and four more lessons from new cutting-edge audit research.
by donny c. shimamoto
strategic technology decisions
often academia is criticized for being out of touch with that is happening in the “real world.” when i was invited to attend the hawaii accounting research conference, i was interested to see whether some of the contemporary research being done by university researchers across the world was actually relevant to those of us in practice.
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while quite a bit of the research provided some data to support commonly held assumptions that many of us have, there were some papers that provided some good food for thought that audit firms big and small should consider.
here are some of the implementable takeaways that i got from listening to the paper and discussions.
address internal control weaknesses to improve customer satisfaction
the paper “internal control and customer satisfaction – a study of amazon product ratings” by chen, liu, wan and wang demonstrated a direct relationship between higher internal control weaknesses (“icws,” as reported under section 404) and lower product ratings on amazon. additionally, increased organizational complexity, increased geographical distribution and if a product was not one of the company’s core product all increased the likelihood for lower ratings.
the authors provided the reasoning that when icws are present, the company must spend more of its resources addressing the icws, which causes decreased spend in product development, operations and customer support, which could all be reasons for the lower ratings.
takeaway: if you’re trying to convince a client to address your management letter comments or other less severe icws, see if you can identify how it ties to their product quality or customer satisfaction – which could then potentially be tied to increased customer loyalty, increased revenue and reduced customer service costs – all reasons a cfo could use to get buy-in from other executives that icws need to be addressed.
more diversity in audit partners results in better audit quality
diversity and inclusion have been a hot topic in our profession for a while, but is there really a benefit to increased diversity? this paper provided a resounding “yes” to this question for audit. “audit leadership diversity and audit quality” by zimmerman, seidel, lisic and truelson, showed that when there is a culture emphasizing diversity, there are fewer subsequent restatements and a more conservative approach to accruals. the authors measured diversity using the following factors: age, gender, ethnicity, industry specialization and education.
takeaway: even if your audit team can’t be ethnically diverse (perhaps because of the region of the country that you live in) be sure to consider the other diversity factors when assembling your audit team.
charitable auditors result in better audit quality
china’s audit environment differs from ours in the u.s. in that signing auditors are identified on audit reports, and there is publicly available information about whether cpa license holders have engaged in charitable activities. liu, wang and zhou used that data to answer the question “do charitable auditors deliver better audit quality? – evidence from chinese cpas.” their research showed that auditors who engage in charitable activities demonstrate lower discretionary accruals, and are more conservative in issuing modified audit opinions.
takeaway: when hiring for your audit teams, hire people who show a strong history of volunteerism and other charitable activities. my assumption on this is people who feel a stronger connection to serving the public and less fortunate will prioritize the “correct” opinion over potential pressure from client’s management and audit fees.
reward professional skepticism to reduce detection risk when using data analytics
being someone who is asked to speak often about data analytics, i was definitely interested when i saw the title of this paper, “data analytics and skeptical actions: the countervailing effects of false positives and consistent rewards for skepticism” by barr-pulliam, brazel, mccallen and walker. the research found that you must reward people for investigating false positives, even if they don’t result in an actual change. this is often contrary to the “don’t blow up my engagement budget” pressure that many audit leaders place on their audit teams, which the research shows actually decreases auditor exercise of professional skepticism, which potentially also increases the detection risk of the audit.
takeaway: firms need to ensure that they create an environment where professional skepticism is rewarded, not penalized, to not increase their detection risk. in my view, when artificial intelligence is also used with data analytics, firms need to include additional data that can be identified as the mitigating factor for the false positive so that the ai can learn to look for that additional data to decrease the volume of false positives.
digital audits = higher audit fees
a lot of the talk around the use of digital technologies for audit efficiency focuses on the decrease in cost of performing the audit – which could result in better engagement profitability. rather than reducing audit fees, most partners probably see this as recouping write-offs that they have been sustaining for years. the research done by maghakyan, jarva, niemi and sihvonen on “the effect of partner digitalization expertise on audit fees” shows instead that firms with a higher digitization expertise can charge premiums for their audits. in fact, in the u.s. this premium was 63-65 percent – and clients were not balking at paying these higher fees.
when i thought about it, the higher fees made sense … the more digital the client, the more the auditor would have to engage specialists like it auditors, digital product specialists, cybersecurity specialists, etc. to be able to properly assess risk and understand the operations of the client. but with the coming changes in the cpa exam, i wonder how long this fee premium will last because eventually all auditors will have some level of digital skills.
takeaway: if you’re working with digitally focused clients, be sure that you’re getting your full potential fees and don’t feel like you should be charging them the same as your non-digital clients. also, if your clients are starting to go through digital transformation be sure that you are starting to have the conversations with them about how that may affect their fees – and be sure that you have the right specialists on your team or on contract from a partner firm.
closing thoughts
most of the sessions i chose were focused on improving audits because this is the area that had the most potential application to those of us in practice, but there is a wide variety of topics including tax, financial reporting, disclosures, diversity, governance, esg and valuation. a couple of the organizers and professors reached out to me after the conference to thank me for providing insights from how their research may apply (or conflict) with what is actually happening in practice, so i’m sure that if any of you would like to help improve the usefulness of accounting research, they would welcome your participation too.
next year’s hawaii accounting research conference will be january 3-5 again. hopefully we will be able to meet in person by then and you can justify a trip to hawaii for some cpe too!
