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Volume 06

A Study of Public Comment Letters on the
Auditor's Consideration of the Going Concern Issue (SAS 59)

Steven Kaplan and Kurt Pany

Auditing standards setting in the United States is performed by the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants. The process generally followed is one in which the ASB develops a proposed statement on auditing standards (SAS), or "exposure draft" with suggested modification to the professional standards and circulates it publicly. Public comment is then considered prior to any standards change.

This paper selects a controversial recent change in audit requirements-that related to considering a client's ability to continue as a going concern-and analyzes in detail the source and content of letters written to the ASB and considers the extent to which suggestions made in these letters were reflected in the final standard, SAS 59. The paper aggregates respondents into four groups--Big 8 public accounting firms, other CPA firms, other accounting firms, companies, and other interested parties. Our results indicate that Big 8 letters of comment surpass those of other groups of respondents, and that Big 8 recommended revisions were in general included in the subsequent pronouncement. Few letters of comment were received from corporate entities, that might be expected to be affected by the changes. Volume 6, 1992, pgs. 3-23.

A Critical Assessment of FASB
Due Process and Agenda Setting

Timothy Fogarty, J. Edward Ketz,
and Mohamed Elmutassim Hussein

This paper asserts that the ability to appreciate the political nature of financial accounting standard-setting is systematically undercut by the belief in several other widely held notions about standard-setting, due process, and agenda decisions. This paper argues that politics is an inherent feature of standard-setting, not a perversion of the process. Furthermore, political aspects of due process and agenda setting are essential to the explanation of this regulatory process. Volume 6, 1992, pgs. 25-38.

Conformance to GAAS Reporting Standards in
Municipal Audits and the Economics of Auditing:
The Effects of Audit Firm Size, CPA Examination Performance, and Competition

Terrence B. O'Keefe and Peter J. Westort

There is evidence that many audits of government entities do not conform to generally accepted auditing standards [GAAS]. Two suggested causes of this low audit quality are (1) audit firms' lack of industry-specific knowledge and (2) either too much competition among audit firms [AICPA 1986; Treadway Commission, 1987] or too little competition [GAO, 1987].

The purpose of this paper is to examine, both theoretically and empirically, the assertions that knowledge and competition affect audit quality. We construct a model of the supply of audit quality that predicts that audit quality increases with the audit firm's level of general knowledge (knowledge not specific to a client) because high levels of knowledge make it more likely that material errors in the client's financial statements will be discovered.

The same model of the supply of audit quality predicts that competition among audit firms will increase audit quality because the lower fees resulting from competition increase demand for audit quality. However, Blair and Rubin [1980] provide a competing, but not mutually exclusive, theoretical model predicting that competition will lower audit quality. Thus, theory indicates that competition has offsetting effects on audit quality and that the net effect of competition is an empirical question.

We test the general knowledge and competition hypotheses using a sample of municipal audits. We use the conformance of the audit firm to GAAS reporting standards as a proxy for audit quality. We use the CPA examination performance of the partner responsible for the audit and the size of the audit firm as proxies for general knowledge. We find that both CPA examination performance and audit firm size are positively related to conformance to GAAS reporting standards. We proxy for competition with a concentration ratio, that is, the ratio of audit firms licensed to conduct municipal audits in the client's market area to the number of municipalities in the market area. We find that conformance to GAAS reporting standards increases with competition.

A by-product of this study is the knowledge model presented in this paper. It provides an alternative theory to those of DeAngelo [1981], Dopuch and Simunic [1982], and Simunic and Stein [1986], predicting a positive relationship between audit firm size and audit quality. Volume 6, 1992, pgs. 39-77.

Audit Demand Prior to Regulation:
The Profession's Role in the Development of the Insurance Concept

Richard A. Turpen

Contemporary theorists often cite the securities legislation of the 1930s as an important juncture in the history of the accountant's legal liability since these laws empowered the financial community with the ability to recover losses from the independent auditor. Although this feature of the securities acts alarmed many accountants, historical analysis reveals that practitioners had actually helped foster the capital market's demand for auditing's "insurance" aspects by promoting the audit as a means of insuring against loss, long before the concept's statutory recognition in 1933-1934. Ironically, the profession thereby created lasting expectations it has since found impossible to alter. This study explores the origins of the insurance dimension, the effects it continues to have on the profession's credibility, and the implications it holds for current audit policy research. Volume 6, 1992, pgs. 79-111.

An Evaluation of the SEC's Safe Harbor Rule
for Managers' Forecasts

William Ruland and Samuel Tung

This paper reports on the effects of the SEC's safe harbor rule managers' forecasts. This regulation protects managers from liability associated with forecasts disclosed in SEC filings and in annual reports to shareholders. The study of actual safe harbor forecasts shows that relatively small numbers of SEC reporting firms release forecasts that qualify for safe harbor protection and that only a few of these forecasts duplicate forecasts released to the press. The results also show that forecast deviation, forecast error, earnings variability, the magnitude of recent earnings changes, and forecast horizen are quite similar for safe harbor forecasts and forecasts that do not qualify for this protection. These results do not suggest that the safe harbor rule has been responsible for substantial numbers of managers' forecasts. Volume 6, 1992, pgs. 113-129.

Public Policy, Experience Requirements,
and Turnover in Public Accounting

Gary S. Robson, Russell M. Barefield,
and E. Daniel Smith

This study empirically links turnover patterns to the length and scope of the CPA licensing experience requirement. Comparisons are made between states requiring one versus two years of experience and between two-year experience requirement states that differ in their focus on public accounting experience. The timing of turnover in public accounting differs distinctly across these jurisdictions with the differences being those predicted by variations in the experience requirements. These results bear on the current 150-hour rule debate because AICPA policy links the education and experience requirements and because compromises in the legislative process are likely to sacrifice the experience requirement to achieve adoption of the education requirement. Volume 6, 1992, pgs. 131-148.

Availability and Cost of Audit Committee Members

Mohammad J. Abdolmohammadi and Elliott S. Levy

Both the American Institute of Certified Public Accountants (AICPA) and the Securities and Exchange Commission (SEC) strongly recommend but do not require formation of audit committees by publicly traded companies. The SEC has not mandated such a requirement because of a concern for the heavy burden (e. g., insufficient availability, heavy costs) that audit committees would place on small companies [Vise, 1988]. There is no evidence in the literature, however, on the extent of the burden that an audit committee would place on corporations. This study provides preliminary evidence on this issue.

Audit committee members of corporations whose stocks are traded on the New York Stock Exchange, the American Stock Exchange, and the Over-the-Counter National Market System were randomly selected and surveyed to investigate the issues of cost and willingness to serve on audit committees. The results indicate that there are many current audit committee members who are willing to serve on one or more audit committees of other corporations and they are willing to do so for a modest or no fee. Implications for research and regulation are discussed. Volume 6, 1992, pgs. 149-162.

Disciplinary Actions by the
AICPA Against Individual Members, 1980-1990

Donald E. Tidrick

Despite the apparent importance of ethics and ethics enforcement on the public standing of the accounting profession, empirical evidence regarding ethics enforcement is not widely available, particularly with respect to individual members of the American Institute of Certified Public Accountants. This study first examines the Bylaws of the AICPA to identify sanctions available to the Institute when individual members violate the ethics rules or Bylaws. The study then discusses the 327 disciplinary actions by the AICPA against individual members reported by the Institute in the CPA Letter for the 11-year period 1980-1990. These actions indicate the remedial nature of the sanctions imposed by the profession's national body over the recent past.

Nearly two-thirds of the cases (210) were handled under the Bylaws' "automatic" provisions. Of these, 147 cases resulted in expulsions and the remaining 63 cases resulted in suspensions. Expulsions from the Institute are required when, for example, the individuals' certificates are revoked by their state boards of accountancy or when they are convicted of such misdeeds as felonies. Suspensions are required when, for example, the members' certificates are suspended by their state boards of accountancy or when felony convictions are under appeal.

The remaining 117 cases were handled by formal hearings under authority of the Institute's Joint Trial Board. The judgments of the Joint Trial Board were fairly evenly distributed among expulsions (41), suspensions (27), and admonishments or censures (42). Seven additional cases resulted in "other' sanctions, including requirements for additional CPE and quality reviews. The technical standards (Rules 202-204) were most frequently involved with 41 violations; 37 violations of the Bylaws related to failure to cooperate with the Institute's investigation or comply with their requirements; 28 acts discreditable (Rule 501) were reported; 21 violations of the general standards (Rule 201) were identified; and seven independence violations (Rule 101) were found. Suspensions by the trial board ranged from two months to two years, the maximum allowed per the Bylaws, and averaged about 15 months. Volume 6, 1992, pgs. 163-177.

Peer Review as a Market Signal:
Effective Self-Regulation?

Richard G. File, Bart H. Ward,
and Charles A. Gray

In response to criticism from congressional, regulatory, and other sources, the AICPA has instituted a mandatory peer review program. This is one of the actions taken to address the expectation gap. Some, including the PCPS, have used this development in a positive way to attempt to reduce the perceived importance of an audit firm's size as an indicator of quality. This paper reports on a comparison of bankers' and auditors' perceptions of the impact of peer review, firm size, and industry expertise on judgments of auditor credibility.

Results are based upon questionnaire responses obtained from bankers and auditors. Responses from these two groups form the basis for discriminate models of the relationship among these three factors as they influence perceptions of auditor credibility. We conclude that mandatory peer review participation may indeed be useful in closing the "expectation gap." Successful peer review participation also may reduce reliance on size as a surrogate for auditor credibility. Volume 6, 1992, pgs. 179-193.


Primacy: Assets or Income?

Oscar Gellein

Editor’s note: Oscar Gellein is a former member of the FASB and a retired senior partner of the firm that is now Deloitte & Touche. The following paper is an excerpt from a letter by Oscar Gellein to Eugene Flegm, assistant controller of General Motors Corporation. The letter presents Mr. Gellein’s personal views of Mr. Flegm’s paper, “Reflections on the FASB Conceptual Framework” (Research in Accounting Regulation, volume 4, 1990, pp. 153-168). In that paper, Mr. Flegm refers to a July 26, 1978, meeting of the FASB with several prominent invited participants. Mr. Gellein was a member of the FASB at that time, and Mr. Flegm was an invited participant.

…I contend further that by giving primacy to the meaning of assets, historical cost can be improved. My article in the June 1987 issue of Accounting Horizons addressed that issue. I believe that since income cannot be made to have conceptual primacy, there is nothing inherent in matching that enables one to distinguish between appropriate accounting and inappropriate accounting. There is no built-in test identifying the bounds of matching, except the notion of the primacy of assets… Volume 6, 1992, pgs. 197-199.

Financial Reporting in an Investor Fund Economy:
Regulation and Reports to Portfolio Investors

Gary John Previts

Since the stock market plunge in October 1987, academics in accountancy have been seeking to improve their understanding of the implications of this event as to the financial reporting process. As a result of research undertakings in capital markets history and in the public policy affecting accountancy, and by considering writings of business historians, a general description of the evolution of U. S. investment markets emerges. A principal finding is the change in focus from the individual acting as the primary investor to the professional investor fund manager becoming the primary investor. The limitations of current accounting practice, education and reporting in this changed order of capital markets sourcing are then considered. Volume 6, 1992, pgs. 201-210.

In Memory of Oracle E. Johnson

July 30, 1925 - November 1, 1991

Joni J. Young

When asked to write this memorial, I was unsure of an appropriate emphasis for the piece, I considered only reviewing the research of Orace Johnson and assessing its significance. However, as a graduate student, I worked closely with Orace and I believe that an emphasis upon his published work fails to capture his full contribution to accounting research. After all, the legacy of Orace Johnson lies not only in his published work but also in his contributions to the development of future accounting scholars. With this assessment firmly in mind, I provide a brief biography and a discussion of Orace’s work and a more lengthy discussion of his cultivation of the intellectual development of accounting scholars. Volume 6, 1992, pgs. 211-218.