Academic journal article Auditing: A Journal of Practice & Theory

Analytical Procedures and Audit-Planning Decisions

Academic journal article Auditing: A Journal of Practice & Theory

Analytical Procedures and Audit-Planning Decisions

Article excerpt

SUMMARY

This study examines auditors' decisions to revise preliminary audit plans after analytical procedures performed during interim testing reveal significant, unexpected fluctuations. We examine the effects of two variables on these decisions: (1) the presence or absence of an explicit incentive for management to misstate the financial statements, and (2) the degree to which management's explanation for the fluctuation is independently corroborated. We hypothesize that these two variables interact. Auditors will be more likely to increase their planned tests when there is minimal corroboration of management's explanation for the fluctuation and there is an explicit incentive for management to misrepresent the financial statements. The results of an experiment are consistent with this hypothesis. While our results suggest that auditors are more likely to revise audit plans in these conditions, we also find that a relatively high proportion of auditors do not revise their plans when faced with increased audit risk signaled by significant, unexpected fluctuations. Future research is needed to better understand auditors' reluctance to expand testing end whether this reluctance jeopardizes audit effectiveness.

Key Words: Preliminary analytical procedures, Audit planning, Planned substantive tests, Corroboration.

Data Availability: Contact the authors.

Auditors perform analytical procedures (i.e., comparisons of unaudited financial data with expected results) in planning the nature, timing, and extent of testing (AICPA 1988). Significant fluctuations between the current year's unaudited data and expected results signal an increased risk of material error (Arens and Loebbecke 1997) and help auditors focus their planned tests on high-risk areas. As documented by Hirst and Koonce (1996), auditors typically ask management to provide an explanation for observed fluctuations before making changes (e.g., increases in audit hours, modifications in the nature or timing of planned tests, or changes in staffing) in their preliminary audit plans, which are usually based on the prior year's audit.

In this study we investigate the effect of two factors on auditors' changes in preliminary audit plans: (1) the extent to which management's non-error explanation for a significant fluctuation is independently corroborated by the auditor, and (2) the presence or absence of an explicit incentive for management to misstate financial results. (1) We examine these factors jointly because we expect them to interact. Specifically, we expect that auditors will be more likely to increase planned tests when there is minimal independent corroboration and management has an explicit incentive to misstate financial results.

The hypothesized interaction results because, irrespective of whether there is an explicit incentive to misstate, extensive corroboration effectively reduces the increased risk of material error revealed by a significant unexpected fluctuation. Changes in preliminary audit plans are, therefore, not necessary when there is extensive corroboration. However, even when there is minimal corroboration, auditors are not likely to make significant changes in preliminary audit plans unless management has an explicit incentive to misstate. This follows from previous research (Bedard and Biggs 1991; Heiman 1990; Koonce 1992) which suggests that auditors who have inherited a plausible non-error hypothesis from management may be overconfident regarding its veracity and completeness. Thus, auditors are unlikely to substantially revise audit plans when management provides a plausible non-error hypothesis for a significant unexpected fluctuation. However, when management has an explicit incentive to misstate financial results, auditors are more likely to consider the likelihood that the financial statements contain material error and, consequently, expand planned tests.

We investigate our hypothesis using data from 67 auditors who participated in an experiment in which they were asked to consider revising their initial audit plans following observation of a significant unexpected fluctuation. …

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