCAOB) has raised concerns about the effectiveness of auditors’ responses to fraud risks and has noted variations in the quality of brainstorming sessions. We develop a measure of brainstorming quality to examine whether and how it affects the relationships among fraud risk factors, fraud risk assessments, and auditors’ responses to fraud risks. We test our measure using data from a field survey of auditors’ actual brainstorming sessions and fraud-related judgments for 179 audit engagements. We find considerable variation in the perceived quality of brainstorming sessions conducted in practice. We find some evidence that the quality of brainstorming sessions moderates the relations between fraud risk factors and fraud risk assessments. We also find that brainstorming quality positively moderates the relations between fraud risk assessments and the nature, staffing, timing, and extent of fraud-related audit procedures. Our results suggest that the benefits of brainstorming do not apply uniformly, because low quality sessions likely incur the costs of such interactions without the attendant benefits. By documenting best practices from high quality brainstorming sessions, our evidence can inform auditors in practice on how to improve their fraud decision-making processes.

brainstorming, fraud, fraud risk assessments, fraud risk response

Abstract:
The promulgation of PCAOB Audit Standard No. 3 (2004) highlights the recent focus on workpaper documentation quality and its influence on audit quality. Our study examines how the mode of audit workpaper review affects reviewer judgments through its influence on workpaper documentation. Due to technological advancements such as email and electronic workpapers, firms can now perform workpaper review electronically as well as through a more traditional face-to-face approach. Recent research has found that review mode can affect the judgments of auditors preparing the workpapers (Brazel et al., 2004). Our study extends the literature by examining the extent to which review mode (electronic vs. face-to-face) affects the quality of documentation in the workpapers and whether reviewers are able to discern and compensate for these documentation quality issues. We propose a model which predicts that the relationship between the method of review and reviewer judgment quality is mediated by the documentation quality assessment gap (i.e., actual versus reviewer assessments of documentation quality). Such a mediation model provides insight into why the review format affects reviewer judgment quality. Consistent with expectations, we find that preparers of workpapers who were anticipating an electronic review provided lower quality documentation than preparers expecting a face-to-face review. As predicted by our mediation model, we find that the effect of review mode on reviewer judgments is mediated by the documentation quality assessment gap. Specifically, when the mode of review was electronic, reviewers were unable to recognize the lower quality documentation, resulting in lower quality judgments compared to when the mode of review was face-to-face. These results suggest that the effect of review mode persists to the reviewer's judgment through its influence on documentation quality.

Documentation, judgment quality, electronic review, face-to-face review

Abstract:
The decision to announce a seasoned equity offering typically comes with a decline in firm value, as investors interpret this decision as a signal of poor financial health. This "bad news" signal is extenuated when investors are aware that managers' personal wealth is tied to that of the firm's performance. In this paper, we analyze the short-term and long-term market reaction to SEO announcements and the executives' link to firm value. The extent to which executive's personal wealth is tied to that of firm value is measured by the proportion of CEO equity-based compensation. Results support the hypothesis that as the proportion of CEO equity-based compensation increases, so does the credibility of the signal and the strength of the negative reaction to the announcement of SEOs.

seasoned equity offering, executive compensation, signaling

Abstract:
Due to recent technological advancements such as online workpapers and e-mail, audit firms have alternative methods of workpaper review that they did not have in the past. While audit workpaper preparers typically know they will be reviewed, and know the form their review will take, prior research has focused on comparing the judgments of auditors who expect to be reviewed with auditors who expect to remain anonymous. This study examines the effects on preparers of using two different methods of review: face-to-face and electronic review. The study also compares both review groups to a no-review control group. Consistent with the Heuristic-Systematic Model, we find that the method of review affects preparer effectiveness and efficiency. Specifically, preparers anticipating a face-to-face review are more concerned with audit effectiveness, produce higher quality judgments, are less efficient at their task, are less likely to be influenced by prior year workpapers, and feel more accountable than preparers in both the electronic review and no-review conditions. Interestingly, electronic review preparers generally do not differ from the no-review group. These results suggest that how a review will be conducted, and not merely the expectation that a review will occur, affects the decision maker's judgments and perceptions.

Review process, audit effectiveness, audit efficiency, accountability, heuristic-systemic model

Abstract:
Due to recent technological advancements such as online workpapers and e-mail, audit firms have alternative methods of workpaper review that they did not have in the past. While audit workpaper preparers typically know they will be reviewed, and the form their review will take, prior research has focused on comparing the judgments of auditors who expect to be reviewed and auditors who expect to remain anonymous. This study examines the effects on preparers of using two different methods of review: face-to-face and electronic review. The study also compares both review groups to a no-review control group. Consistent with the Heuristic-Systematic Model, we find that the method of review affects preparer effectiveness and efficiency. Specifically, preparers anticipating a face-to-face review were more concerned with audit effectiveness, were less efficient at their task, were less likely to be inappropriately influenced by prior year workpapers, and felt more accountable than preparers in both the electronic review and no-review conditions. Interestingly, electronic review preparers generally did not differ from the no-review group. These results may suggest that it is how a review is to be conducted, and not merely the expectation that a review will occur, that affects the decision maker's judgments and perceptions.

review process, audit effectiveness, audit efficiency, accountability

Abstract:
The advent of electronic communication and electronic workpapers at audit firms has provided workpaper reviewers with options of how to interact with their audit team. Concurrently, other review formats have developed that rely more on in-person communication (e.g., review-by-interview). Prior research indicates that in-person discussion during review results in qualitatively different workpapers and judgments than when the reviewer interacts with the workpaper preparer electronically. As reviewers typically have discretion over how to conduct their reviews, the choice of review format can be viewed as a controllable audit input. Thus, the reviewer's choice of review format could impact the quality of the audit review team's work. Our study extends the audit review process literature by examining reviewers' choice of the form of their reviews and by considering factors that influence that choice. Specifically, we examine the effect of misstatement risk and workload pressure on this choice. We find that misstatement risk and workload pressure affect reviewers' review mode choices, with both those facing low risk and those under high pressure more likely to perform their reviews electronically. Further, risk and workload pressure interact to affect reviewers' likelihood of choosing to review electronically. Results indicate that misstatement risk moderates the effect of workload pressure such that, when risk is high, the effect of workload pressure is reduced. Our findings provide insight to firms and regulators regarding the impact of misstatement risk and workload pressure on how audit workpaper reviewers conduct their reviews. These issues are particularly relevant in light of recent changes in the regulatory environment that both emphasize the auditor's role in detecting fraud/misstatements and exacerbate traditional workload pressures during busy times of the year.

review process, electronic communication, face-to-face interaction, workload pressure, workload compression, misstatement risk

Abstract:
We develop a model that examines nonprofessional investors’ utilization of financial statement information, their perception of the frequency of fraud occurrence, the importance they place on fraud risk assessment as an investment activity, and ultimately, their use of fraud red flags. To test our model, we administered a survey to 194 nonprofessional investors. Our model predicts and we find that the positive relation between investor reliance on financial statement information and the importance of fraud risk assessment becomes stronger as investor perceptions of the rate of fraud increase (i.e., when investors are more likely to question the validity of financial statement information). Investors who perceive fraud risk assessment to be an important activity appear to act on these perceptions. We find a positive association between the importance of making fraud risk assessments and investors’ use of fraud red flags (e.g., analyses of accruals, management turnover) when making investment decisions. With respect to the importance of red flags that have been documented in the literature, additional analysis reveals that investors tend to focus on SEC investigations, pending litigation, violations of debt covenants, and high management turnover. In contrast, investors seem to rely less on company size, age of the company, the need for external financing, and the use of a non-Big 4 auditor. Also, we illustrate that investors appear to rely more on analysts, regulators, external auditors, and audit committees to detect and report fraud. Investors expect less from low/mid-level employees, upper management, the media, and short-sellers. Last, we provide initial empirical evidence that nonprofessional investors may be achieving higher market returns by assessing fraud risk and using red flags when investing.

fraud, fraud detection, investor, red flags

Abstract:
The promulgation of standards (e.g., PCAOB 2004b; IFAC 2008b) highlights the importance of workpaper documentation quality and its influence on audit quality. Our study matches audit workpaper preparers with reviewers to examine how alternative workpaper review methods affect sequential audit review team judgments through their impact on preparer workpaper documentation. While reviewers maintain the option of reviewing workpapers on site ("face-to-face review"), they can now also perform their reviews electronically from remote locations ("electronic review") because of technological advancements such as email and electronic workpapers. Recent research has found that review mode can affect the judgments of auditors preparing the workpapers. Our study extends the literature by examining the extent to which review mode (electronic versus face-to-face) affects the quality of documentation in the workpapers and whether reviewers are able to discern and compensate for these documentation quality issues. Our results indicate that reviewers' judgments are ultimately affected by the form of review expected by their preparer. We test two alternative mediation models to provide insight into why the review format affects reviewer judgment quality. Mediation analyses suggest that the effect of review mode on reviewer judgments is mediated by a documentation quality assessment gap. Specifically, with electronic review, reviewers' burden to recognize and compensate for lower-quality documentation was generally greater, often resulting in lower-quality reviewer judgments than when the mode of review was face-to-face. These results suggest that the effect of review mode can persist to the reviewer's judgment through its influence on preparer workpaper documentation and the resulting documentation quality assessment gap.

documentation, review process, judgment quality, electronic review; face-to-face review

Abstract:
ERP systems have become the system of choice for the majority of publicly traded companies and have radically changed the way accounting information is processed, prepared, audited, and disseminated. In this study, we examine whether ERP system implementations have affected the extent to which firms manage earnings amounts and release dates. We find, for a sample of ERP adopters, that implementations led to increases in the absolute value of discretionary accruals (i.e., greater earnings management). We also find a positive relationship between the extent of ERP module adoption and the extent of earnings management. With respect to earnings release dates, firms with incentives to increase the timeliness of their release dates experienced a decrease in reporting lag after implementing ERP systems. These results should be of interest to financial statement preparers initially adopting or implementing new versions of ERP applications, auditors serving clients with ERP systems, and regulators overseeing the financial markets and consolidation in the ERP industry.

ERP systems, discretionary accruals, implementation, reporting lag

Abstract:
In complex accounting information system (AIS) environments, auditor planning judgments are affected by the quality of work supplied by both computer assurance specialists (CAS) and auditors. Prior research has indicated that there are concerns about CAS competence in practice and the profession has acknowledged that auditors need to expand their expertise in the AIS domain. In this study, we investigate the effects of CAS competence and auditor AIS expertise on auditor planning judgments in a complex AIS environment. We find both CAS competence and auditor AIS expertise significantly affected auditor risk assessments. More importantly, auditors' AIS expertise levels moderated their ability to effectively incorporate CAS evidence into their planned substantive testing. Specifically, when CAS competence was low, auditors with higher AIS expertise effectively expanded the scope of their audit testing beyond the scope set by auditors with lower AIS expertise. The effect of AIS expertise diminished when auditors received evidence from a highly competent CAS. A mediation analysis indicates the ability to identify potential AIS-specific risks as a mechanism behind the moderating effect of auditor AIS expertise. Our results suggest auditors' AIS expertise can play a significant role in complex AIS settings and in their ability to compensate for CAS competence deficiencies.

Accounting information systems, Audit planning, Audit risk model, Computer assurance specialist, ERP systems, IT audit specialist, Source competence

Abstract:
Empirical research on seasoned equity offerings indicates that the decision to make an SEO typically engenders a decline in firm value, as investors interpret this decision as a signal of poor financial health or that the stock is overpriced. Here, we add to the literature by analyzing the short-term market reaction to SEO announcements and the chief executive officer's link to firm performance (i.e., the proportion of CEO equity-based compensation). Results support the hypothesis that investors are more likely to view the announcement of an SEO as a last resort source of capital when the proportion of CEO equity-based compensation is high. In such cases of high equity-based compensation, our findings indicate that the SEO announcement provides an incremental signal of financial distress above that provided by financial statements. We also find this relationship (last resort signal) to be stronger when large information asymmetries exist between management and investors. Thus, managers should consider the ramifications of executive compensation structure when considering whether to make an SEO.

Equity-Based Compensation, Seasoned Equity Offering, Signaling

Abstract:
The purpose of this study is to develop, assess, and provide uses for a measure of perceived enterprise resource planning (ERP) systems expertise for financial statement auditors. ERP systems are the dominant system used by the public company clients of audit firms. In such settings, the Theory of Planned Behavior suggests that auditor perceptions of their own ERP systems expertise should influence their perceived behavioral control and, in turn, explain auditor behavior. A five-item measure of perceived ERP systems expertise is developed from a review of audit expertise studies and the Theory of Planned Behavior. An assessment of the measure shows that it possesses a high level of reliability and construct validity (i.e., convergent and discriminant validity). Factor analysis results indicate that all five items satisfactorily load on one factor. The results also suggest that auditors' perceptions of ERP systems expertise are not simply a by-product of general audit experience. Possible future uses of the measure, including whether the measure explains auditor control testing performance and the customization of the measure for IT audit specialists and internal auditors, are discussed. This study's measure should provide researchers with a tool to examine how auditor self-perceptions of ERP systems expertise can affect auditor behavior and the quality of contemporary audit services.

Auditor, ERP systems, expertise, measure, Theory of Planned Behavior