Abstract One of the most common decisions facing an internal auditor is choosing which line items to investigate. An extensive literature (Dworin and Grimlund 1984; Leslie et al. 1980; Menz& fricke 1984; Teitlebaum and Robinson 1975) deals with the statistical and decision-theoretic aspects of his choice. This paper expands on previous work by adding a strategic source of errors: dishonest employees. It addresses the question of how the presence of strategic errors affects the relationship between the auditor's testing strategy and item value. I show that incorporating strategic errors can lead to audit strategies similar to Physical Units and Dollar Units Sampling. I highlight the assumptions driving the results by contrasting a firm's (or internal auditor's) use of an optional test in four stylized models of accounts receivable. The first model examines the firm's behavior when faced with nonstrategic (statistical) billing errors. In this model the accounting system generates random errors that result in over- or underbilling customers. The firm can use a costly, imperfect test to remove errors before the bills are sent out. In this nonstrategic model the firm randomizes and tests an item if and only if the benefit is greater than the cost. Because the amount of billing error is unrelated to the item value, there is no clear link between the firm's testing decision and the value of the line item. The second billing model adds the possible existence of dishonest employees who can steal from line items. A dishonest employee makes two decisions. He decides whether to steal from the line item, and, if he steals, he chooses the amount of the theft. A dishonest employee would steal the entire item if he were certain that the firm would never test that item. The dishonest employee's behavior forces the firm to consider the value of the item in determining the region of untested items. Specifically, low value items are never tested. As in many strategic models, the interaction with dishonest employees may lead to randomization. In particular, the randomized testing strategy can look like Stratified Physical Units Attributes Sampling (Leslie et alt 1980). The firm sorts items into different groups and each item in a group has the same probability of being tested. The third model contains only the statistical errors of incorrectly adding or deleting a sales discount, a percentage of the item value. Since the testing gain is directly related to the value of the line item, the firm's strategy depends on an item's value. The firm always tests high value items, and never tests low value items. The fourth model adds potentially dishonest employees who can pros vide unearned sales discounts to their confederates. In this model the firm stratifies items into three groups. It never investigates small items, always investigates large items, and randomizes over intermediate value items with probabilities roughly proportionate to the value of the item. This procedure is similar to a common audit procedure, Dollar Unit Cell Width Sampling (Leslie et al. 1980).

[One of the most common decisions facing an internal auditor is choosing which line items to investigate. An extensive literature (Dworin and Grimlund 1984; Leslie et al. 1980; Menzefricke 1984; Teitlebaum and Robinson 1975) deals with the statistical and decision-theoretic aspects of his choice. This paper expands on previous work by adding a strategic source of errors: dishonest employees. It addresses the question of how the presence of strategic errors affects the relationship between the auditor's testing strategy and item value. I show that incorporating strategic errors can lead to audit strategies similar to Physical Units and Dollar Units Sampling. I highlight the assumptions driving the results by contrasting a firm's (or internal auditor's) use of an optional test in four stylized models of accounts receivable. The first model examines the firm's behavior when faced with non-strategic (statistical) billing errors. In this model the accounting system generates random errors that result in over- or underbilling customers. The firm can use a costly, imperfect test to remove errors before the bills are sent out. In this nonstrategic model the firm randomizes and tests an item if and only if the benefit is greater than the cost. Because the amount of billing error is unrelated to the item value, there is no clear link between the firm's testing decision and the value of the line item. The second billing model adds the possible existence of dishonest employees who can steal from line items. A dishonest employee makes two decisions. He decides whether to steal from the line item, and, if he steals, he chooses the amount of the theft. A dishonest employee would steal the entire item if he were certain that the firm would never test that item. The dishonest employee's behavior forces the firm to consider the value of the item in determining the region of untested items. Specifically, low value items are never tested. As in many strategic models, the interaction with dishonest employees may lead to randomization. In particular, the randomized testing strategy can look like Stratified Physical Units Attributes Sampling (Leslie et al. 1980). The firm sorts items into different groups and each item in a group has the same probability of being tested. The third model contains only the statistical errors of incorrectly adding or deleting a sales discount, a percentage of the item value. Since the testing gain is directly related to the value of the line item, the firm's strategy depends on an item's value. The firm always tests high value items, and never tests low value items. The fourth model adds potentially dishonest employees who can provide unearned sales discounts to their confederates. In this model the firm stratifies items into three groups. It never investigates small items, always investigates large items, and randomizes over intermediate value items with probabilities roughly proportionate to the value of the item. This procedure is similar to a common audit procedure, Dollar Unit Cell Width Sampling (Leslie et al. 1980).]

Abstract Integrated sampling procedures have been suggested in recent accounting literature. Yuji Ijiri and Robert Kaplan have proposed a nonlinear model which, when solved, yields a sampling procedure which satisfies several auditing goals. This paper presents a solution procedure for the proposed model. The solution procedure takes advantage of lagrange multipliers to create a problem which is linear in the constraints and convex in the objective function. A search technique then is used in conjunction with the convex simplex method to solve the problem. The procedure is used to test the model results in an actual auditing environment. The results of this study indicate the feasibility of using this approach for generating sampling designs.

Abstract Reviews the book "Expert Systems in Accounting," by Alex Edwards and N.A.D. Connell.

Abstract Reviews the book "Accounting Information Systems: A Book of Readings With Cases," edited by James A. Davis and Barry E. Cushing.

ABSTRACT: We examine the value relevance of a comprehensive set of summary performance measures including sales, earnings, comprehensive income, and operating cash flows. We find that, while value relevance peaks for measures “above the line,” no single measure dominates around the world. Instead, a measure is more relevant when it captures, directly and quickly, information about firms’ cash flows. Specifically, for each performance measure by country, we estimate eight attributes commonly used to assess earnings quality. We find these attributes highly correlated—most of their variance is explained by only two principal factors. A factor capturing articulation with cash flows is positively associated with a measure’s value relevance; a factor reflecting the measure’s persistence, predictability, smoothness, and conservatism is negatively associated. Our results suggest that, when it comes to equity valuation, accounting researchers and standard-setters should focus not on what performance measure is “best” at a given point in time, but on the underlying attributes that investors find most relevant.

ABSTRACT The Public Company Accounting Oversight Board recently proposed amendments to the standard audit report that would require the disclosure of critical audit matters (CAMs), and the Securities and Exchange Commission continues to evaluate the use of principles-based (imprecise) accounting standards within U.S. generally accepted accounting principles. We assert that jurors perceive precise accounting standards to constrain auditors' control over financial reporting outcomes, resulting in a lower propensity for negligence verdicts when the accounting treatment conforms to the precise standard. However, we hypothesize that the use of either imprecise standards or CAMs reduces the extent to which jurors perceive this constraint to exist, leading to increased auditor liability. We present experimental evidence supporting this argument. Our results highlight the similarities between the effects of imprecise accounting standards and CAMs on negligence assessments. These results provide insight for regulators and the auditing profession about the potential consequences of the proposed regulatory changes.

ABSTRACT Our study is motivated by the theory of credence goods in the auditing setting. We propose that audit committee accounting expertise should reduce information asymmetries between the auditor and the client, thereby limiting auditors' ability to over-audit and under-audit. Consistent with this notion, our results indicate that when audit committees have accounting expertise, clients (1) pay lower fees when changes in standards decrease required audit effort; (2) pay a smaller fee premium in the presence of remediated material weaknesses; and (3) have a reduced likelihood of restatement when audit market competition is high. Our findings in the under-auditing setting generally are strongest among non-Big 4 engagements, consistent with non-Big 4 auditors being less sensitive to market-wide disciplining mechanisms such as reputation, legal liability, and professional regulation. We also provide evidence that the nature of audit committee members' accounting expertise differentially impacts the committee's ability to curtail over- and under-auditing. JEL Classifications: M40; M41; M42.