Auditors are getting more vigilant about beating up on the risk of management bias in arriving at accounting estimates, but not so much when it comes to the risk of measurement imprecision.
New academic research emerging from the University of Arizona says the risk of error in accounting estimates due to imprecise measurement methods is just as important as the risk of management bias, but it isn’t getting the same level of attention from regulators. That means it’s not getting the same level of attention from auditors either.
The study suggests auditors generally respond to a high risk of management bias with a high level of audit effort. But when management bias is less threatening, auditors tend to lower their guard both on the risk of management bias and the risk of measurement imprecision, the study says. “A more balanced emphasis on both bias and imprecision not only results in a more optimal allocation of audit effort, but also provides evidence that auditors employ a more deliberative, systematic decision making approach,” the study says.
The Public Company Accounting Oversight Board has called out audit procedures around accounting estimates, including fair value, heavily in recent inspection cycles. Behind audit problems with internal control over financial reporting, it’s one of the more common trouble spots flagged by inspectors.
The board has had a project on its agenda almost from the beginning of its existence to rewrite or upgrade its standards around the auditing of accounting estimates and fair value. The PCAOB has discussed it with its Standing Advisory Group as far back as 2007, only a few years after the PCAOB was formed under Sarbanes-Oxley.
The PCAOB issued a staff consultation paper in 2014 outlining a number of ideas and looking for feedback before proceeding, but got very mixed feedback. Aside from a few public discussions with the SAG, the board has taken no further action.
PwC even took the unusual step of addressing the issue in its official reaction to its 2011 inspection report, calling on the PCAOB to accelerate its standard-setting efforts in this area. “In our view, the consistency of audit execution, not only within a single firm but across the profession, can be greatly enhanced with standards that reflect the increasingly complex accounting and auditing environment in which we operate,” the letter says.
The recent academic study suggests professional standards, inspections, and practitioner methodologies could all benefit from a more balanced focus on both management bias and measurement imprecision as equivalent risks to accounting estimates. Such an approach “would likely help mitigate auditors’ behavioral tendency to under-audit when the risk of bias is low,” the study says.