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Volume 09

Auditor Reporting for Bankrupt Companies:
Evidence on the Impact of SAS No. 59

Van E. Johnson and Inder K. Khurana

Connor (1986) suggests that one of the primary sources of the public's dissatisfaction with the audit profession is the (public's) expectation that the auditor will warn them about impending business failure. Prior research has documented that less than one-half of the companies filing for bankruptcy received a going concern audit report in the year prior to bankruptcy. Carmichael and Pany (1993) suggest that these results may not bode well for the profession in today's litigious environment and question whether auditor performance on this dimension has improved subsequent to the passage of SAS 59, bankrupt companies were more likely to receive modified audit reports prior to the bankruptcy. Results of this study indicate that a larger proportion of bankrupt companies received modified audit reports after SAS 59 became effective. Limitations and implications of the research findings are also discussed. Volume 9, 1995, pgs. 3-22.


The European Union:
Regulation Moves Financial Reporting Toward Comparability

Kathleen R. Bindon and Helen Gernon

The main objective of the European Union (EU) is the creation and development of a Common Market through the free flow of goods, persons, and capital. Within this context, one of the goals was to harmonize financial reporting practices across the 12 member states in order to make these practices more comparable. This move toward harmonization was accomplished through the issuance of Directives that were legally binding. Thus, the EU was in the unique position of being able to use a legal framework to harmonize the financial reporting practices of a particular region of the world. However, the designers of the Directors took a mutual recognition approach to developing their content. This approach allows for more diversity and results in less comparability. Ultimately, mutual recognition of cultural differences, accounting values, and regulatory environments across the 12 EU countries was necessary to achieve adoption of the Directives by the member countries. This paper addresses the question of why the EU took a mutual recognition approach given that it was in the unique position of having the opportunity to use a legal framework to enhance the comparability of financial reporting practices. The paper explores and explains why achieving comparability of financial reporting practices could not be expected to result from the Directives. The paper helps the reader understand that comparability could not be achieved at this time due to the persistent underlying differences in cultural attitudes, accounting values and individual regulatory environments across the 12 member states. The harmonization argument is developed by applying, extending, and integrating prior classification models to explain the persistent diversity in accounting measurement, valuation, and disclosure practices that exist across the EU countries. Patterns in measurement, valuation, and disclosure have been studied by many researchers in a variety of ways. Other researchers have used more of a Farmer-Richman (1966) approach where environmental analysis is used to explain and understand differences in accounting principles and modes of regulation. This paper integrates selected pieces from the pattern research literature with selected pieces from the environmental analysis research literature to offer an innovative interpretation as to why financial reporting diversity continues to exist in the European Union. Volume 9, 1995, pgs. 23-48.


Security Price Response Associated with the Accounting
Regulation of Purchase Combinations Increasing Goodwill

Kathleen Blackburn Heathcox

This study examines whether the popular belief that the large decrease in reported earnings from the required amortization of purchased goodwill is supported empirically. Specifically, is the purchase transaction that increases goodwill associated with a decrease in the security prices of acquiring companies? Additionally, this study investigates whether the magnitude of the goodwill change is negatively related to the magnitude of the stock price reaction. Employing a sample of 88 firms reporting increases in goodwill from 1988 to 1989 and using CRSP and Compustat data, the cumulative abnormal returns (CARs) of the firms over a 24-month test period were analyzed. The results indicate a significant decrease in stock prices associated with mergers that were accounted for by the purchase method and had goodwill increases. Further, the greater the increase in goodwill, the greater the stock price decline. Volume 9, 1995, pgs. 49-62.


The Effect of Peer Review on Audit Economies

Gary Giroux, Donald Deis, and Barry Bryan

This paper is an extension of the audit economics literature in the public sector, with primary focus on fees and costs of the audits, as well as audit quality. A gap in this literature is the relative lack of information on the effects of peer reviews, which is of major concern in this project. Texas school district information provided by the Texas Education Agency represents a rich database for extensive analysis. Univariate and multivariate analysis of audit fees indicate significance with peer review, suggesting a price premium. However, the lack of significance with fees per hour suggests a more thorough audit and no price premium. Audit quality is strongly associated with peer review and several other factors. Overall, results indicate that peer reviewed audit firms provide higher quality audits with fee premia related to more extensive audit procedures. Volume 9, 1995, pgs. 63-82.


Reducing the Incidence of Fraudulent Financial Reporting:
Evaluating the Treadway Commission Recommendations and Potential Legislation

Jerry R. Strawser, John O' Shaughnessy,
and Philip H. Siegel

The Treadway Commission provided recommendations to public companies, independent public accountants, and oversight bodies to enhance reliability of the financial reporting process. The ultimate goal of the Treadway Commission's report (National Commission on Fraudulent Financial Reporting, 1987) is to reduce the incidence of fraudulent financial reporting in the United States. This paper presents the results of a survey of internal audit managers regarding the implementation of measures to reduce the incidence of fraudulent financial reporting and their perceptions of the effectiveness of potential legislation in reducing the incidence of fraudulent financial reporting. The measures and legislation examined herein include recommendations of the Treadway Commission as well as other items determined through a pretest. Details of this test are provided in the text. The results of this survey indicate that, in general, public companies are in compliance with the recommendations of the Treadway Commission; however, some exceptions (particularly the existence of a quality assurance program and the use of the IIA's Professional Standard [IIA, 1978] as evaluation criteria0 do continue to exist. Also, several proposed forms of legislation appear to be perceived by internal audit managers as being effective in preventing and detecting fraudulent financial reporting. The findings this survey have implications for public companies, their internal audit functions, and oversight bodies (such as the Securities and Exchange Commission). Volume 9, 1995, pgs. 83-104.


An Empirical Analysis of the Comparability of Disclosure
Tendencies Within and Across Industries:
The Case of Hazardous Waste Lawsuits

Philip Little, Michael Muoghalu,
and David Robison

This paper extends the work of Thompson, Smith, and Williams (1990) on the adequacy of loss contingency disclosures by examining the financial statement treatment of hazerdous waste lawsuits. The extension is in three directions. First, we control for the relative importance of suits using an event-study method to estimate the impact of the announcement of the suit on stock prices. We assume large negative abnormal returns signal suits important to investors. Second, we separate firms in the sample into subgroups based on industry. Third, we examine a single type of suit--hazardous waste lawsuits--rather than suits in general. Our findings reveal substantial variation in the financial statement disclosures of hazardous waste lawsuits across industries even when controlling for the expected magnitude of the loss. Thus, like Thompson, Smith, and Williams, we find that financial statement users may have difficulty making comparisons across firms with outstanding loss contingencies. Further, because we focused on a single type of lawsuit and controlled for the importance of the suits, our results suggest more strongly that there is a lack of comparability in lawsuit disclosures especially across different industries. Volume 9, 1995, pgs. 105-117.


Public Accounting in an Older Society:
Some Key Personnel Issues

Stephen E. Loeb

This paper further develops existing literature relating the prospect of an older population in America to personnel issues in public accounting. Relevant legal considerations and ethical standards are discussed. Policies relating to mandatory retirement of partners or their equivalent in certain public accounting firms are considered. An in-depth discussion of certain issues relating to the provision of opportunities for older individuals is presented. The issue of "equity" (Moody, 1992, 208) between generations of individuals who work in public accounting is considered. Volume 9, 1995, pgs. 121-150.


Aiding and Abetting After the Central Bank of Denver

Mark A. Segal

Considerable litigation has been brought against accountants for allegedly aiding and abetting Section 10 (b)(5) violations. Recently the Supreme Court ruled in the case of Central Bank that no implied private cause of action exists for aiding and abetting Section 10 (b) violations. The ruling and its rationale appear to signify a turning point in the development of accountant liability. In this paper, this important case and its implications are examined. Understanding Central Bank and its ramifications is important to determining the standards of conduct to which accountants will be subject, and to enacting legislation which will meet the interests of both the accounting profession and the investing public. Volume 9, 1995, pgs. 153-162.


Reforming Accountants' Liability
to Third Parties and the Public Interest

Zhemin Wang

Accountants' liability to third parties for ordinary negligence has expanded dramatically in the last two decades. While accountants argue that the legal system has excessively burdened the accounting profession, proponents of the current liability system insist that such massive liability is necessary to protect the public interest through increased vigilance, and that any legal reform would only serve the self-interest of accountants and will leave the public with little protection. The analysis of this study indicates that the current liability system regarding accountants' liability to third parties for ordinary negligence unfairly overpenalizes accountants and is economically inefficient. Furthermore, contrary to the claim that it protects the public interest, the analysis suggests that third-party users and the general public whom the system is supposed to protect is consequential victims of the unfair legal attack on accountants. It is concluded that reforming the liability system to allow a more equitable risk sharing would not only make the liability system fairer and more economically efficient, but also serve the best interest of third-party users and the general public. Volume 9, 1995, pgs. 163-179.


The Changing Profile of the AICPA:
Demographics of a Maturing Profession

Stephen J. Young

In this paper I explore trends in the membership of the American Institute of Certified Public Accountants (AICPA) from 1887-1994. The paper has two primary goals, to provide a single source of information on past membership data, and on a preliminary basis, to explore trends on the membership. This exploration identifies three major trends in AICPA membership. First, after many decades of rapid increase, membership growth is slowing. This slowdown appears both in absolute growth rates and rates relative to key economic indicators. The second major trend is that members in corporate practice are now as large a membership category as those in public practice. The third major shift in the membership is gender based. In the youngest age category, women outnumber men on the membership rolls. This ratio of women to men slowly declines as the age category increases, suggesting that women will play a much larger role in the future leadership of the profession. Volume 9, 1995, pgs. 181-198.


Audit Conflict and Cost Standards in the Defense Industry

Norma C. Holter

A firm accepts accounting regulation as a part of the cost of doing busines with the government. The government assures compliance with these regulations through a framework of audit and oversight. Conflicts arise during an audit, over cost determinations, and defense contractors perceive a power imbalance in favor of auditors from the Defense Contract Audit Agency (DCAA). This perception of auditor power is investigated. Volume 9, 1995, pgs. 199-209.


Assessing the Utility of Continuing Professional Education
for Certified Public Accountants

Paul J. Streer, Ronald L. Clark,
and Margaret E. Holt

Over the past decade there has been significant growth in continuing education for CPAs. There is however, little research that measures the effectiveness of the profession's CPE efforts. Reports by the Sanford and Netterville committees on the AICPA's role in the CPE suggest the need for additional research. We conducted a survey of accountants to determine the impact of CPE courses on their practice. Adult and continuing professional education literature suggests that "transfer of learning" is an important element of CPE effectiveness. Some indicators of learning transfer are use of materials, follow up on points raised during the course, and discussion of course content with colleagues back in the workplace. Our findings have several implications for regulators and providers of CPE programs. Volume 9, 1995, pgs. 211-222.

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