The Hindu Business Line : The knowledge edge

To a question as to why an auditor crossed the road before commencing audit, the reply given was: That was done last year. These days, such a situation cannot be imagined even in jest. After the multiple scans and vigilant legislation, the once-staid profession has become staider still, to the extent that one can say that it certainly takes a lot to be an auditor these days.

Knowledge of the business — one of the basic requirements for an auditor — is becoming even more crucial. Recent research has only validated this point. Jacqueline S. Hammersley of the University of Georgia has done some research in this area, which reiterates the fact that industry specialist auditors are going to be the future.

Auditors' failure to identify and report complex financial statement misstatements has had severe consequences for financial statement users and for auditors themselves. Misstatements in financial statement that are complex are hard to diagnose because they are likely to be described by a pattern of individually innocuous cues.

The problem of diagnosing such misstatements is further complicated when the pattern is incomplete. It is important to understand the determinants of how well auditors interpret incomplete patterns suggestive of misstatement. Auditors must make judgments and decisions during the planning and evidence collection stages of the audit with incomplete information.

Additionally, the division of labour among audit team members suggests the possibility of different auditors collecting the pieces of information that form a pattern. Individual auditors, who likely have seen only part of the pattern, would not have enough information, on their own, to identify the potential increased risk of misstatement. Consequently, unless at least one team member receives all of the information forming the pattern, the risk of misstatement may be assessed too low or identification of a misstatement may be delayed, negatively impacting both audit effectiveness and efficiency. Moreover, because individual pieces of information are not in themselves very suggestive of misstatement, they are unlikely to be communicated.

The experiment

Teams of auditors from the cream of accounting firms were given specific instances and statements where a material misstatement was planted purposely — a seeded misstatement, that is. Matched Specialists is the term given to auditors who are specialists in the particular industry they are auditing. Auditors judge the likelihood of misstatement, explain the misstatement(s) about which they are concerned, determine necessary additional audit procedures, and perform surprise recalls for each case.

The results

Consistent with expectations, the research concluded that matched specialists develop more complete problem representations about the seeded misstatement when they receive partial- or full-cue patterns than when they receive no-cue patterns.

Additionally, matched specialists who receive partial- and full-cue patterns assess the likelihood of misstatement higher than matched specialists who receive no-cue patterns.

Matched specialists respond to a partial-cue pattern that potentially indicates misstatement by developing more complete problem representations about the seeded misstatement. In contrast, mismatched specialists generally do not develop more complete problem representations about the seeded misstatement, even when they receive full-cue patterns.

Additionally, despite assessing higher misstatement risk when receiving a partial-cue pattern versus no-cue pattern, mismatched specialists' suggested procedures do not focus on the seeded misstatement.

Collectively, these results suggest that industry specialists will improve audit quality when industry-specific knowledge is necessary to identify a misstatement and when knowledge of general accounting and audit testing, and thinking by analogy are not adequate substitutes for this knowledge. Although the Institute of Chartered Accountants reiterates knowledge of the business as a sine qua non, clearly the time has come to prescribe something more concrete. Would we be having industry-specific auditors in India too some years down the line?

(The author is a Hyderabad-based chartered accountant.)

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