Brad J. Reed

Demand for Audit Quality: The Case of Laventhol and Horwath’s Auditees

This study investigates the demand for audit quality for the firms being audited by Laventhol and Horwath (LH) at the time LH declared bankruptcy. The demand for audit quality by the former LH clients is inferred from their decisions to select Big Six or non–Big Six auditors. Because the change in auditors was involuntary, the sample avoids self-selection issues associated with voluntary auditor switches. LH clients that selected Big Six auditors tended to be more highly leveraged, have less management ownership, and issue more securities in the year after selecting the new auditor than LH clients that selected non–Big Six auditors.

The Role of Related Party Transactions in Fraudulent Financial Reporting

Motivated by mixed findings in the auditing literature about the importance of related party transactions as red flags indicating potential fraud, this study examines 83 SEC enforcement actions involving both fraud and related party transactions. In addition to comparing the characteristics of firms in this sample with firms examined in other fraud studies, we describe generally how each type of related party transaction might potentially be used to misstate financial reports and then document the types of related party transactions actually occurring in these fraud cases. Overall, the most frequent type of transactions in the enforcement actions were loans to related parties, payments to company officers for services that were either unapproved or non-existent, and sales of goods or services to related entities in which the existence of the relationship was not disclosed. Misappropriation of the companys assets are most often related to transactions where the cash flow is outward, while instances of misstatement of financial reports are more often related to transactions where the cash flow is expected to be inward. Generally, related party transactions are not necessary as mechanisms for fraud, and their presence need not indicate fraudulent financial reporting. An implication is that it is important for the auditing profession to understand the benign nature of most related party transactions, the differentiating features between benign and fraudulent transactions, and the importance of evaluating a companys related party transactions in light of its broader corporate governance structure.

Using Comprehensive Research Projects for Skill Development and Responsive Learning Assessment: A Portfolio Approach

Abstract A framework for developing a multi-course undergraduate research project is presented, which (1) allows students to connect coursework learning with real company data, (2) engages students in relevant critical analysis, and (3) provides meaningful, content-rich learning assessment data that can be used to improve student learning. Sample assignments, an assessment rubric, and sample assessment data reports are also presented to illustrate how diverse assignments, with regard to scope, structure, and accounting skills, can be evaluated and used to improve student learning across the accounting curriculum. Importantly, the process of responding to the assessment data to make improvements to “close the loop” is discussed.

Postretirement benefits: The implementation of SFAS No. 106 ‘versus’ accrual accounting in the mining industry

Abstract The implementation of Statement of Financial Accounting Standard [SFAS] No. 106 required the accrual of the expected costs of postretirement benefits. The guidance given in the standard regarding the transition obligation resulting from the adoption of SFAS No. 106 is unclear and may be interpreted as conflicting with the matching principle. This case is an exercise in how to resolve conflicts between the specific guidance of an original pronouncement of the Financial Accounting Standards Board and the broader application of the accural accounting model.

The Effect of Insured Liabilities on the Demand for External Audits: The Case of Privately-Held U.S. Banks

This study examines the effect of the government provided insurance on bank debt on the voluntary audit choice made by privately held banks in the United States. By using data available from banking regulators, we are able to overcome data limitations of prior research on voluntary demand for auditing services. Banks have the unique feature of insurance on customer deposits that is provided by the Federal Deposit Insurance Corporation, and these insured customer deposits comprise a significant portion of the debt of most banks. Consistent with prior research we find that the voluntary choice to be audited is positively related to agency costs as measured by the size of bank assets. Prior research has found a mixed association between the demand for auditing and debt, and our results may shed some light on this issue. Our results show a negative association between a bank’s insured deposits and the choice to be audited, but (consistent with prior literature) a positive association with uninsured liabilities. In addition, we also hypothesize and find that the bank’s voluntary audit choice is positively related to the bank’s growth rate and related to the bank’s primary federal regulator. These findings may have policy implications at a time when changes to banking regulation are being considered.

Auditors as monitors: evidence from discretionary accruals of Laventhol and Horwath clients

Purpose - This paper aims to provide evidence on the hypothesis that auditors differ in how they constrain discretionary accruals (DAs) of their clients. The paper seeks to analyze changes in DAs for clients of Laventhol and Horwath associated with the appointment of a successor auditor. Design/methodology/approach - The study uses regression and archival data to separate a firms accounting accruals into discretionary and non-DAs. The study then examines changes in a firms DAs associated with a change in auditors. Findings - Replacing LH with a new auditor resulted in a statistically significant decrease in DAs. This result is contrary to prior research and could be due to the prior research using voluntary auditor changes where variables such as financial distress and opinion shopping could drive the results. Originality/value - The study provides results that differ from prior research. This study shows that the auditor change is associated with a systematic decline in the level of a firms DAs. The results could be due to the forced nature of this auditor change as opposed to voluntary auditor changes used in prior research.

Revenue and expense recognition cases developed from the accounting and auditing enforcement releases

Abstract This paper presents four revenue and expense recognition cases to be used in the intermediate accounting sequence. The cases are adapted from Accounting and Auditing Enforcement Releases, so they are based on real-world situations. Each case requires students to search accounting databases to find the appropriate pronouncements or other accounting guidance. Students must also synthesize the information to provide compelling arguments for their proposed solutions. The cases can help develop critical thinking skills in unstructured environments while reinforcing key financial accounting concepts.