Auditing, Stratified Sampling, Substantive test, Stochastic modeling

Capital structure, Tax incentives, Dividends, Dividend reinvestment plan

In 1976, the U. S. Senate Subcommittee on Reports, Accounting, and Management (Metcalf Committee) provided data indicating that the eight largest auditing firms in the country (the Eight) are overwhelmingly the major suppliers of audit services to the largest corporations in the United States. The Subcommittee concluded from these data that monopolistic practices by the Big Eight have led to a two-tier structure in the audit industry-one tier consisting of the eight largest auditors and the second tier consisting of all other auditors, with the Big Eight dominating the industry. In the light of these findings, the committee suggested that more activist regulation of the audit industry was needed by the Securities and Exchange Commission. Dopuch and Simunic [1980] examined a wide variety of evidence that might tend to support or refute allegations of a lack of competition in the auditing profession. They (D-S) concluded that the industry was competitive, and in a subsequent paper [1982] they argued that many of the apparent monopolistic characteristics of the industry could be explained by a product-differentiation hypothesis. More specifically, they hypothesized that different auditing firms provide auditing services which are perceived by investors to be different in quality, and in particular, that the Big Eight auditors are perceived as being more credible than non-Big Eight auditors. If this is the case, the Big Eight firms would be

In addition to the recent interest of the Securities and Exchange Commission, executive forecasts of earnings have received a considerable amount of attention in the academic literature (Basi, Carey, and Twark [1976], Lorek, McDonald, and Patz [1976], McDonald [1973], Copeland and Marioni [1972], Kapnick [1972], Daily [1971]). Much of this attention has focused either on the absolute or relative accuracy of such forecasts or on the ethical, legal, and practical problems of publishing and reviewing executive forecasts of earnings in external accounting reports. One aspect that has not been adequately considered is investor reaction to executive long-range forecasts of earnings. The purpose of this study is to investigate the information content of voluntarily disclosed long-range earnings forecasts by executives by determining security return reactions to a sample of such forecasts that were reported in the Wall Street Journal. The inclusion of management estimates of future earnings in annual reports is advocated on the assumption that such forecasts contain information, of interest to investors or other persons outside the firm, not otherwise publicly available. Not only do executives have information about internal and external factors expected to affect future operations and earnings, but they also exert considerable effort evaluating these factors and their impact on prospective operations in the normal planning function. Consequently, executive forecasts of earnings might be of inter-

Replacement cost, Rule 3-17, Inventories, Estimators of replacement costs

R&D, Materiality, Capitalization, Resource allocation decision

Disclosures, Earnings announcements, Trading periods, Nontrading periods

ABSTRACT Auditors experience significant problems auditing complex accounting estimates, and this increasingly puts financial reporting quality at risk. Based on analyses of the specific errors that auditors commit, we propose that auditors need to be able to think more broadly and incorporate information from a variety of sources in order to improve audit quality for these important accounts. We experimentally demonstrate that a deliberative mindset intervention improves auditors’ ability to identify unreasonable estimates by improving their ability to identify and incorporate into their analyses contradictory information from diverse parts of the audit and improving their ability to think critically about the evidence. We perform additional analyses to demonstrate that our intervention improves auditor performance by causing them to think differently rather than simply to work harder. We demonstrate that critical thinking can improve the identification of unreasonable estimates and, in doing so, we provide new directions for addressing audit quality issues.