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Auditing the Auditors

Jan. 18, 2017

When an auditor walks into a company, it is presumed he or she has good judgment. But could auditors be better at making judgments and taking action?

Accounting & Business Law Assistant Professor Owen Brown decided to find out.

"My research focuses on judgment and decision-making, most often in the context of financial statement audits," he said. "In particular, my research seeks to apply relevant theory from Psychology to help better understand, evaluate and, ultimately, improve auditor judgments, decisions and actions while performing their professional responsibilities."

Broadly, financial statement audits help to ensure the information contained in a company's financial statements is reliable, credible and relevant. Investors and creditors require high quality information to make informed decisions. By improving auditor judgment, the quality of financial statement audits should improve.

The article "The Interplay of Management Incentives and Audit Committee Communication on Auditor Judgment," which was published in Behavioral Research in Accounting, investigates auditor interactions with client management and the audit committee, all of whom play a critical role in corporate governance.

"At the time I began this research, a new professional auditing standard had recently been issued, which provided new direction and expectations for how and when communications between the auditor and the audit committee were to take place," Brown said. "This paper attempts to shine a light on the relative effectiveness communications between auditors and the audit committee can have on improving auditor performance."

To examine this issue, he, along with his co-author Velina Popova, conducted an online, survey-style case study and recruited approximately 70 professional, practicing auditors to complete it. The auditor participants were assigned a standard audit task, and their judgments in completing the task were recorded and subsequently analyzed. As an additional part of the case materials, approximately half of the auditor participants were provided with additional communication from the audit committee indicating its expectations for the audit, whereas the other half were not given additional audit committee communication.

The researchers found that, in support of the new professional auditing standard, the audit committee's informal communication with the auditor can have a significant and positive impact on auditor performance. However, under certain conditions, a reporting preference expressed by the client's management became more influential than the audit committee's communicated preference. In these instances, overall audit quality could become impaired.

"Our findings highlight the importance of examining the interrelationships among the various actors contributing to corporate governance [the auditor, management and the audit committee] and also inform standard setters about the benefits of increased communication between audit committees and auditors," he said.

Understanding the impact of an auditor's communications with company management and audit committees in various scenarios is crucial for improving the auditing process and making it as unbiased as possible.

"In light of enhanced oversight and regulation of the auditing industry, I was somewhat surprised that, under certain conditions, a company's management was still relatively influential over auditors' decision-making processes," Brown said.

The majority of Brown's research focuses on judgment and decision-making through the application of a psychological lens. He has utilized this approach to investigate other auditing and accounting related issues, such as auditors' application of professional skepticism and the whistleblowing intentions of corporate accountants.

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