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Paper Summary Advanced Auditing 2023/2024

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Summary of everything that’s discussed during the lectures about the papers (both in live lectures and video lectures), and where necessary supplemented with information from the online papers. Important figures and tables are copied from the papers instead of slides to make them better readable....

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  • December 14, 2023
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  • 2023/2024
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Papers Advanced Auditing 2023/2024

[1] Jamal, K. and Sunder, S., 2011. Is mandated independence necessary for audit quality?
Accounting, Organizations and Society, 36(4-5), pp.284-292.

Independence in ISAs
● Independence of mind
○ Not affected by influences
○ Allowing to act with integrity
○ Exercise objectivity and Professional Skepticism
● Independence of appearance
○ Avoidance of facts and circumstances
○ Reasonable third party
○ Concludes integrity, objectivity, or Professional Skepticism is compromised

Baseball card certification
● Similarities with Audit
○ Willing to pay for expertise
○ Standards serve as a certification reference
○ Reputation of certifier matters
● Differences with Audit
○ No post-audit negotiations and adjustments
○ No negotiation in market for certifying baseball cards
○ Certifiers are either pure auditors or cross-sellers

Conclusion
● Grade (information), grader-identity (reputation) associated with return
● Market dominated by PSA and BECKETT that cross-sell
● Independent graders do not have a larger market share, and this is not valued

[2] Watts, R.L. and Zimmerman, J.L., 1983. Agency problems, auditing, and the theory of the firm:
Some evidence. The Journal of Law and Economics, 26(3), pp.613-633.

Theory of the firm
● Firm is nexus of contracts (Coase)
● Different contractual arrangements provide different incentives for opportunistic behavior.
● Enforcement of contracts
○ Bonding
○ Monitoring (Audit)

Agency cost (JM1976)

, ● Endogenous: Independent audit reduces incentive problems of the manager and should
exist in earliest firms [JM1976]
● Exogenous: Audit textbooks: recent product of government intervention (e.g., created by
securities acts)


Merchant Guilds (1200s) Regulated companies (1500s) Joint stock companies (1600s)

Bonding: Alderman oath of all Bonding: Treasurer statement of Bonding: sureties and guarantees by
profits receipts officers
Monitoring: audit of expenses Monitoring: audit Monitoring: audit
Auditors: committee of members Auditors: committee of members Auditors: committee of shareholders
Independence: fine and reputation Independence: fine and reputation and directors
Independence: fine and reputation


Conclusion
● Audit existed early in the development of corporations (endogenous)
● Evolved to mandatory audit by first English Companies Act (exogenous)
● Monitoring crucial to formation of firms
● Long survival of audit: efficient tool for organizing a firm

[3] Houston, R.W., Peters, M.F. and Pratt, J.H., 1999. The audit risk model, business risk and
audit-planning decisions. The Accounting Review, 74(3), pp.281-298.

Research question
● Identify conditions under which the audit risk model does (not) describe audit planning and
pricing
● Audit Risk = RMM
● Audit Business Risk = risk of loss to an auditor’s practice due to client relationships (a.k.a.
engagement risk)

Engagement risk
● Litigation risk → (the more users you have the more people might sue you). Private
enforcement
● Regulatory penalties → public enforcement
● Reputation Loss
● Lack of profitability → (auditors don’t get paid if company goes bankrupt)

Audit planning and fees




Hypotheses
● H1: Incremental effect of engagement risk (over audit risk) on planned investment is greater
when risk of irregularities is high than when risk of errors is high.
● H2: Incremental effect of engagement risk (over audit investment) on fees is greater when
the risk of irregularities is high than when the risk of errors is high

Conclusion
● Likelihood of error high:
○ Audit risk model dominates business risk

, ○ No risk premium
● Likelihood of irregularity high:
○ Business risk model dominates audit risk model
○ Risk premium
● Irregularity standard (ISA 240) is incomplete

[4] Low, K.Y., 2004. The effects of industry specialization on audit risk assessments and
audit-planning decisions. The accounting review, 79(1), pp.201-219.

Research Question
● Question: Effect of industry specialization on audit risk assessment and audit planning
● More knowledge: Industry specific experience
● Experiment manipulate level of audit risk (high versus low)

Hypotheses
Industry-matched auditors …
● H1: better discern audit risks (confirmed)
● H2: make more procedure changes (confirmed)
● H3: procedure changes are more sensitive to risk assessment (confirmed)
● H4: procedure changes have higher perceived quality (confirmed)

Conclusion
Industry experience ….
● Affects modification of audit procedures
● Modifications have higher quality

[5] Free, C., & Murphy, P. R. (2015). The ties that bind: The decision to co‐offend in fraud.
Contemporary Accounting Research, 32(1), 18-54.

Fraud categories

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