Healthy skepticism leads to sound judgment among auditors
Research on professional skepticism in auditing named "best paper" by top auditing journal
Mark Nelson earned “best paper” honors in January
from a top, peer-reviewed
journal, Auditing: A Journal
of Practice & Theory, for
his sole-authored paper,
“A Model and Literature
Review of Professional
Skepticism in Auditing.”
Nelson, the Eleanora and
George Landew Professor
of Management and
professor of accounting at
Johnson, is the inaugural recipient of the award, which recognizes
the paper published in the past three years that has had the most
significant influence on, or the most potential to significantly influence,
audit research or practice. The work also led to Nelson’s invitation
to testify before the Public Company Accounting Oversight
Board in October 2012.
For more than 20 years, Nelson has examined issues related to audit judgment and auditors’ professional skepticism, or PS, in his research. For his award-winning project, sponsored by the Center for Audit Quality, he synthesized more than 250 research studies and developed a model of the determinants of PS, which is fundamental to the judgment process inherent in auditing.
“When major audit failures have occurred, a lack of professional skepticism is often cited as a root cause,” Nelson said. “The clues were there, but weren’t followed up, or management assertions were not corroborated sufficiently. Auditors need to be able to critically evaluate evidence and know when they need to probe more deeply.”
Nelson was asked to speak about how his model might inform auditor independence and firm rotation to the Public Company Accounting Oversight Board, an entity established by Congress to oversee audits of public companies. The PCAOB has been considering whether public companies should be required to rotate auditing firms in order to increase auditor independence.
Nelson testified that his research, on balance, does not present a persuasive case for mandatory audit firm rotation to increase auditors’ professional skepticism.
“Overall, the model and extant research highlight multiple ways that mandatory rotation could increase or decrease auditors’ PS by affecting auditors’ knowledge and incentives,” he said. “Under a very short rotation period, I think it is likely that the costs associated with obtaining and setting up new clients would dominate the benefits. Under a longer rotation period, the costs are spread over more years, but the benefits of rotation are reduced.”
Nelson encouraged board members to consider alternatives to mandatory firm rotation that might prove more effective in increasing PS. These include changing the “frame” by which audit procedures are outlined, from positive to negative. For example, a procedure described with a positive frame is “determine whether client assumptions are reasonable,” while the same procedure described with a negative frame is “determine whether client assumptions are not reasonable.”
Nelson has conducted follow-up research with Eldar Maksymov, a Johnson PhD student, and Professor William R. Kinney Jr. of the University of Texas, that investigates the effectiveness of reframing audit procedures.
“Our results indicate that auditors given a positive frame plan significantly fewer hours than do auditors given a negative frame, particularly with respect to procedures that the auditors view as less verifiable, like those that assess the reasonableness of managements’ assumptions,” Nelson said.
Audit managers under pressure to design especially efficient audits also tend to plan significantly fewer hours than their counterparts experiencing less pressure, which also may lead to reduced PS, Nelson said.