SYNOPSIS Private equity investors have recently begun acquiring stakes in public accounting firms, both small and large. The structure that enables these investments is called an alternative practice structure (APS), a mechanism devised in the 1990s to permit “consolidators” to acquire equity interests in public accounting firms. This paper investigates the antecedents of private equity investment in U.S. CPA firms, including audit companies, accounting firm merger and acquisition activity during the 20th century, and the profession’s decision to allow non-CPA ownership of CPA firms. We demonstrate that modern private equity investment represents a return to an operating model the CPA profession previously abandoned, and we offer important historical insights—including a review of private equity investment in the healthcare profession—into the risks, implications, and regulatory challenges presented by these recent events.

ABSTRACT A critical component of accounting education is the ability to recognize ethical dilemmas and make ethical decisions. This case provides three vignettes involving ethical dilemmas faced by staff accountants early in their professional careers. The fictional vignettes are inspired by SEC and PCAOB enforcement actions that resulted in severe penalties for the individuals and firms involved. After completing this case, students will be better able to (1) apply critical thinking skills to a real-world scenario (i.e., cheating on professional exams) to understand ethical dilemmas, identify and evaluate alternative paths of action, and determine and defend a preferred outcome scenario; (2) demonstrate an understanding of ethical issues related to cheating on professional examinations and the related impact on the accounting profession; and (3) apply ethics-related principles from the AICPA Code of Professional Conduct to ethical dilemmas seen in the real world. JEL Classifications: M41; M42.

On June 12, 2024, the Public Company Accounting Oversight Board (the Board or PCAOB) issued a request for comment on Proposed Auditing Standard-Designing and Performing Substantive Analytical Procedures and Amendments to Other PCAOB Standards (PCAOB 2024a). This comment letter presents the views of the participating members of the Auditing Standards Committee of the Auditing Section of the American Accounting Association. We applaud the PCAOB for its ongoing commitment to improve audit quality by addressing enhancements to substantive analytical procedures. Based on our committee's assessment of the proposal, we provide some overall observations, an analysis based on academic research, and perspectives on the proposal's economic analysis.

SYNOPSIS Transparency concerns related to global group audits led the PCAOB to introduce the Form AP, requiring the lead audit firm to disclose the participation and relative contribution of component audit firms in a group audit. As prior research suggests that investors fail to seek out Form AP information, this study leverages experimental design to explore investors’ reactions to group audit information directly provided to them, examining their likelihood to invest based on the percentage of audit work completed by a component audit firm and the lead audit firm’s decision to assume or divide responsibility. Results indicate that investors are less likely to invest when a larger portion of the audit is conducted by a component audit firm, regardless of whether the lead audit firm assumes or divides responsibility for the component firm’s work. These findings have significant implications for auditors, regulators, and investors concerning group audit transparency and disclosure practices.

When auditors identify a misstatement, they typically engage in client inquiry to understand the misstatement's cause (e.g., whether due to error or fraud). If a misstatement was caused intentionally, client management may attempt to reduce auditor skepticism by making their behavior seem unintentional (an excuse) or appropriate (a justification). Using two experiments, we examine the type of explanation managers use to conceal their fraudulent intent and its effectiveness in reducing auditor skepticism. We predict and find managers use excuses (e.g., "I forgot"), rather than justifications, to "explain away" fraud caused by omission/inaction (omitting information from a source document) as opposed to active misrepresentation (providing misleading information). When these same excuses are provided to auditors, we find they have a skepticism-decreasing effect, particularly when used to explain misstatements resulting from omission. Together, our findings suggest managers' ability to conceal fraud may persist even after the auditors have identified an intentional misstatement

ABSTRACT In September 2016, the Consumer Financial Protection Bureau (CFPB) announced an enforcement action against Wells Fargo related to improper sales practices. Following investigations revealing widespread abuse by thousands of employees (e.g., opening deposit and credit accounts without customer consent), Wells Fargo paid civil monetary penalties of $185 million and other substantial punitive fees and fines. This case study uses this real-world example to explore the influence of materiality on the scope of an audit, the auditor’s responsibility for detection and communication of noncompliance with laws and regulations (NOCLAR), and the auditor’s consideration of the control environment in the evaluation of internal controls over financial reporting (ICFR). After completing the case, learners are able to discuss relevant professional standards and recognize the impact of materiality considerations on decisions about financial statement misstatements, NOCLAR, and internal control deficiencies. JEL Classifications: M41; M42.

ChatGPT, a language-learning model chatbot, has garnered considerable attention for its ability to respond to users' questions. Using data from 14 countries and 186 institutions, we compare ChatGPT and student performance for 28,085 questions from accounting assessments and textbook test banks. As of January 2023, ChatGPT provides correct answers for 56.5 percent of questions and partially correct answers for an additional 9.4 percent of questions. When considering point values for questions, students significantly outperform ChatGPT with a 76.7 percent average on assessments compared to 47.5 percent for ChatGPT if no partial credit is awarded and 56.5 percent if partial credit is awarded. Still, ChatGPT performs better than the student average for 15.8 percent of assessments when we include partial credit. We provide evidence of how ChatGPT performs on different question types, accounting topics, class levels, open/closed assessments, and test bank questions. We also discuss implications for accounting education and research.

In this article, we provide a practitioner summary of our paper "Error or Fraud? The Effect of Omissions on Management's Fraud Strategies and Auditors' Evaluations of Identified Misstatements" (Hamilton and Smith 2021). In that study, we investigated (1) whether managers employ an "omission strategy" to reduce the perceived intentionality of their fraudulent misstatements and (2) whether auditors are prone to believe that such omissions are unintentional. We found that managers choose to perpetrate fraud by omitting transactions from the financial statements and by omitting critical information from supporting documents, rather than using more active forms of fraud (e.g., providing false information). We also found that auditors are less skeptical of misstatements when they involve omission, as opposed to more active forms of misrepresentation. Overall, our study identifies a concerning pattern, wherein the method of fraud chosen by managers-omission-is unlikely to be judged as intentional by auditors.

In 2017, KPMG discovered that several high-ranking partners in its Department of Professional Practice (DPP) had surreptitiously obtained highly confidential information on upcoming PCAOB inspections. In obtaining this information, these KPMG partners were able to anticipate and prepare for PCAOB inspections, causing the firm's inspection deficiency rate to plummet and its executives to tout the success of their efforts to improve audit quality. Once the firm discovered the scandal, the individuals involved were terminated, and six of them were ultimately convicted of felonies. This case study introduces students to relevant auditing standards, audit quality concepts, and facilitates discussion of a number of ethical issues. Learning objectives for this case include obtaining an understanding of the PCAOB and its inspection program, understanding audit documentation standards, demonstrating the ability to evaluate ethical issues, applying the fraud triangle in a unique setting, and assessing responsibility for the various parties involved.

We investigate the stock market's reaction to events leading up to the Securities and Exchange Commission's and Public Company Accounting Oversight Board's 2007 regulatory changes that reduced the scope of and documentation requirements for assessments of firms' internal controls over financial reporting (ICFR), as required by the Sarbanes-Oxley Act, Section 404. We examine abnormal returns surrounding key dates leading to the passage of these regulations and offer two main findings. First, investors reacted negatively on key event dates, suggesting that investors viewed the regulations as likely to reduce financial reporting quality rather than to drive audit efficiencies. Second, this negative market reaction is larger when ICFR effectiveness should matter most-when firms are more complex, have higher litigation risk, and greater fraud risk. Overall, our results may imply that investors prefer stronger government regulation when it comes to the assessments of a firm's internal controls over financial reporting.

Using experiments with 58 corporate managers and 215 auditors, we examine whether managers attempt to reduce the perceived intentionality of their fraudulent misstatements by perpetrating fraud via omission, as opposed to a more active form of commission, and how auditors evaluate the resulting misstatements. We find that managers choose to omit a transaction from the financial statements rather than record a transaction inappropriately. They also choose to omit critical information from supporting documents rather than provide misleading information. However, auditors generally believe misstatements involving omissions are unintentional. Specifically, we find auditors are less skeptical of an omitted transaction compared to a misrecorded transaction. They are also less skeptical of a misstatement that results from management omitting information from a supporting document compared to misrepresenting information. Overall, our studies identify a method of fraud-omission-that managers are likely to use, but that auditors are unlikely to judge as being intentional.

In an effort to provide more meaningful information to financial statement users, the Public Company Accounting Oversight Board (PCAOB) recently adopted sweeping changes to the audit report, requiring the audit firm to disclose whether or not it identified a critical audit matter (CAM) and its tenure with the client. To our knowledge, ours is the first study to explore how nonprofessional investors' judgments are influenced by (1) the relative effects of a CAM disclosure versus a disclosure that the auditor did not identify a CAM, and (2) the disclosure of the audit firm's tenure. We find that, relative to disclosing that no CAMs were identified, disclosing a CAM reduces investment intentions. We do not find a significant effect of tenure disclosure on investment intentions, despite evidence that participants attended to and understood the tenure manipulation. Concerning investors' cognitive processes, we find that perceptions of both risk of material misstatement and management disclosure credibility mediate the effect of CAM disclosure on investment intentions, while perceived audit quality suppresses this effect. Our contributions include furthering the understanding of cognitive mechanisms through which CAM disclosure influences investment intentions, identifying a relatively unique setting in which perceptions of management disclosure credibility and audit quality move in opposite directions, and providing evidence that auditor tenure disclosure does not appear to affect investment intentions. Our findings should be of interest to regulators, auditors, issuers, and investors.

This case provides students an introductory experience to substantive analytical procedures in a realistic audit setting. Students are presented with a scenario, adapted from a real-world example, requiring them to (1) research relevant auditing standards, (2) develop an independent expectation for a client's revenue account, and (3) consider the precision of the estimate, additional audit procedures, and the reliability of the underlying data and evidence obtained. In completing the case, students will learn to: (1) explain the benefits and challenges of using substantive analytical procedures, (2) research relevant auditing standards, (3) create and analyze relevant substantive analytics, (4) evaluate the appropriateness of data aggregation in substantive analytical procedures, and (5) discuss factors affecting the reliability of data used by the auditor. The case is typically assigned as an out-ofclass assignment, combined with a subsequent in-class discussion. It can be used in either undergraduate or graduate auditing courses.

At a time when there is enormous pressure on school leaders and staff to perform within the externally set accountability measures every aspect of leader and teacher behaviour has become subject to microscopic scrutiny. The development of leadership and research into effective behaviours has ensured that there is a significant amount of research into how school leaders can and should impact upon organisational culture. Missing from this research base is the role that humour plays in forming and reforming organisational cultural identity. The role of the staff meeting as being a central part of the architecture of school life in which power is both enacted and enabled led to fourteen Primary School staff meetings being recorded digitally. The captured data was analysed using a typography based upon Martin’s (2003) Humour Styles Questionnaire. This typography was further developed to enable the categorisation of both the production and reception of humour within the staff meeting. The data shows that humour is used in Primary School Staff meetings for a number of reasons: establishing a framework, conflict management, creating a safe place for contentious discussion, emotional release, reducing scrutiny and enabling topic control. In addition humour is shown as being an integral part of organisational culture and not something that should be studied separately. Understanding humour in individual schools is shown to be a complex relationship between leader, follower, context and authenticity. The production and reception of humour are shown to be equally influential in the development of organisational culture. The paper concludes by proposing that school leaders and staff members should have regard to the way that humour use reveals the lived values of the school community.

In this paper, we provide a practitioner summary of our paper "The Influence of Judgment Decomposition on Auditors' Fraud Risk Assessments: Some Trade-Offs'' (Simon, Smith, and Zimbelman 2018). In that study, we investigate potential unintended consequences from current auditing guidance on risk assessments. Specifically, auditing standards recommend separate assessments of the likelihood and magnitude of risks (hereafter, LM decomposition) when auditors assess risk. Our study involved several experiments, including one with experienced auditors, where we found evidence that LM decomposition leads auditors to be less concerned about high-risk fraud schemes relative to auditors who make holistic risk assessments. Our other experiments involved non-auditing settings and replicated this finding while exploring potential explanations for it. After providing a summary of our study and its results, we offer concluding remarks on the potential implications of our findings.

Seventy‐nine experienced internal auditors participated in an experiment investigating two factors that may affect internal auditors’ objectivity: (1) whether the internal audit function is used as a management training ground, and (2) whether the internal auditors’ reporting line is to management or the audit committee. Participants completed a case wherein management and the audit committee hold conflicting preferences regarding a major corporate investment opportunity. Participants evaluated relevant business risks and made an overall recommendation concerning the investment. The results include three important findings. First, we observe an interaction effect between management training ground and reporting line. When the internal audit function is not used as a management training ground, internal auditors’ risks assessments do not significantly differ by reporting line. However, when the internal audit function is used as a management training ground, internal auditors’ risk assessments align with management's preferences when auditors report to senior management versus the audit committee. Second, when the internal audit function is a management training ground, internal auditors provide more favorable investment recommendations (i.e., consistent with management's preferences). Third, internal auditors unexpectedly provided more favorable recommendations to the audit committee than to management.

ABSTRACT Auditing standards recommend separate assessments of the likelihood and magnitude of risks (hereafter, LM decomposition). Prior research shows that decomposition can focus individuals on the components of a judgment and make them more sensitive to information. An experiment with 101 experienced auditors shows that LM decomposition leads auditors to be less concerned about high-risk fraud schemes relative to auditors who make holistic risk assessments. Our analyses also show that, relative to those making holistic risk assessments, the correlation between auditors' likelihood judgments and their overall fraud risk judgments and the coherence of their fraud risk judgments are higher for auditors who perform an LM decomposition. Two follow-up experiments with students replicate these findings for higher-risk events, and (unlike the auditor experiment) we also find that LM decomposition results in lower risk judgments for lower-risk issues. We also find that LM decomposition mitigates the influence of affective responses on high-risk judgments.

The Sarbanes-Oxley Act (SOX) and its associated regulations significantly expanded the oversight role of audit committees and improved independence, but regulators bypassed restrictions on audit committee equity incentives. We examine the association of audit committee members' equity incentives and financial reporting quality in the post-SOX time period. We find that audit committee members' stock-option awards and holdings are positively associated with the likelihood of meeting/beating analyst earnings forecasts. On average, a company whose audit committee holds the mean value of exercisable option holdings is associated with a 10.0 percent increase in the likelihood of meeting or just beating its consensus analyst forecast. This effect increases to 17.8 percent for companies with high-growth opportunities. These results suggest that-even in the post-SOX era-the stock-option incentives provided to independent audit committee members are associated with reduced financial reporting quality.

In this study, seventy-nine experienced internal auditors from the gaming industry participated in an experiment designed to investigate two factors that may affect internal auditors' objectivity: (1) reporting to two masters (management or audit committee) who have conflicting preferences and (2) whether or not the internal audit function (IAF) is used as a management training ground (MTG). The participants completed a case – developed with assistance from industry chief audit executives – wherein they were asked to evaluate business risks associated with a major gaming investment and to make a final recommendation. The results include three important findings. First, the internal auditors' risk assessments reveal an interaction effect between masters’ preferences (MP) and MTG. When the IAF is not used as a MTG, internal auditors' risks assessments do not significantly differ when the IAF reports to senior management versus the audit committee. However, when the IAF is used as a MTG, internal auditors' risk assessments are significantly lower when the IAF reports to senior management versus the audit committee. Second, the internal auditors' recommendations show that they provided more favorable recommendations regarding the investment to the audit committee than to management. Third, when the IAF is used as a MTG, the internal auditors provide more favorable recommendations than when the IAF is not a MTG. Overall our results highlight the interplay between MP and whether or not the IAF is being used as a MTG on internal auditors’ objectivity.

In this study, seventy-nine experienced internal auditors from the gaming industry participated in an experiment designed to investigate two factors that may affect internal auditors' objectivity: (1) reporting to two masters (management or audit committee) who have conflicting preferences and (2) whether or not the internal audit function (IAF) is used as a management training ground (MTG). The participants completed a case – developed with assistance from industry chief audit executives – wherein they were asked to evaluate business risks associated with a major gaming investment and to make a final recommendation. The results include three important findings. First, the internal auditors' risk assessments reveal an interaction effect between masters’ preferences (MP) and MTG. When the IAF is not used as a MTG, internal auditors' risks assessments do not significantly differ when the IAF reports to senior management versus the audit committee. However, when the IAF is used as a MTG, internal auditors' risk assessments are significantly lower when the IAF reports to senior management versus the audit committee. Second, the internal auditors' recommendations show that they provided more favorable recommendations regarding the investment to the audit committee than to management. Third, when the IAF is used as a MTG, the internal auditors provide more favorable recommendations than when the IAF is not a MTG. Overall our results highlight the interplay between MP and whether or not the IAF is being used as a MTG on internal auditors’ objectivity.