Why Do Auditors Over-rely on Weak Analytical Procedures? The Role of Outcome Bias and Insensitivity to Precision Steve Glover Doug Prawitt Jeff Wilks Brigham Young University

Importance of Analytical Procedures  Frequent and increasing use of analytical procedures (Ameen & Stawser 1994; McDaniel & Kinney 1995; Hirst & Koonce 1996; Kinney & McDaniel 1996; Bell et al. 1997)  Findings of the POB (2000) –Analytical procedures used for substantive testing provided insufficient assurance 20% of the time. –Insufficient procedures typically related to income statement accounts.

Reliance on Audit Evidence  Auditors sensitive to –Source competence (Bamber 1983) –Objectivity (Hirst 1994, Caster & Pincus 1996) –Amount, composition, directness, and deviations from expectations (Caster & Pincus 1996)  What might explain over-reliance on audit evidence, and analytical procedures in particular?

Favorable Outcome Effect  When analytical procedures produce expected or even desired results, auditors are less critical of the procedure. –Motivated reasoning (Kunda 1990) –Inherited hypotheses (Swann & Giuliano 1987) –Biased hypothesis testing (Pyszczynski & Greenberg 1987)

Sensitivity to Precision  Precision –The expected closeness of an observed statistic to the “correct” amount –A critical determinant of the quality of evidence produced by substantive analytical procedures –SAS No. 56 suggests that Disaggregated data produces more precise expectations than aggregated data Precision also affected by reliability of source data, predictability of account, and type of procedure

Sensitivity (continued)  Contingent auditor sensitivity to precision –Auditors sensitive to precision when testing a hard account, but not estimates (McDaniel & Simmons 2003) –We argue “no-significant-difference” outcomes diminish auditor sensitivity to precision

Experiment 1 No Significant Difference Significant Difference Aggregate Procedure Assess Evidential Strength

H1: Outcome Bias The assessed strength of audit evidence obtained from an aggregate analytical procedure will be greater for auditors who observe no significant difference (a favorable outcome) than for auditors who observe a significant difference.

Experiment 1 No Significant Difference Significant Difference Aggregate Procedure Assess Evidential Strength Significant Difference Disaggregate Procedure Assess Evidential Strength Reassess Strength of Part A

After evaluating the disaggregated procedure, auditors who initially observe no significant difference will lower their assessments of the aggregate procedure’s evidential strength more than will auditors who initially observed a significant difference. H2: Sensitivity to Precision

Expected Results Evidential Strength No Yes Initial Assessment of Aggregate Procedure Reassessment of Aggregate Procedure Originally Observed Significant Difference

Experiment 1: Method  Task –Determine appropriateness of interest income –Compute expectation for current year based on annual loan balances and rates –Compute new expectation based on quarterly and categorized loan balances and rates  Participants –67 supervising seniors from one Big Four firm participated during national training sessions –34.5 months of audit experience (standard deviation 12.8)

Experiment 1: Method  Design (2x2 mixed design) –Favorable outcome: Yes or no (between subjects) –Precision of analytic: Aggregate or disaggregate (within-subject)  Primary dependent measure –Evidential strength: 1 (extremely weak) to 7 (extremely strong)

Results (Table 1)

Control Conditions Evidential Strength No Yes Initial Assessment of Aggregate Procedure Reassessment of Aggregate Procedure Originally Observed Significant Difference

Cueing Sensitivity to Precision  Ex ante warning to consider weaknesses can lead to more careful scrutiny (Petty & Cacioppo 1986) –Evidenced by lower assessments of strength –Possible demand effect  Include two types of participants –Auditors with relevant task knowledge –Students without such knowledge

H3: Cueing Sensitivity to Precision Part 1: The perceived strength of evidence obtained from a weak, high-level analytical procedure will be lower for auditors who are cued ex ante to critically evaluate the quality of the analytical procedure than for auditors who are not cued to critically evaluate the procedure. Part 2: An ex ante cue to critically evaluate the quality of a procedure will make no difference in students’ assessments of evidential strength.

Expected Results Evidential Strength Students Auditors No CueCued to Critically Evaluate

Experiment 2: Method  Participants –84 supervising seniors from one Big Four firm participate during national training sessions (34.5 months of audit experience, standard deviation 12.8 months) –90 graduate students in a second auditing course  Design (2x2 between subjects)  Task and materials same as Part A, Exp. 1 (ND)  Dependent measures same as Part A, Exp. 1 (ND)

Experiment 2: Method  The text of the cue read as follows: Before computing an expectation of interest income for the current year, please consider the strength (quality and sufficiency) of the evidence provided by the interest income analytical procedure used by the audit team last year. Please list in the space provided below one or more weaknesses of this analytical procedure.

Results

Conclusions & Implications  An outcome effect can explain in part why auditors may over rely on weak analytical procedures. –Hinders consideration of precision –May also hinder consideration of…? Source competence (Bamber 1983) Objectivity (Hirst 1994, Caster & Pincus 1996) Amount, composition, directness, and deviations from expectations (Caster & Pincus 1996)

Conclusions & Implications  Ex ante prompt to consider weaknesses of an analytical procedure appears to –Produce no demand effect –Lead to more careful scrutiny by those who have relevant task knowledge

Limitations & Future Research  All auditors from one Big Four firm  The impact of teamwork, the review process, and accountability not examined