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Volume 02

Cost and Information Effects of Accounting and Auditing Regulation of Local Governments

Robert W. Ingram

This study examines two related questions concerning certain cost and benefits the regulation and audit of local government reporting practices: (1) What is the magnitude of direct costs assumed by local governments to comply with accounting and auditing regulations? (2) What is the magnitude of financial information available to report users associated with compliance with the regulations? This study demonstrates that financial administration costs are positively associated with CAAP-based information disclosures and with GAAP regulations but not with CPA audits. CPA audits are positively associated with information disclosures, while GAAP regulations are not associated with the disclosures. Volume 2, 1988, pgs. 7-24.

A Proposal and Filed Test of an Option Pricing
Technique for Auditor Review for Possible Insider Trading

Karen Craft Denning and Kuldeep Shastri

This paper presents a methodology for the detection of insider trading. The methodology, which is based on the variance implied by the Black-Scholes option pricing model, is applicable to those firms with traded options. It can be appropriately applied in situations where there has been a significant corporate event that is likely to have an impact on the expectations of market participants during the audit year. The methodology does not provide irrefutable proof that insider trading violations have occurred, but does provide a signal that highlights a firm for closer audit and/or scrutiny. Examples of how the data can be applied and interpreted are provided here.Volume 2, 1988, pgs. 25-39.

Toward a More Coherent Regulatory Policy for Auditor Changes: An Empirical Study of Their Impact on Financial Statement Credibility

Michael C. Knapp

Regulatory authorities have voiced concern that auditor changes diminish user confidence in the reliability of switching firms' financial statements. Alternatively, proponents of the product differentiation hypothesis contend that auditor changes often enhance financial statement credibility. The lack of empirical evidence concerning the validity of these views complicates efforts to develop a coherent policy to regulate auditor switching behavior. The purpose of this study is to provide additional insights on the auditor switching phenomenon that should prove relevant for future policy making decisions. Specifically, this study investigates the effect of auditor switches and related 8-K auditor -client disagreement disclosures on the credibility of switching firms' financial statements. A repeated measures, ANOVA experiment was conducted with utilized 102 commercial loan officers as subjects. The results of this study demonstrate that certain auditor changes may increase the credibility of switching firms' financial statements. In addition, the results raise a question as to whether the SEC's disagreement disclosure rule serves as an effective deterrent to auditor changes motivated by a management intent to obtain more compliant auditors. Volume 2, 1988, pgs. 41-59.

Audit Pricing Models for Regulation Research:
Reliability and Stability

Robert H. Colsen, Michael W. Maher, Amy J. Broman, Peter Tiessen

A stream of research beginning in 1980 has enhanced our understanding of the determinants of external audit fees in regulated and free markets. This research has identified a number of auditee-specific factors that affect in significant, systematic ways the fees that auditors charge for their audit services. This paper reports the results of original empirical research concerning the validity and reliability of a developing audit pricing model. The ability to model audit prices is important to economic consequences of changes and developments in the audit environment. Properly formulated audit pricing models, and a well-disseminated understanding of such models, should enhance rational communication among auditors, auditees, researchers, and regulators about both the current state of price competition in the audit industry and the effects of fee structures of proposed and actual changes in either self regulation or governmental regulation. Volume 2, 1988, pgs. 61-79.

The Regulatory Philosophy of Carman Blough: A Persisting Legacy for the 1980s and 1990s

Robert Chatov

The regulatory philosophy and legacy of Carman George Blough, the first Chief Accountant of the Securities and Exchange Commission, is examined in the context of an extensive interview given by him to the author in 1972. An evaluation is offered of the persistence of Blough's influence in the structural conditions of the contemporary relation of the accounting profession to the SEC. Volume 2, 1988, pgs. 81-105.

Public Accounting Licensure and Service Quality: Issues, Analysis, and Evidence

S. David Young

Evidence on occupational licensure indicates that such laws impose costs on consumers without improving the quality or reliability of service offered by practitioners. In light of this evidence, academic and practicing accounts should consider whether restrictive licensing laws in public accountancy serve the interest of the general public. That is, does accounting licensure promote high-quality service without imposing unreasonable costs on users of accounting services? This paper also considers whether the benefits of licensure-namely its use as quality signal-may be conveyed just as effectively through non-restrictive certification laws. Volume 2, 1988, pgs. 107-121.

State Boards of Accountancy:
Quality Review and Positive Enforcement Programs

Wanda A. Wallace and Ronald L. Campbell

Some states' legislatures have mandated that their state boards of accountancy assume a major role in future regulation of the accounting profession in order to protect the public. To that end, a number of states have established quality review or positive enforcement programs, and numerous states express a desire to do likewise. This research describes the current status of such programs in each state. It provides details as to how the programs operated. An in-depth analysis of public files of two state boards permits the consideration of (1) how regulation is likely to change as positive enforcement programs grow in number and scope, (2) whether the tracking of certain attributes of certificate holders and units of practice might prove useful in identifying problems, and (3) the implications for the profession of past findings by an existing positive enforcement program. Such research is particularly timely in providing perspectives on the likely experiences of the AICPA, should its plan to Restructure Professional Standards be implemented. That plan's provisions with respect to educational requirements, quality review, and the AICPA's disciplinary system are intended, in part, to deter the need for State Board's regulatory activities. Volume 2, 1988, pgs. 123-154.

Audit Firm Size and Internal Control Assessment: An Experiment

Larry M. Parker, John C. Corless, and Michael J. Tucker

There has been ongoing discussions in the accounting literature of perceived differences in the audit capabilities of small and large public accounting firms [e.g., Carpenter and Strawser, 1971]. The Congressional Subcommittee on Oversight and Investigation of the House Committee on Energy and Commerce (the Dingell committee) has tended to focus on the problems of large public accounting firm clients (e.g., ESM, Wedtech, and ZZZZ Best). However, there have also been questions raised concerning audit quality and smaller public accounting firms. For example, John C. Treadway, Chairman of the National Commission on Fraudulent Reporting, stated that of the lawsuits against auditors since 1980 involving management fraud, about 74 percent of the defendants were nonnational firms. Of that 74 percent, about 81 percent were not in the SEC Practice Section of the AICPA [Treadway, 1987]. Also, a study by the General Accounting Office of the quality of CPA audits of governmental units found that about 14.5 percent of the audits done by large firms were unsatisfactory, about 26 percent of audits by medium firms were unsatisfactory, and about 65 percent of audits by small firms were unsatisfactory [U.S. GAO, 1986, p. 21, and Brown, 1987, pp. 142-145]. Furthermore, Kunitake [1987] reports that a disproportionate number of SEC enforcement actions involve smaller CPA firms. Some of the questions related to the 1987 AICPA vote on the requirement to belong to the SEC Practice Section, the AICPAs "Vote for Excellence," and the current AICPA discussions of contingent fees are related to issues about firm size. Academics have also studied perceptions of firm size and audit quality [e.g., Shockly, 1981; Knapp, 1985]. The questions concerning firm size and audit remain controversial and difficult to resolve.

This paper reports the results of an experiment to test whether auditors from large and small firms evaluate audit information differently. We believe this is a unique attempt to study the way individual auditors from small and large firms evaluate audit information in a specific set of circumstances. Volume 2, 1988, pgs. 155-166..

The SEC and Fraudulent Financial Reporting

Karen V. Pincus, William W. Holder, and Theodore J. Mock

This article reports on a research project performed for the National Commission on Fraudulent Financial Reporting. The study concerned the role of the Securities and Exchange Commission in reducing the incidence of financial reporting. The two primary research questions addressed were: (1) How effective are current SEC policies/activities at preventing, detecting and disciplining fraud? and (2) What potential changes to current SEC policies/activities would be effective in improving fraud deterrence and detection? The project phases included a literature review, a mail survey of parallel samples of major participants in the financial reporting process (management, attorneys, external auditors and internal auditors), and in-depth interviews with twenty experts on fraud and the SEC. Highlights of results of the survey and interview phases are presented. Volume 2, 1988, pgs. 167-185.

The Summary Annual Report

Eugene H. Flegm

One of the most controversial subjects in the field of financial accounting in recent years has arisen from the correspondence exchanged between General Motors and the Securities and Exchange Commission (SEC) concerning the manner by which a Summary Annual Report (SAR) similar in the financial data area, at least, to the quarterly reports to stockholders could be distributed in place of the traditional annual report (hereinafter termed the "glossy" report). While the possibility of an SAR had been considered by many companies, notably those who were or are members of the Financial Executives Institute's Committee on Corporate Reporting, since the SEC issued its integrated disclosure requirements in September 1980 SEC Release No. 33-6235, it wasn't until the SEC/GM correspondence in 1986 that the way was cleared for the implementation of an SAR. Writing from the perspective of the person who initiated the concept discussed with the SEC, the following is the background, reasons and a prediction of the future of SARs. Volume 2, 1988, pgs.189-205.

Facilitation of Multinational Securities Offerings

Clarence Sampson

Accounting Principles are promulgated either by governmental bodies, by standard setting bodies established in the private sector, or some combination  thereof. A number of reasons for the different approaches to standard setting can be cited, including legal, cultural, economic, and political. However, one factor which seems to have played a more significant role than others is the diversity of ownership of interests. Where corporate ownership is concentrated in the hands of a few institutional holders, or where family held businesses predominate, there is often less impetus for the development of comprehensive, sophisticated financial reporting systems. Consequently, the accounting professions in those countries may be less advanced and have less influence in the standard setting processes. To the extent that there are generally accepted accounting principles and practices in those countries, they are promulgated largely by governmental agencies and embodied in various company laws, or other statutes which are often driven by the information needs of the public sector. On the other hand, where corporate ownership is more diverse, audited financial statements take on much greater significance, and this in turn increases the influence of private sector bodies. In the United Kingdom and Australia, for example, accounting principles are broadly stated in company law and amplified through standards established by the accounting profession, generally under the oversight and with the backing of governmental entities. And at the Federal level in Canada, relevant statutory provisions defer to the recommendation of the Canadian Institute of Chartered Accountants for authoritative accounting standards. Volume 2, 1988, pgs. 207-218.

Selected SEC Financial Statement Requirements Beyond GAAP


 The Securities and Exchange Commission (SEC) has exercised its powers to regulate the reporting of financial information on numerous occasions. While the Commission normally accepts pronouncements issued by such private sector groups as the Financial Accounting Standards Board (FASB), SEC requirements sometimes go beyond traditional GAAP disclosure rules (SEC rules are also considered to be a source of GAAP). While many of these "differential" or "compliance" disclosures were eliminated by the SEC's Integrated Disclosure Project in the early 1980s several such reporting requirements remain in effect.

The purpose of this article is to summarize the primary differences that currently exist, although the paper does not purport to present all such differences. The summary is presented in tabular format with key topics alphabetized. A brief summary of the incremental SEC disclosure requirement follows, along with the primary disclosure area affected, such as the pertinent financial statement or footnote. A reference column is provided for those wishing to pursue the subject in more detail. Hopefully, the information will prove handy for instructors who wish to go beyong disclosure requirements generated by the FASB.Volume 2, 1988, pgs. 219-233.