Analytical review has been characterized as a diagnostic, sequential and iterative problem-solving process. The auditor determines that an unusual fluctuation exists in an account balance and then develops an hypothesis to explain the unexpected fluctuation. This hypothesis guides the information search for additional data to be used in the final hypothesis evaluation stage. If the hypothesis is determined not to explain the unexpected fluctuation, the auditor generates another hypothesis, and the process begins again. Thus, each unexpected account fluctuation is a problem that must be identified, and the cause of that fluctuation is the problem solution. Previous audit research has primarily focused on the hypothesis generation and hypothesis evaluation stages in isolation. However, since analytical review is a sequential process, successful hypothesis generation first requires successful problem identification. This study builds upon these previous studies and contributes to our understanding of the overall analytical review process by investigating the less frequently examined problem identification stage.
This study uses a computerized variation of the information board methodology to present case materials to subjects and to record their information search patterns, identified problems and generated hypotheses. The case materials included background information and financial statements of an hypothetical company. The financial statements reflected the effects of three errors that had been seeded in otherwise "correct" statements. Forty-two auditors at various levels of experience from the Big Six firms and one regional firm participated in the study. General (number of years of audit experience) and task-specific (number of merchandising preliminary analytical reviews performed, total number of preliminary analytical reviews performed, number of analytical review courses completed, number of merchandising clients, and number of merchandising audits) experience measures are employed to assess auditors' problem identification and hypothesis generation abilities since cognitive psychology and auditing research have both demonstrated experience-related differences in problem solving approaches and results.
Psychology research has demonstrated that the organization of a problem solver's memory is a significant factor in the problem-solving process, particularly in "knowledge-rich" domains such as auditing, where problem solvers possess significant amounts of knowledge that must be used in order to successfully solve the problem at hand. Audit research has identified at least two schemes used by auditors to organize their knowledge -- transaction cycle and audit objective, and both schemes have been found to increase in importance as experience is gained. This study investigates auditors' knowledge structures in two ways. First, the order in which the auditors obtained case information was examined. This method revealed that auditors at all experience levels appear to employ a transaction cycle organization scheme. The second method, a card sorting task using accounting errors, revealed that audit objectives become a more prominent organizing feature as general audit experience increases. Results based on task-specific experience measures were not so clearly defined; however, the experience levels that exhibited the highest problem identification ability appear to employ an organization scheme based on both transaction cycle and audit objective.
Researchers argue that a more experienced auditor should have a more complete and better organized knowledge base, including a more complete understanding of account relationships, than a less experienced auditor. This additional knowledge should allow the experienced auditor to more successfully recognize patterns in account balances and identify problems through analytical review than a less experienced auditor. This study finds formal training in analytical review to be significantly related to differences in problem identification ability, i.e. auditors with training in the use of analytical procedures are better at identifying errors than auditors with no such training. This suggests that formal training in the proper use of analytical procedures can improve auditors' ability to detect errors in financial statements. No other experience measures were found to be significantly associated with problem identification ability.
The ability to recognize patterns in account balances is important not only in identifying that a problem exists, but is also important in identifying the probable cause of the problem. More experienced auditors, drawing on their more complete and better organized knowledge, should be better equipped to correctly hypothesize error causes based on identified patterns in account balances than less experienced auditors. Since hypothesis generation can only occur after the identification of a problem, only those hypotheses generated in response to identification of an account containing a seeded error were examined. None of the experience measures was associated with improved hypothesis generation. However, auditors having performed at least one merchandising preliminary analytical review were significantly worse at generating the correct hypothesis to explain the seeded errors than those not having this experience. These experienced auditors appeared to hypothesize frequently occurring errors to explain the seeded errors in an attempt to increase audit efficiency.
Previous research in hypothesis generation has documented accessibility effects, where those errors most recently encountered in practice and those errors perceived to occur most frequently are more likely to be hypothesized to explain current audit findings. Since the analytical review process is sequential and iterative, it is reasonable to expect that these accessibility effects would also be present during problem identification. Analysis of the auditors' responses to the case materials found that as experience is gained through formal training in the use of analytical procedures, auditors are more likely to identify recently encountered errors and more frequently occurring errors to explain unexpected account balances. This behavior may be a result of the auditors attempting to increase audit efficiency by examining the more likely explanations first. Contrary to expectation, no experience effects based on years of audit experience were found for auditors' hypothesis generation ability.
This study contributes to the understanding of the development and organization of auditors' knowledge. Contrary to conjectures from previous research, auditors at all levels of experience were found to have a well-developed knowledge of transaction cycles. Knowledge organization appears to change with experience, however, in terms of organization by audit objectives. Additionally, in light of recent studies finding that general audit experience may not an appropriate experience measure for certain audit tasks, this study employs several task-specific experience measures. It was found that while exposure to and performance of analytical procedures may generally increase with length of tenure in public accounting, other factors appear to better explain performance differences in the use of such procedures. The results based on the number of analytical review courses completed indicate that expertise in analytical review may be gained, at least in part, through formal education. The fact that a single experience measure was not found to be significant for both problem identification and hypothesis generation indicates that these two skills may be developed separately. The fact that an auditor can correctly identify the existence of an unexpected account balance does not necessarily mean that he or she can hypothesize the correct cause of the error.
Return to Charles E. Davis' vita
Return to Charles E. Davis' Home Page
Send E-mail to Charles_Davis@baylor.edu.