Auditing, Substantive test, Sampling, Accounting population

During the late 1990s, the SEC alleged that banks were overstating loan loss allowances to establish cookie jar reserves. Their intervention in bank accounting culminated in 2001 with new guidance (SAB 102) designed to improve financial reporting quality. We show that banks' allowance estimation changed in response to the SEC's intervention. While allowance informativeness (as proxied by the ability to explain future losses) improved for Strong Banks, informativeness declined for Weak Banks whose incentives are to understate allowances. Our results help to explain why some (Weak) banks delayed loss recognition during the recent financial crisis.

[This paper investigates the relationship between sampling risks and audit consequences under error and audit value projection testing approaches. The latter approach typically is presented in auditing textbooks in connection with classical variables sampling, while the former approach is shown to underlie both dollar-unit sampling methods (in which an upper precision limit for monetary error is computed) and statistical compliance testing methods. In particular, we demonstrate analytically that error projection approaches implicitly test null hypotheses which effectively are equivalent to an alternative hypothesis underlying audit value projection. We also present outcome matrices to identify the effect of such hypothesis interchange on the audit consequences of sampling risks, and thus provide a basis for clarifying sampling risk discussions in textbooks and the recently issued Audit and Accounting Guide: Audit Sampling.]

The article presents comments of authors on a paper by C.L. Norton and R.E. Smith, titled "A Comparison of General Price Level and Historical Cost Financial Statements in the Prediction of Bankruptcy," published in the January 1979 issue of the journal "The Accounting Review." Authors of the article raised several issues concerning the paper by Norton and Smith. Authors argued in the first section that the paper's competing information system framework was inappropriate for assessing the usefulness of general price level (GPL) information. In the second section of the present article, they establish that the paper was biased against a finding of predictive value for GPL information since potentially important GPL information was excluded from GPL models and GPL information was required to meet an unnecessarily restrictive multiple dominance criterion. In the third section of the article, the time period, the single aspect of the study, which appears to "favor" GPL information, is shown to be less favorable than implied.

In this study, we present a nonstrategic, dynamic Bayesian model in which auditors' learning on the job and their choice of professional services jointly affect audit quality. While performing audits over time, auditors accumulate client‐specific knowledge so that their posterior beliefs about clients are updated and become more precise (that is, precision is our surrogate for audit quality) — what we call the learning effect. In addition, auditors can enrich their knowledge accumulation by performing nonaudit services (NAS) that, in fact, may influence clients' managerial decisions — what we call the business advisory effect. This advisory effect permits auditors to anticipate and to learn about changes in clients' business models, which in turn improves their advisory capacity. These dual “learning” and “advisory” effects are interdependent and mutually reinforcing. The advisory effect of NAS may increase or reduce auditors' engagement risk. We show that large professional fees can induce auditors to provide NAS that increase engagement risk and diminish audit quality. However, when NAS reduce engagement risk and increase audit quality, auditors may provide NAS without charging clients. The feature that distinguishes our study — the interdependence between the learning and advisory effects — provides new insight into the trade‐off between audit fees and audit quality. Consequently, our analysis helps explain why the scope of the audit has evolved over time and why the boundaries between audit and NAS are constantly shifting. A recent example of such a shift is that the Sarbanes‐Oxley Act adds control attestation to audits for public companies traded in U.S. markets.

This study examines the effects of uncertainty on taxpayers' reporting decisions in conjunction with economic factors. Previous research is extended by (1) simultaneously modelling taxpayers' reporting decisions and the tax agency's audit policies, (2) incorporating taxpayers' uncertainty about the tax agency's audit costs and uncertainty about their tax liabilities, and (3) investigating the effects of both transferable monetary and nontransferable penalties for underpayment of taxes. The analysis shows that tax liability uncertainty can have different effects upon taxpayers' reporting decisions than uncertainty about the audit cutoff point. Furthermore, these specific effects will depend upon the presence or absence of monetary penalties and the anticipated audit probability in the initial equilibrium which, in turn, depends upon the penalty and tax rates. Specifically, increased tax liability uncertainty will induce more taxpayers to report a high level of income under proportional monetary penalties, but sometimes can have the opposite consequences under fixed, nontransferable penalties. Similar results also hold with respect to tax rate changes. The findings have direct implications for experimental studies of taxpayers' reporting behavior and potential policy implications for the effects of changes in the tax laws and reduction in tax and penalty complexity both of which would likely affect taxpayers' uncertainty.

[This study examines the effects of uncertainty on taxpayers' reporting decisions in conjunction with economic factors. Previous research is extended by (1) simultaneously modelling taxpayers' reporting decisions and the tax agency's audit policies, (2) incorporating taxpayers' uncertainty about the tax agency's audit costs and uncertainty about their tax liabilities, and (3) investigating the effects of both transferable monetary and nontransferable penalties for underpayment of taxes. The analysis shows that tax liability uncertainty can have different effects upon taxpayers' reporting decisions than uncertainty about the audit cutoff point. Furthermore, these specific effects will depend upon the presence or absence of monetary penalties and the anticipated audit probability in the initial equilibrium which, in turn, depends upon the penalty and tax rates. Specifically, increased tax liability uncertainty will induce more taxpayers to report a high level of income under proportional monetary penalties, but sometimes can have the opposite consequences under fixed, nontransferable penalties. Similar results also hold with respect to tax rate changes. The findings have direct implications for experimental studies of taxpayers' reporting behavior and potential policy implications for the effects of changes in the tax laws and reduction in tax and penalty complexity both of which would likely affect taxpayers' uncertainty.]

This paper presents an analysis of the audit risk consequences of PPD ex- tremeness deficiencies and miscalibration.While there is empirical evidence that auditors, like many other decision makers, assess miscalibrated PPDs , the attendant inferential risk consequences of such deficiencies have not been addressed in the extant literature.The comparative statics analysis performed in this study indicates that the risk effects of miscalibration and extremeness deficiencies on the auditor's (substantive testing) evaluation decision are complex and cannot be predicted from an examination of the planning (sampling size) decision.

This study presents an analysis of the managerial incentive problem in a stock market economy in which incentive contracts are structured in terms of security ownership. In our model, the manager's ownership share signals effort and is determined endogenously as the solution to a special portfolio decision problem. Managerial investment in the firm is evaluated under various security pricing arrangements. Our analysis indicates that, in general, stockholders should sell shares to a manager at a discount to ensure a Pareto efficient ownership (incentive) structure. However, efficient pricing (discount) schedules generally are nonlinear and, in many respects, isomorphic to discriminating price functions which have been considered in neoclassical models of monopoly.

This study presents an analysis of the managerial incentive problem in a stock market economy in which incentive contracts are structured in terms of security ownership. In our model, the manager's ownership share signals effort and is determined endogenously as the solution to a special portfolio decision problem. Managerial investment in the firm is evaluated under various security pricing arrangements. Our analysis indicates that, in general, stockholders should sell shares to a manager at a discount to ensure a Pareto efficient ownership (incentive) structure. However, efficient pricing (discount) schedules generally are nonlinear and, in many respects, isomorphic to discriminating price functions which have been considered in neoclassical models of monopoly.