Error Management in Audit Firms: Error Climate, Type and Originator

Abstract

Audit standard setters and regulators are increasingly focused on the management context within the audit firm that conducts the audit for that context’s effects on audit quality. We examine a key, but little understood facet of organizational life in audit firms, namely how audit staff who discover and report errors in audit files are routinely treated in response to reporting such errors. This construct, denoted as audit office error-management climate, can be characterized on a continuum from a relatively “blame-oriented” climate to a relatively more “open” climate. The former is one where errors are not tolerated and those committing errors are punished. In contrast, the latter characterizes error commitment as a normal, albeit unfortunate aspect of organizational life, where the error commitment and discovery is used as an opportunity for the organization to learn without sanctions on the originator if similar errors are not repeated by the auditor. We examine audit office error-management climate in the context of audit-specific factors that might affect the decision to report the discovered errors: audit error type (conceptual or mechanical) and who committed the error (the individual who discovered it or a peer). We find that an open error-management climate results in an increase in the reporting of mechanical (but not conceptual) errors and an increase in reporting peer errors (bringing them to the level of reporting of own errors) versus a blame climate. More directly our findings raise questions about how the implementation of an open error-management climate might be enhanced so as to promote greater reporting of own conceptual errors. Our post-hoc findings that auditors are significantly more willing to report their own mechanical errors than their own conceptual errors (while the difference between reporting willingness of peers’ mechanical and conceptual errors is insignificant) suggests that this obstacle for reporting conceptual errors particularly stems from auditors’ own impression management concerns. Our findings also suggest that audit firm management needs to understand that what may appear to be innocuous differences in management style at the individual audit office might affect audit quality at the client level through varying the individual auditor perceptions of the office error management climate. Further, our findings suggest that standard setters and regulators need to understand how their standards and inspections may impact the audit firm error-management climates and how the differences in such climates can affect audit quality by encouraging (or suppressing) the reporting by staff of errors in working paper files.

A shorter version of this paper will appear in the January 2014 issue of The Accounting Review.

This paper was previously circulated under the title “The Impact of Error-Management Climate, Error Type and Error Originator on Auditors’ Reporting Errors Discovered on Audit Working Papers."

Keywords: error discovery, working paper review, error reporting, error management, climate, audit quality

JEL Classification: M4