Enforcement Release Evidence on the Audit Confirmation Process: Implications for Standard Setters
Diane Janvrin, Iowa State University, Paul Caster, Fairfield University, Randy Elder, Syracuse University
The audit confirmation process involves obtaining evidence from third parties about information affecting financial statement assertions. Recently, the confirmation process has drawn the attention of both regulators and practitioners (American Institute of Certified Public Accountants (AICPA), 2007a, [International Federation of Accountants, 2006], [International Federation of Accountants, 2008] and Public Company Accounting Oversight Board (PCAOB), 2004) due to questions regarding whether this widely used audit procedure provides persuasive audit evidence. This paper examines confirmation-related evidence from relevant Security and Exchange Commission (SEC) Accounting and Auditing Enforcement Releases (AAERs).
Our findings integrate the confirmation process and enforcement release outcomes to provide guidance to regulators and researchers. Specifically, we found situations where fraud may have been detected if auditors had confirmed additional items such as material cash balances, marketable securities, and terms of significant transactions. We also noted (1) situations where management requested that auditors not confirm specific accounts, (2) several examples of collusion between the auditee and either vendors or customers, as well as related parties, and (3) cases involving failure to authenticate responses. Our detailed examination of enforcement release evidence provides implications for standard setters and areas for future research.
The Unintended Effects of the Sarbanes–Oxley Act of 2002
Nicholas V. Vakkur, RAND Corporation, R. Preston McAfee, VP and Research Fellow, Yahoo! Inc., Fred Kipperman, RAND Corporation
The auditing profession came under intense scrutiny following the collapse of Enron and several other leading firms. Legislators responded swiftly with the Sarbanes–Oxley Act of 2002, a stringent rules-based system widely considered the most comprehensive economic regulation since the New Deal. Researchers such as (DeFond and Francis, 2005), (Baker, 2008a) and (Baker, 2008b) suggest the law may produce serious unintended harmful consequences, resulting in a call for further research to evaluate its impact upon firms. This paper contributes to this literature in several ways. First, it conducts a review and analysis of multiple literatures to formulate several exploratory hypotheses. Second, the strength of the conceptual model is evaluated using a random sample survey of Fortune 500 CEOs (n = 206). This represents the first scholarly attempt to evaluate managerial perception of this important law, which Buckley and Chapman (1997) suggest may be more relevant that its actual costs. Third, drawing from Carmona and Trombetta (2008), we suggest the law’s overarching reliance upon strict, inflexible rules may have influenced CEO perception of Sarbanes–Oxley. Since this is not a cost/benefit analysis, neither the potential benefits of the law nor its net effects were evaluated.
Independence, Impartiality, and Advocacy in Client Conflicts
Michael L. Roberts, University of Colorado Denver
Prior research indicates auditors’ financial reporting judgments are conservative when client preference is unknown, but auditors are less conservative (though not client-supportive) when clients’ preferred accounting methods for favorable financial reporting are explicitly communicated. This paper reports, for the first time, a situation in which experienced auditors exhibit client-supportive behavior. Professional judgments in an audit setting in which there is an explicit client preference for a material, income-increasing reporting classification and the relevant GAAP standard is principle-based are compared to a similar judgment in a tax setting. This research design contrasts the auditor’s ethical duty to exercise “judicial impartiality” toward the client with Certified Public Accountants’ ethical duty to be a client advocate in tax contexts. The results suggest experienced CPAs’ are as client-supportive in audit settings as they are in tax settings when exercising their professional judgment, and ethical standards mandating impartiality in auditing are not uniformly being followed.
Internal Control Deficiencies and the Issuance of Going Concern Opinions
Wei Jiang, California State University, Kathleen Hertz Rupley, Portland State University, Jia Wu, University of Massachusetts Dartmouth
This study examines whether internal control quality is associated with auditors’ going concern assessments following the implementation of the Sarbanes–Oxley Act of 2002 (SOX). Based on a sample of financially distressed firms that issued internal control reports under SOX Section 404 in 2004 and 2005, we find that firms with material internal control weaknesses are more likely to receive going concern audit opinions. Further analysis indicates that the positive association between disclosures of material weaknesses and auditors’ propensity to issue a going concern opinions is largely driven by a subset of firms that disclose company-level material weaknesses, suggesting that only the more severe type of internal control material weakness influences the going concern assessment. These findings add to our understanding of the audit opinion formation process and the potentially important impact of internal control quality on that process.
The Effects of A Cooling-Off Period on Perceived Independence of External Auditors: A Study in the Nonpublic Regulatory Environment
Carl N. Wright, Virginia State University
Audit firms’ professionals often resign their positions to accept employment with their firms’ audit clients. To preserve the audit firms’ independence, under the Sarbanes–Oxley Act a period of dissociation is required before accepting employment with an audit client. This period of dissociation is referred to as a cooling-off period. We examine whether a cooling-off period affects state boards of accountancy members’ perceptions of audit firms’ independence in the nonpublic-company regulatory environment. Findings indicate that perceptions of audit firms’ independence increase significantly with a one-year cooling-off period. However, increasing the length of the cooling-off period from one year to two years fails to significantly increase perceptions of audit firms’ independence.
Stock Market Reactions to Regulatory Investigations: Evidence from Options Backdating
Sakshi Jain, The University of Memphis, Pankaj Jain, The University of Memphis, Zabihollah Rezaee, The University of Memphis,
Option backdating practices have resulted in broad regulatory scrutiny, formal inquiries by federal authorities, and internal investigations by companies. In this paper, we investigate stock market reactions to option backdating probe announcements. For the 245 implicated companies, we detect negative abnormal stock returns, which are modest for internal investigation, larger for SEC probes, and the most severe for Department of Justice investigations. We also find that the market reaction is more negative for companies with higher stock price volatility, less effective corporate governance, and lower quality of financial statements. Results suggest that option backdating practices demonstrate weak corporate governance and financial reporting, and regulatory investigations of such practices are value-relevant as reflected in stock prices.