[Analytical review, the diagnostic process of identifying and determining the cause of unexpected fluctuations in account balances and financial ratios, has become an increasingly important part of auditing. Recent research suggests that analytical review is beneficial for detecting such unexpected fluctuations (Kreutzfeldt and Wallace 1986; Wright and Ashton 1989). It is, however, difficult for an auditor utilizing analytical review to know when the "correct" cause for an observed fluctuation has been determined, especially since no official guidance exists to assist the auditor. Thus, accepting a plausible but incorrect cause is a dangerous and largely unresearched possibility (Kinney 1987). This article describes two experiments that investigate conditions under which auditors may be prone to accepting a plausible, but potentially incorrect, cause when performing attention-directing analytical review. Identifying such conditions is important because either audit effectiveness or efficiency would be compromised with such incorrect acceptance. Although there are no normatively correct causes for the analytical review problem situations employed in this study, relative evidence on such compromises will be obtained by investigating conditions that lead auditors to make different judgments about the cause of an unexpected fluctuation. Differences in auditors' judgments are important since they can lead to differences in decisions as to the cause of an unexpected fluctuation and subsequent auditor actions (cf. Asare 1991). Dichotomizing causes into error and non-error classes reveals several ways in which an auditor performing analytical review may accept a plausible but incorrect cause. One that has particularly significant implications for the effectiveness of the audit would be concluding that a non-error cause adequately accounts for an unexpected fluctuation when the "correct" cause involves a financial-statement error. Since it is unlikely that the auditor would increase planned tests of details if indications of a material error were not present (and it is possible that the auditor may decrease such testing), the likelihood of subsequent detection of the error would be reduced in this situation. Conditions that may lead to this type of decision error will be investigated in this study. The effects of explanation, counterexplanation (i.e., consideration of why an hypothesized cause may not be correct), and their order of performance were studied to determine how such factors affect the propensity for acceptance of a plausible but incorrect non-error cause. Investigating explanation is important since auditors typically document explanations for analytical review findings. Even though current auditing standards do not require auditors to counterexplain, investigating how counterexplanation and the order of counterexplanation and explanation affect auditors' judgments is nevertheless important since it enhances our understanding of the potential for acceptance of an incorrect cause. Auditors from five public accounting firms participated in two experiments conducted to determine the effects of the aforementioned factors on auditors' judgments. Consistent with expectations, auditors revised their beliefs about an hypothesized non-error cause of an unexpected fluctuation in the auditee's gross margin in an upward (downward) fashion when asked to document an explanation (counterexplanation) for that cause. Inconsistent with expectations, however, auditors who were asked to document an explanation initially and then a counterexplanation judged the non-error cause to be less likely to have occurred than did auditors asked to document a counterexplanation initially and then an explanation. Overall, these results identify conditions in which auditors may be prone to compromising audit effectiveness by accepting a potentially incorrect non-error cause.]

Investigates the conditions under which auditors may be prone to accepting a plausible but potentially incorrect, cause when performing attention-directing analytical review. Role of analytical review in auditing; Effects of explanation, counterexplanation and their order of performance; Implications for how audit firms structure analytical review.

ABSTRACT Archival research shows that the market reacts to earnings trend as well as to earnings performance relative to analysts' forecasts (i.e., benchmark performance). We conduct four experiments to investigate how and why investors react to these two measures when both are available over multiple time periods. Our results show that investors rely on an earnings measure only when it is consistent over time. When both measures are consistent over time, investors use them in an additive fashion, suggesting that they view them as providing different information about the firm. Further tests show that investors believe that earnings trend and benchmark performance both provide information about a firm's future prospects and management's credibility. Although judged future prospects fully explain the effect of earnings trend on investor judgments, neither judged future prospects nor management credibility completely explains the effect of benchmark performance. Our study has implications for firm managers and researchers.

Although prior research reports that firms that consistently beat their earnings expectations are rewarded with a market‐valuation premium, most firms are inconsistent in the sign of their benchmark performance, sometimes missing and sometimes beating. In this paper, we report the results of multiple experiments to test the idea that potential investors, evaluating firms that have inconsistent benchmark performance, use a counting heuristic to discriminate among them. Our results provide strong support for the hypothesis that these investors distinguish among firms by counting the number of beats and misses they experience over an observed time interval. The judgmental effect of this beat‐frequency is incremental to the effect of the magnitude of the beats and misses of the benchmark. Our study has implications for firm managers who have inconsistent benchmark performance, suggesting that market participants do make systematic discriminations among such inconsistent firms. It also has implications for researchers by introducing a new theoretical construct to the literature—namely, the counting heuristic.

Auditing, Audit review process, Audit-planning decisions, Audit quality

Considerable debate exists about what analyst experience measures and whether analysts learn from their experiences. Extant research has argued that once innate ability is considered, analysts’ general and firm-specific experiences are not relevant to understanding their forecasting performance. We argue that measures of experience need to be expanded to also include task-specific experience. Our results reveal that analysts’ forecast accuracy is associated with both their innate ability and task-specific experience. In addition, we find that forecast accuracy and task-specific experience are most highly correlated for those analysts who survive the longest and, thus, presumably have the greatest innate abilities.

Analytical procedures have become an increasingly important part of financial statement auditing over the last 10 years. First recommended for audits by the Auditing Standards Board in 1978, analytical procedures are mandated for planning and overall review purposes by Statement on Auditing Standards (SAS) No. 56. In response to increased concerns about audit efficiency and effectiveness, analytical procedures are increasingly being used in place of and as a supplement to substantive tests of details. Despite their increased use, little is known about how analytical procedures are performed in practice. The purpose of this study is to describe how auditors perform analytical procedures at the planning, substantive testing, and overall review stages of the audit. To accomplish this, we conducted a series of interviews with 36 audit professionals at various levels of experience and responsibility (i.e., seniors, managers, and partners) representing all the U.S. Big Six accounting firms. The contributions of our study are threefold. First, by contributing to a more complete understanding of how analytical procedures are performed, we provide the basis for accounting researchers to identify current analytical procedure problems/issues and, thus, perform more relevant research. Second, we provide the Auditing Standards Board members with relevant information about current practice for their deliberations on revised guidance for analytical procedures. Third, we provide educators with a characterization of analytical procedures as performed in practice, thereby facilitating their classroom coverage of this important topic. Résumé. Depuis une dizaine d'années, les procédés analytiques jouent un rôle de plus en plus important dans la vérification des états financiers. D'abord recommandés en 1978 par l'Auditing Standards Board pour les vérifications, les procédés analytiques sont exigés par le Statement on Auditing Standards (SAS) n° 56 pour la planification et l'examen global. Compte tenu des préoccupations accrues que soulèvent l'efficience et l'efficacité de la vérification, l'on fait de plus en plus appel aux procédés analytiques en remplacement et en complément des procédés de corroboration détaillés. Malgré cette utilisation croissante, le mode d'application concrète des procédés analytiques est peu connu. Les auteurs se sont donné pour but de décrire comment les vérificateurs appliquent les procédés analytiques aux étapes de planification, d'application des procédés de corroboration et d'examen global de la vérification. Pour y parvenir, ils ont procédé à une série d'entrevues avec 36 experts de la vérification possédant divers degrés d'expérience et assumant divers niveaux de responsabilités (premiers vérificateurs, chefs de groupe et associés), qui représentaient les six principaux cabinets d'experts comptables des États‐Unis. L'étude contribue à l'avancement des connaissances de trois façons. Premièrement, en permettant de mieux comprendre comment les procédés analytiques sont appliqués, elle munit les chercheurs en comptabilité des éléments nécessaires au diagnostic des problèmes ou des questions actuellement soulevés par les procédés analytiques et, partant, à la réalisation de travaux de recherche plus pertinents. Deuxièmement, elle offre aux membres de l'Auditing Standards Board de l'information pertinente relative aux méthodes courantes afin d'alimenter les délibérations relatives à l'orientation à donner aux procédés analytiques. Troisièmement, elle munit les enseignants d'une définition des procédés analytiques tels qu'ils sont appliqués concrètement, ce qui facilitera l'étude de cette importante question en classe.