the effect of fraud assessment documentation structure

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The Effect of Fraud Assessment Documentation Structure

on Auditors’ Ability to Identify Control Weaknesses:

The Moderating Role of Reviewer Experience

Christopher P. AgogliaDepartment of Accounting

Bennett S. LeBow College of BusinessDrexel University

Cathy BeaudoinDepartment of Accounting


George T. TsakumisDepartment of Accounting


3141 Chestnut StreetPhiladelphia, PA 19104-2875Telephone: (215) 895-2118

Fax: (215) 895-6279E-mail: [email protected]

We would like to thank Todd DeZoort, Rick Hatfield, Carmelita Troy, and participants at the2006 American Accounting Association Annual Meeting for their helpful comments.



The Effect of Fraud Assessment Documentation Structure on Auditors’ Ability to Identify

Control Weaknesses: The Moderating Role of Reviewer Experience

ABSTRACT: The current regulatory environment, brought on by recent high-profile audit

failures, expands the auditor’s role in detecting fraud. For example, auditors must now providean opinion on clients’ internal controls, addressing their effectiveness at preventing or detectingfraud. While the structure of workpaper documentation has been shown to affect audit workpaperpreparers’ assessments of overall fraud risk, prior research has not addressed the role theirreviewers’ experience plays in mitigating documentation structure effects. Our study matchesaudit workpaper preparers with reviewers to investigate whether reviewer task-specificexperience moderates the effect of fraud assessment documentation structure on the audit reviewteam’s ability to identify the presence of significant control weaknesses. Consistent withexpectations, we find that preparers who are required to document components of their fraudassessments inappropriately provided more favorable (and lower quality) assessments of significant control weaknesses than those using either a supporting or balanced documentation

structure. More importantly, results indicate that reviewer task-specific experience moderated theeffect of documentation structure on reviewers’ identification of control weaknesses such thatexperienced reviewers compensated more for the effect of component documentation thanreviewers with less experience. These results suggest that reviewer task-specific experience mayhelp reduce the previously observed “flow-through” effect of preparer workpaper deficiencies onreviewer judgments and provide support for new regulations emphasizing the role of experienceduring the control assessment process.

Keywords: review process; control environment; fraud assessment; control weakness; auditdocumentation; task-specific experience

Data availability: Data are available upon request.



INTRODUCTION

This study examines the role of reviewer task-specific experience in moderating the

effect of fraud assessment documentation structure on the audit review team’s ability to identify

significant control weaknesses.1 Recent high-profile audit failures have prompted Congress and

standard setting bodies to pass new regulations that emphasize and expand the auditor’s role in

detecting and preventing fraud (e.g., the Sarbanes-Oxley Act of 2002 and Statement on Auditing

Standards No. 99). Section 404 of the Sarbanes-Oxley Act now requires management of public

companies to assess the effectiveness of their internal controls, and to include this assessment

with their annual SEC filings. Auditors must also conduct their own independent assessment of,

and issue an opinion on, the effectiveness of their client’s internal controls. This increased

workload has pushed public accounting firms to increase recruiting on college campuses (Arndt

2004; Gomez 2004; The Daily News of Los Angeles 2004). The resulting increase in the ratio of

staff auditors to managers and partners puts additional focus on how firms can best utilize their

experienced reviewers at a time when the Public Company Accounting Oversight Board

(PCAOB) has emphasized the importance of auditor experience for assessing internal controls

(PCAOB 2004a).

As prior research suggests that preparer workpaper deficiencies can flow through the

review process and negatively impact reviewer judgments (Ricchiute 1999; Agoglia et al. 2003;

Tan and Trotman 2003), it is important to consider factors such as experience that may improve

reviewer performance when workpaper deficiencies exist. Research on auditor experience

indicates that task-specific experience often improves auditors’ judgments. Specifically, task-

specific experience obtained through task performance and review of others’ performance in an

1 Similar to Trotman (1985), we define a review team as consisting of a hierarchical pair of auditors: a subordinateauditor who prepares the workpapers (i.e., the preparer) and a supervising auditor who reviews this work (i.e., thereviewer), with the review team’s efforts culminating in the judgments/decisions of the reviewing auditor.



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area can lead to expert decision-making (Bonner 1990). Task-specific experience provides the

opportunity for the development of enhanced knowledge structures, which can improve auditors’

decision-making effectiveness (Biggs et al. 1987; Shelton 1999). Therefore, a reviewer’s

experience reviewing control environment assessments (i.e., task-specific experience) may

influence his/her effectiveness in identifying control weaknesses that present opportunities for

fraud. This is important because a key function of the review process is to help ensure the

appropriateness of conclusions drawn by less experienced auditors (Shelton 1999). Thus,

reviewer experience may be most critical in situations where the reviewer has to overcome

shortcomings of workpaper documentation prepared by less experienced auditors (Libby and

Trotman 1993).

When auditors make assessments, they are typically required to document their

conclusions in the audit workpapers. In practice, the format of such documentation may vary.

Since this documentation may serve as a source of evidence in the event of litigation, it is

important to consider the different ways in which auditors may structure such documentation

(Koonce et al. 1995). Agoglia et al. (2003) show that varying the format of a justification memo

affects the overall control environment assessments and evidence documented by audit

workpaper preparers as well as the judgments of their reviewers. Our study extends prior

research by examining whether reviewer task-specific experience moderates the effect of fraud

assessment documentation structure on the review team’s ability to identify specific control

weaknesses that present opportunities for fraud (as is now required PCAOB Auditing Standard

No. 5).

We presented auditors (preparers) a case containing control environment evidence for a

hypothetical client that was based on the control environment of an actual firm that had



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experienced fraud. Preparers were asked to compile documentation regarding the client’s control

environment and to identify control environment weaknesses with regard to fraud. Specifically,

preparers were required to document the control environment’s ability to prevent fraudulent

activities using evidence to support their assessments (supporting documentation), using both

important positive and important negative evidence about the control environment (balanced

documentation), or using important positive and negative evidence regarding components of the

control environment (component documentation). Preparers were then presented with ten fraud

risk factors identified in SAS No. 99 (AICPA 2002) and asked to assess how likely each was to

be a problem area for the client.

2

A reviewer was paired with each preparer and asked to review

the fraud assessment documentation. Reviewers then provided their own assessment of how

likely each of the ten fraud risk factors was to be a problem with regard to the client’s control

environment.

To investigate the moderating influence of reviewer task-specific experience, we must

first establish an effect of documentation structure on preparers’ workpapers. Our results indicate

preparers using the component documentation structure are less effective at identifying control

weaknesses (i.e., inappropriately assessed control weaknesses more favorably) than those using

either the supporting or balanced documentation structures. More importantly, the results

indicate that task-specific reviewer experience plays a significant role in mitigating the effect of

fraud assessment documentation structure on auditor fraud risk judgments. Specifically, reviewer

experience moderates the effect of component documentation on the identification of control

weaknesses. Relative to reviewers with less task-specific fraud assessment experience, reviewers

with greater experience appear to be better able to overcome judgment difficulties encountered

by their preparers.

2 Fraud risk factors represent potential weaknesses in controls with respect to the ability to prevent/detect fraud.



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The findings of our study contribute to the literature in several important ways. For

example, our results suggest that reviewer task-specific experience may help reduce the

previously observed “flow-through” effect of preparer workpaper deficiencies on reviewer

judgments (e.g., Ricchiute 1999; Agoglia et al. 2003; Tan and Trotman 2003). Thus, our results

help validate the emphasis that recent pronouncements place on experience during the fraud risk

and control assessment process (e.g., PCAOB 2004a; SAS No. 99). Further, while a number of

prior reviewer experience studies have examined differences between reviewers of varying ranks

(e.g., manager versus senior reviewer performance), few have considered (or found) differences

in reviewer reactions to experimental manipulations within experience levels (e.g., Messier and

Tubbs 1994). We find that experienced component reviewers react differently to their preparers’

assessments/documentation than their counterparts in the supporting or balanced documentation

conditions.

The remainder of this paper is organized as follows. The next section discusses the

theoretical background and hypotheses. This is followed by a description of the research method

and a presentation of the results. The final section offers conclusions and implications.

THEORY AND HYPOTHESES

The Current Professional Environment

The accounting profession is undergoing significant changes as a result of a number of

high profile corporate scandals, including Enron, WorldCom, Tyco, and Adelphia

Communications. Both Congress and the Auditing Standards Board (ASB) have acted to impose

greater responsibilities on auditors with respect to fraud and internal controls. Congress acted

with their passage of the Sarbanes-Oxley Act of 2002 and the ASB implemented SAS No. 99,

Consideration of Fraud in a Financial Statement Audit (AICPA 2002). Under SAS No. 99,



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auditors are required to gather and consider more information to assess fraud risk than they have

in the past, as well as explicitly document their assessment in the workpapers. Among other

responsibilities, SAS No. 99 requires that, when obtaining information about the client and its

environment, the auditor should consider the presence of fraud risk factors. SAS No. 99 (para.

31) defines fraud risk factors as “events or conditions that indicate incentives/pressures to

perpetuate fraud, opportunities to carry out the fraud, or attitudes/rationalizations to justify

fraudulent actions.”3

Although fraud risk factors do not necessarily indicate that fraud is present,

they often are present when fraud does exist and are, therefore, important elements to consider

within the scope of an audit engagement.

As part of compliance with Section 404 of the Sarbanes-Oxley Act, managers must

evaluate the effectiveness of their internal control procedures and auditors must evaluate the

accuracy of their client’s assertions.4 PCAOB Auditing Standard (AS) No. 5 addresses the

importance of controls over possible fraud. As a result of this standard, auditors conduct their

own independent assessment of (and issue an opinion on) internal controls, with respect to their

effectiveness at preventing or detecting fraud that may result in material misstatement of the

financial statements. Thus, while it has always been important to the performance of the audit,

the auditor’s responsibility for identifying and documenting control weaknesses has increased

substantially in the new regulatory environment. Further, PCAOB AS No. 3 addresses audit

documentation. AS No. 3 states that auditors who prepare (e.g., preparers) audit documentation

should provide sufficient information to enable an experienced auditor (e.g., reviewer) to

3 SAS No. 99 provides examples of fraud risk factors related to fraudulent financial reporting (e.g., revenuerecognition policies and management estimate issues) and misappropriation of assets (e.g., inadequate controls overcash and inventory items).4 Internal control assessment involves ensuring that steps are in place to prevent or detect the theft or unauthorizeduse of the company’s assets to the extent that such prohibited acts could result in a material effect on the financialstatements. The control environment, a component of internal control, “sets the tone of the organization, influencingthe control consciousness of its people” and is the “foundation” upon which all other internal controls rest (AICPA1995, para. 25).



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understand the procedures performed, evidence obtained, and conclusions reached, including

relevant information inconsistent with conclusions (PCAOB 2004b). This recent guidance

highlights the importance of audit documentation quality and its significance for those who

review the documentation.

Alternative Documentation Structures

Auditors are typically required to document their conclusions in the workpapers, which

will later be scrutinized by those supervising their work. Audit workpapers contain

documentation relating to various aspects of the audit such as planning, internal control

evaluations, and audit procedures performed. The form this documentation takes, however, can

vary in practice. Given that this documentation typically provides rationale for the auditor’s

opinion and often serves as key sources of legal evidence in the event of litigation (Koonce et al.

1995), it is important to consider the potential effect of the documentation’s structure on audit

judgment.

Related research has focused on comparing the differences in judgments between

auditors required, or not required, to justify their decisions (e.g., Johnson and Kaplan 1991;

Koonce et al. 1995; Peecher 1996; Hoffman and Patton 1997). Although this research indicates

that justification can affect audit judgments, it does not examine the effects of how that

documented justification is structured. A recent study examines the effects of alternatively

structured justification memos on audit judgments. Agoglia et al. (2003) find that the format of

these justifications (i.e., how the workpapers require them to be structured) can affect the overall

fraud risk assessments of auditors preparing this documentation as well as those of auditors

reviewing their work. Following Agoglia et al. (2003), we investigate three different structures in

which preparers can document their fraud assessments: (1) supporting documentation, which



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requires preparers to provide evidence supporting their conclusions; (2) balanced documentation,

which requires preparers to document important positive and negative evidence (e.g., both

strengths and weaknesses of a client’s control environment); and (3) component documentation,

which requires preparers to document important positive and negative information for

components of their task (e.g., strengths and weaknesses of components of the control

environment).5 The first two represent more holistic approaches to documentation, while the

third can be thought of as a decomposition of the workpapers into smaller parts.

The literature on judgment decomposition reveals some relative advantages and

disadvantages of breaking judgments down into components, compared to holistic judgments

(e.g., Einhorn 1972; Gettys et al. 1973; Slovic et al. 1977; Jiambalvo and Waller 1984; Jako and

Murphy 1990). For example, attending to a single component at a time may allow the individual

to consider more information regarding the particular component than when making a more

holistic judgment (Armstrong et al. 1975; Ravinder et al. 1988). Somewhat ironically, however,

this increase in total information considered could also result in a shift in focus away from

critical items toward this additional, and often less relevant, evidence. Cornelius and Lyness

(1980) demonstrate that judgment decomposition can force individuals to attend to

inappropriate/irrelevant information and to use more information than is necessary for the overall

judgment, resulting in less effective performance. Further, it appears that individuals are not

particularly good at combining portions of a judgment into an integrated whole. Prior research

suggests that requiring individuals to integrate their component judgments into overall judgments

can diminish, or even reverse, the benefits of decomposition (e.g., Cornelius and Lyness 1980;

5 While not intended to represent an exhaustive list of possible documentation structures, these three documentationstructures were chosen to be consistent with prior research and because they represent structures similar to those thathave been used in practice (Agoglia et al. 2003). Further, discussions with practicing auditors and an examination of a sample of workpapers from international public accounting firms suggests that these structures are similar to thoseauditors are familiar with in practice.



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Lyness and Cornelius 1982; Jiambalvo and Waller 1984). Thus, component documentation,

which similarly requires preparer integration of smaller parts into a greater whole, may not

compare favorably to more holistic approaches like balanced and supporting documentation.

The results of Agoglia et al. (2003) support this notion. They find that component

justification memos result in the greatest amount of evidence documented and the lowest (i.e.,

most favorable) overall fraud risk levels assessed by preparers, relative to balanced and

supporting memos. They attribute this result to the fact that auditors using component memos

documented more total evidence items than auditors in the other memo conditions. If a large

amount of evidence is documented, the relative weight given to each evidence item is likely to

decrease (Pincus 1989), which may affect an auditor’s judgments when the proportion of positive

and negative evidence is imbalanced. For example, if a client’s control environment has only a

small number of weaknesses, the relative weight given to these weaknesses is likely to decrease

as the overall set of evidence considered increases (e.g., Hackenbrack 1992; Glover 1997;

Hoffman and Patton 1997; Shelton 1999).

Given that even troubled clients typically have a greater proportion of positive control

environment characteristics than negative characteristics (Agoglia et al. 2003), the increased

documentation requirements for our component documentation structures will tend to result in a

greater focus on positive evidence. In turn, component documentation preparers may be less

likely to identify significant control weaknesses as areas of concern than supporting or balanced

preparers. Thus, we expect that documentation structure will affect preparers’ ability to identify

specific control weaknesses in much the same way as it has been found to affect overall

assessments of the control environment. It is necessary to first establish that this effect exists in



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order to investigate the role reviewer experience plays in moderating it, our primary focus in this

study. Therefore, we test the following hypothesis to establish the requisite effect:

H1: Component documentation preparers will assess control environment weaknesses

more favorably than preparers using supporting and balanced documentation.

Reviewer Task-Specific Experience

When auditors make assessments, they are typically required to document their

conclusions in the audit workpapers, which are subject to review by a supervising auditor (Emby

and Gibbins 1988; Brazel et al. 2004). One of the main functions of the review process is to

ensure workpaper quality (i.e., the adequateness of procedures performed and appropriateness of

conclusions drawn) (Libby and Trotman 1993; AICPA 2006b). However, this quality control

function becomes a more challenging task for reviewers when there are shortcomings in their

preparers’ workpapers which they must overcome. Prior research suggests that biases and

deficiencies in the workpapers can flow through the review process and negatively impact

reviewer judgments (Ricchiute 1999; Agoglia et al. 2003; Tan and Trotman 2003; Agoglia et al.

2007). For example, Ricchiute (1999) finds that receiving different (biased) subsets of a larger

evidence set can bias partners’ going concern decisions, and Agoglia et al. (2003) demonstrate

that altering the format of a justification memo can affect preparers’ judgments and, in turn, that

this effect persists through the review process to influence reviewer judgments. These prior

studies, however, do not investigate potential factors that may mitigate workpaper deficiencies

during the review (i.e., factors that reduce the observed “flow-through” effect). Reviewer

experience is an important variable to consider since a primary function of the hierarchical

review process is to reduce the likelihood of the audit being compromised by the judgments of

less-experienced auditors (Solomon 1987; Shelton 1999; Brazel et al. 2004).



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Research on auditor experience indicates that auditors’ judgments often improve with

greater experience. Bonner and Lewis (1990) show that auditors with more experience generally

perform more effectively than auditors with less experience. Experience provides an opportunity

for the acquisition of relevant technical knowledge, which is essential for improving task

performance (Libby 1995). As a result, auditors with more experienced-based knowledge usually

make better decisions than auditors with less (Libby and Luft 1993). For example, Knapp and

Knapp (2001) show that, with greater levels of experience, auditors become more effective at

assessing the risk of financial statement fraud. Prior research also suggests that task-specific

experience improves auditors’ judgments. Task-specific experience, obtained through exposure

to an area, can lead to expert decision making (Bonner 1990). As a result of their well-developed

knowledge structures, expert auditors tend to use directed strategies to acquire information

pertinent to a specific decision or task, resulting in more effective decision making (Biggs et al.

1987; Shelton 1999).6

The judgment and decision-making literature suggests that experienced individuals are

better able to integrate large or complex data sets for evaluative tasks due to their more fully

developed knowledge structures (e.g., Larkin et al. 1980; Patel et al. 1986; Hassebrock et al.

1993; Wiggins and O’Hare 1995; Sohn and Doane 2004). For example, Wiggins and O’Hare

(1995) show that individuals experienced at an evaluative task are more likely to go beyond

6 However, while experience has been shown to improve auditor performance in general, there are some exceptions

to these findings (e.g., Monroe and Ng 2000; Chung and Monroe 2000). For example, Choo and Trotman (1991)find that, while their performance is superior on certain recall measures, experienced auditors are more likely thaninexperienced auditors to incorrectly recall atypical items that were not part of the original evidence set. Studiesspecifically examining the role of reviewer experience in audit workpaper review have produced somewhat mixedresults as well. For example, Ramsay (1994) and Harding and Trotman (1999) find that, compared to lower rankingreviewers, higher ranking reviewers (e.g., partners versus managers) are better at detecting conceptual errors but notas effective at detecting mechanical errors, and Ballou (2001) finds no benefit of reviewer experience in his setting.Further, prior reviewer experience studies have typically not found differences in reviewer reactions to experimentalmanipulations within experience levels (as we expect in our study). For example, Messier and Tubbs (1994) find nosignificant differences in judgment for experienced reviewers (managers) in “review” and “no-review” conditions.



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surface representation of the problem/task and to use more structured and efficient information

search strategies than their less experienced counterparts. Patel et al. (1986) and Hassebrock et

al. (1993) find that, through more fully developed knowledge structures, experienced individuals

tend to focus more on information relevant to a decision than those with less experience.

Thus, the knowledge structures developed through task-specific experience (e.g.,

experience performing and reviewing evaluations of the effectiveness of a client’s control

environment) should help reviewers to focus their reviews on more relevant evidence items

(Biggs et al. 1987; Shelton 1999), allowing them to better identify the true nature of a specific

fraud risk factor(s). Reviewers with greater task-specific experience are likely to be less

influenced by their preparers’ conclusions/documentation (i.e., better equipped to formulate an

independent evaluation of the evidence), particularly in situations where the preparer’s

assessment does not appropriately reflect conditions at the client. This notion is consistent with

Brazel and Agoglia (2007), who view the auditor risk assessment process as a belief revision

task, with a prior assessment serving as a starting point, or “anchor.” This anchor is then revised,

often insufficiently, to create a current assessment. In cases where preparer assessments and

workpapers do not fully reflect conditions at the client, reviewers with lower task-specific

experience may be less able to properly integrate evidence and appropriately assess the impact of

specific fraud risk factors on the firm’s control environment given their less-developed

knowledge structures. Therefore, these reviewers may be more likely to anchor on their

preparers’ fraud risk factor assessments and, in turn, their assessments may deviate less from

those of their preparers. In contrast, more experienced reviewers’ knowledge structures should

enable them to better integrate evidence to identify and react to specific weaknesses affecting the

firm’s control environment, resulting in assessments that deviate farther from their preparers’



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assessments (when preparers’ assessments do not appropriately reflect current conditions) than

those of less experienced reviewers.

Therefore, while prior findings suggest that inadequacies in preparer workpapers tend to

flow through to reviewer judgments (Ricchiute 1999; Agoglia et al. 2003; Agoglia et al. 2007),

more experienced reviewers’ knowledge structures may allow them to more effectively

overcome the challenges presented by documentation structure and better assess the impact of

fraud risk factors on the firm’s control environment than their less experienced counterparts.

With respect to the three documentation structures investigated here, more experienced reviewers

may be better equipped to overcome the potential oversights of preparers in the component

documentation condition (i.e., relative to those with less experience, experienced component

reviewers may be more likely to identify control weaknesses that their preparers may have

overlooked). If the supporting and balanced conditions result in better preparer documentation

and assessments, then there is less of a burden on the reviewer and reviewer experience becomes

less of a factor. Thus, we expect that reviewer task-specific experience will moderate the effect

of documentation structure on the difference between preparer-reviewer control weakness

assessments. That is, given the requisite preparer documentation effect anticipated by H1, we

expect preparer-reviewer assessment differences to be greatest when preparers document their

assessments using component documentation and the reviewer is more experienced. The

following hypothesis is, therefore, tested:

H2: As reviewer task-specific experience increases, differences between preparer andreviewer assessments of control environment weaknesses will be greater forcomponent documentation audit teams than for the supporting and balanceddocumentation audit teams.



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METHOD

Participants

One hundred and eight practicing auditors from large international accounting firms

participated in the study (54 as preparers and 54 as reviewers). Auditors participating as

preparers were generally audit seniors with an average of 4.0 years experience, while auditors

participating as reviewers were generally audit managers with an average of 8.7 years

experience. Discussions with audit partners indicate that auditors with these titles and levels of

experience are familiar with evaluating control environments and reviewing these evaluations,

respectively. Mean years of audit experience were not significantly different between

experimental conditions for either preparer or reviewer participants.7 Participants completed the

experiment at their offices.

Experimental Case

The experimental materials relate to the control environment of a hypothetical client and

are based on the audit of an actual company that experienced a misappropriation of assets (i.e.,

fraud). We choose this setting for our experiment given a number of recent high-profile audit

failures in which weak aspects of the control environment were unable to prevent a

misappropriation of assets (e.g., Tyco International, Adelphia Communications, and Patterson-

UTI Energy (Glovin 2003; Howe 2002; Blaney 2005)). Our case is derived from materials

developed and employed by Agoglia et al. (2003) and updated, where necessary, to reflect the

current auditing environment. While much of the evidence presented in the case is similar, the

dependent variables we gather from participants are different than in their study. In our study, we

7 Demographic variables including familiarity with authoritative guidance, effort spent on the task, and pressure toperform the task were not significantly different between groups and did not have a significant effect on the overallfindings (p’s > .40).



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collect data relating to the identification of certain fraud risk factors, rather than more holistic

assessments of fraud.

We choose to investigate the identification of specific fraud risk factors in a control

environment setting given the relevance of the control environment to an entity’s ability to

prevent, deter, mitigate, and/or detect fraud. SAS No. 106 (AICPA 2006a) states that the auditor

must obtain a sufficient understanding of the entity and its environment, including the control

environment, to assess the risk of material misstatement due to fraud. Further, SAS No. 78

(AICPA 1995) indicates that controls intended to address the risks of fraud should be considered

when assessing internal controls, and that an effective control environment can help reduce the

risk of fraud. SAS No. 99 (AICPA 2002) requires explicit assessment of the risk of material

misstatement due to fraud (from both misappropriation of assets and fraudulent financial

reporting) and identifies three conditions that are generally present when fraud exists:

incentive/pressure for management to commit fraud, opportunity for fraud to be perpetrated, and

a culture or environment that enables management to rationalize committing fraud. Evidence

gathered to assess an entity’s control environment can be useful in determining the

presence/absence of these three conditions. In fact, SAS No. 99 explicitly recommends the

consideration of a number of fraud risk factors specifically relating to the control environment

when assessing the risk of fraud at the client. The evidence presented in our case is designed to

provide information relevant to determining the existence of these three conditions for fraud, and

the fraud risk factors that our participants consider directly relate to these conditions.

We selected ten fraud risk factors for inclusion in our study. The ten factors come from

SAS No. 99 and relate to the control environment. Two individuals involved with the actual

audit examined the case materials to identify whether each fraud risk factor was likely or



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unlikely to be a problem area with respect to the control environment’s ability to prevent fraud.

Based on the evidence provided in the case materials, four of the ten fraud risk factors were

determined to be serious problem areas (i.e., significant weaknesses), while the remaining six

were determined to be areas of strength.8 Fraud risk factor categorization as a weakness or

strength was confirmed by three experts (audit partners) not involved with the actual audit

engagement. These expert responses were used to determine the appropriateness of participants’

fraud risk assessments.

The case materials included background information on the client and detailed

information regarding the client’s control environment. The information was presented in the

form of audit team member comments provided across the seven control environment

dimensions incorporated in SAS No. 78 (AICPA 1995). The seven dimensions are: integrity and

ethical values, commitment to competence, board of directors and audit committee,

management’s philosophy and management style, organizational structure, the assignment of

authority and responsibility, and human resource policies and practices. The evidence set

presented to participants was extensive, containing 126 separate evidence items.

Preparer Task

Preparers were randomly assigned to a fraud assessment documentation structure

condition, provided a case booklet, and required to prepare and document an assessment of the

control environment’s ability to prevent fraudulent activities. The instructions required preparers

to structure their assessment documentation in one of three ways: using evidence that supports

their assessment of the client’s control environment (supporting documentation), using both

8 The four problem areas are: (1) management’s attitude toward overriding controls, (2) degree of oversight relatedto the company’s control structure exercised by management, (3) controls related to safeguarding of assets, and (4)segregation of duties, particularly for personnel in key functions.



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positive and negative evidence about the control environment (balanced documentation), and

using positive and negative evidence about components of the control environment (component

documentation). We examined a sample of workpapers from international audit firms to ensure

that participants would be familiar with these structures. Our examination suggests that: a)

auditors are commonly required to document evidence for components of a larger judgment, b)

auditors are often asked to document evidence in support of their judgments, and c)

documentation of important inconsistent evidence may be requested (which is noted in PCAOB

AS No. 3). Discussions with auditors from international firms also suggest that they are regularly

asked to provide documentation in various formats and that our structures are familiar to these

auditors.9 After completing the documentation, preparers assessed the impact of the ten randomly

ordered specific fraud risk factors (six control strengths and four control weaknesses, discussed

above) on the control environment’s ability to prevent fraud. Specifically, preparers were asked

whether each factor was likely or unlikely to be a problem area. Responses were made on ten-

point scales, with endpoints labeled “highly unlikely to be a problem area” (coded as 10) and

“highly likely to be a problem area” (coded as 1). Preparer participants then responded to a series

of demographic and case-related questions.

Reviewer Task

Reviewers received the same client background and control environment information as

preparers. They were randomly matched with a preparer and reviewed that individual’s fraud

9 Additionally, while we received informal feedback from many participants upon completion of the study, nonementioned any discomfort with the format of the documentation. We also analyze a measure of effort preparer andreviewer participants spent on their respective tasks to help provide assurances that our results are not driven byparticipants’ familiarity with the assigned documentation structure (e.g., one might expect a participant to reportspending more effort on a workpaper in which the documentation structure was unfamiliar). Analyses using thisvariable indicate that there are no differences between documentation structure groups on this variable and thatincluding it as a control variable does not alter our conclusions. While these additional insights are not conclusive,they provide us with greater confidence that a “novelty” effect is not at play in our results.



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assessment documentation, which had been structured using one of the three documentation

conditions. After reviewing their preparer’s control environment assessment documentation,

reviewers were provided with a list of the ten specific fraud risk factors, along with their

preparer’s assessments of these factors. Reviewers were asked to assess whether each of the ten

fraud risk factors was a potential problem area for the client on the same ten-point scales as those

utilized by the preparers. Like the preparer participants, reviewers also responded to a series of

demographic and case-related questions, including a measure of task-specific experience.

RESULTS

Hypothesis One

Hypothesis 1 predicts that component documentation preparers would assess control

environment weaknesses as less problematic (with regard to fraud) for the client than preparers

using supporting or balanced documentation. To test H1, we analyzed preparers’ responses in a 1

x 3 ANOVA with documentation structure (supporting, balanced, or component) as the

independent variable and participants’ mean assessments of four control environment

weaknesses as the dependent variable. Participants indicated how likely each factor was to be a

problem with regard to the control environment’s ability to prevent fraud on a 10-point scale

(where 1 = “highly likely to be a problem area” and 10 = “highly unlikely to be a problem area”).

Thus, lower (higher) scores indicate that the participant perceived the control environment as less

likely (more likely) to prevent fraudulent activities associated with that risk factor. Table 1

presents participants’ assessments of the four control environment weaknesses.

[Insert Table 1]

Panel A of Table 1 shows that preparers’ mean assessments (across the four control

environment weaknesses) were 3.89, 3.94, and 5.61, respectively, for the supporting, balanced,



18

and component documentation groups (F = 7.930, p = .001). Contrast tests presented in Panel B

indicate that the mean assessment of the component group was significantly higher (i.e.,

component preparers assessed the four factors as lower risk) than the balanced and supporting

groups (p’s < .001). Similar results are observed for each of the four control weaknesses

individually (see Table 1). Consistent with H1, these data suggest that the component

documentation preparers inappropriately viewed control weaknesses more favorably than

preparers in the supporting and balanced groups. Specifically, preparers using component

documentation indicated that there was a lower likelihood that these control environment

weaknesses would be a problem with regard to the control environment’s ability to prevent

fraud. It appears that, consistent with the development of H1, the increased documentation

requirements for the component documentation structure resulted in a greater focus on positive

evidence, in turn leading to more favorable assessments of control weaknesses observed for

component group preparers. We find that preparers in the component group documented

significantly more positive evidence items (62.8% of their total documented evidence), on

average, than either the supporting or balanced groups (43.5% and 49.6%, p = .001 and p = .023,

respectively).10

In addition, we examine the quality of the preparers’ assessment. Similar to Tan (1995),

assessment quality is measured as the absolute deviation of preparer assessments from expert

assessments of the four control environment weaknesses, where more (less) deviation from

expert assessments indicates lower (higher) preparer assessment quality.11 Preparers’ mean

10 On average, preparers in the component group documented 51.9 total evidence items (33.4 positive items), whilethose in the supporting and balanced groups documented 21.0 (7.9 positive) and 27.9 (14.6 positive) items,respectively.11 Expert assessments came from three experts (audit partners) not involved with the actual audit engagement uponwhich the experimental case is based. For each participant, absolute deviations are calculated for each of the fourcontrol weaknesses individually and then averaged across the four items to produce a mean absolute deviation fromexpert assessments (i.e., our measure of “assessment quality”).



19

absolute deviations from experts’ assessments were 1.69, 1.64, and 2.89 for the supporting,

balanced, and component groups, respectively. Contrast tests indicate that component preparers’

mean absolute deviations from the experts was significantly higher than both the supporting (p =

.003) and balanced groups (p = .002). Thus, it appears that not only were component preparers’

control weakness assessments more favorable than those of preparers in the supporting and

balanced groups, they were also of lower quality.

Recall that preparers were also asked to assess the impact of six control strengths on the

control environment’s ability to prevent fraud. Interestingly, and contrary to what we found for

the four control weaknesses, documentation structure had no significant affect on preparers’

assessments of the control strengths (means = 6.89, 7.43, and 7.28 for the supporting, balanced,

and component groups, respectively; p = .492). These results indicate that the preparers in the

supporting and balanced conditions were not simply more conservative across the board (i.e., all

three groups were equally effective at recognizing control strengths), but that they were better

able to selectively direct attention to areas of weakness (i.e., they were better able to identify and

appropriately assess the weaknesses present at the hypothetical client) than those in the

component group.

Hypothesis Two

Given the H1 results, which establish the prerequisite effect of documentation structure

on preparers’ assessments of control weaknesses, we now turn our attention to H2 and the role of

reviewer task-specific experience in moderating the effect of documentation structure. To test

H2, we ran the following multivariate regression:

DIFF i = a0 + a1TSE + a2COM + a3TSE*COM + e (1)



20

DIFF represents the difference between preparer and reviewer responses. Specifically, DIFF is

calculated as the preparer’s minus the reviewer’s mean assessment for the four control

weaknesses. TSE represents reviewers’ task-specific experience.

12

Specifically, reviewers were

asked how much experience they had in reviewing evaluations of the effectiveness of a client’s

control environment. Responses were made on a 9-point scale, with endpoints labeled “very

extensive experience” (coded as 9) and “very limited experience” (coded as 1). Documentation

structure was dummy coded. COM is coded as 1 for component documentation and 0 otherwise.

Thus, the supporting and balanced groups serve as the baseline conditions since hypothesized

differences relate to comparisons between them and the component group. TSE*COM represents

the interaction between reviewer task-specific experience and documentation structure.

Table 2 reports the results from estimating the multiple regression model specified in

equation (1). Hypothesis 2 predicts that as reviewer task-specific experience (TSE) increases,

differences in preparer and reviewer assessments of control weaknesses will be greater for the

component documentation pairings than for the supporting and balanced audit teams. That is,

experience has the greatest impact when preparers are less effective at identifying significant

weaknesses in the client’s control environment. Given this hypothesized effect of reviewer

experience, we expect (and find) that component reviewers’ mean assessments begin to converge

toward those of the reviewers in other conditions (means = 4.04, 3.92, and 4.60 for the

supporting, balanced, and component groups, respectively; p = .396). With respect to a direct test

12 While it is generally preferable to manipulate independent variables to take better advantage of the benefitsoffered by experimental designs, one cannot easily manipulate factors such as forms of intelligence or expertise(Peecher and Solomon 2001), typically necessitating measurement of such variables. Ideally, given that our TSEvariable was to be measured, we would have preferred to use an independently (or researcher) assessed measure of reviewer expertise at performing the specific task. However, since an observable measure of expertise reviewingcontrol environment evaluations would have been infeasible to obtain (Abdolmohammadi and Shanteau 1992), weused a self-reported measure of task-specific experience as a surrogate for actual participant expertise (similar toBonner and Lewis’s (1990) measures of control and ratio knowledge; see also DeZoort and Salterio 2001;O’Donnell 2002; Brazel and Agoglia 2007).



21

of H2, we expect a significant positive coefficient for a3. Table 2 shows that the coefficient for

the interaction term (TSE*COM) is in the expected positive direction and statistically significant

(p = .008), providing support for H2.13, 14 Interestingly, when a general measure of experience

(years of audit experience) is substituted for TSE in the model, the interaction term is no longer

significant (p = .146). Thus, it appears that experience specific to the task (reviewing control

environment assessments), and not generic experience, is critical to reviewers being able to

overcome the challenges presented by documentation structure.

[Insert Table 2]

Although not hypothesized, we find a similar interactive effect for reviewers’ assessment

quality. As with preparer assessment quality, reviewer assessment quality is measured by

computing the mean of absolute deviations of reviewers’ assessments from experts’ assessments

across the four control environment weaknesses. Using an equation similar to equation (1) in

which reviewer assessment quality is substituted for DIFF as the dependent variable, we find that

task-specific experience (TSE) and documentation structure have an interactive effect on

reviewer assessment quality (TSE*COM is significant at p = .017). That is, as task-specific

experience (TSE) increases, component documentation reviewers’ assessment quality is less

affected by documentation structure. Thus, relative to less experienced component reviewers, it

appears that not only were experienced reviewers’ control weakness judgments less affected by

(anchored on) their preparers’ more favorable assessments, they were also of higher quality.

13

Altering the model to allow us to compare the component group directly to each of the other groups producessignificant interaction coefficients for the component-balanced comparison (p = .029) and the component-supportingcomparison (p = .024). Thus, H2 holds not only for comparisons between the component group and the balancedand supporting groups combined, but also for individual comparisons (i.e., component versus balanced andcomponent versus supporting).14 We dichotomize the component group at the median level of reviewer task-specific experience as a furtherillustration of the effect of task-specific experience. Resulting mean control weakness assessments for the high andlow experience reviewers are 3.79 and 5.03, respectively, suggesting that it is the experienced reviewers that aredriving this effect. Further, experienced reviewers tended to deviate farther from their preparers’ assessments (2.25lower than their preparers, on average) than less experienced reviewers (0.31 lower).



22

DISCUSSION

The current regulatory environment (e.g., the Sarbanes-Oxley Act of 2002 and SAS No.

99), brought on by recent high-profile audit failures, emphasizes and expands the auditor’s role

in detecting and preventing fraud. Sarbanes-Oxley requires management of publicly-traded

companies to assess the effectiveness of their internal controls, and to include this assessment

with their annual SEC filings. Auditors must also conduct their own independent assessment of,

and issue an opinion on, the effectiveness of their client’s internal controls. This increased

workload in the new regulatory environment has pushed public accounting firms to dramatically

increase recruiting, resulting in an increase in the ratio of audit staff to audit managers and

partners at a time when regulatory agencies are recognizing experience as playing a crucial role

in the effective assessment of internal controls and fraud risk (AICPA 2002; PCAOB 2004a). As

prior research suggests that preparer workpaper deficiencies can flow through the review process

and negatively impact reviewer judgments (Ricchiute 1999; Agoglia et al. 2003; Tan and

Trotman 2003; Agoglia et al. 2007), it is important to consider factors such as experience that

may improve reviewer performance when workpaper deficiencies exist. Prior research provides

some support for the importance of auditor experience, showing that experience obtained

through specific task performance can lead to improved decision-making (e.g., Bonner 1990).

And while the structure of workpaper documentation has been shown to affect auditors’

assessments of overall fraud risk (Agoglia et al. 2003), prior research has not addressed the role

their reviewers’ experience plays in mitigating documentation structure effects.

Our study matches audit workpaper preparers with reviewers to investigate whether

reviewer task-specific experience moderates the effect of fraud assessment documentation

structure on the audit review team’s ability to identify significant control weaknesses. Consistent



23

with expectations, we find that preparers using component documentation inappropriately assess

weaknesses in the control environment more favorably than those using either supporting or

balanced documentation, resulting in lower quality assessments for the component preparers.

More importantly, we find that reviewer task-specific experience moderates the effect of

documentation structure on reviewers’ identification of control weaknesses. Specifically,

experienced component reviewers react differently than their experienced balanced and

supporting counterparts by compensating more for the effect of documentation structure, while

less experienced component reviewers are unable to make this adjustment.

As with all research, our study’s limitations should be considered when evaluating the

findings. For example, due to logistical impracticalities we utilize a self-reported measure of

reviewer task-specific experience rather than an observable measure, likely introducing noise

into the measurement of task-specific experience. Further refinement of the reviewer task-

specific experience measure might allow for more precise conclusions. Additionally, our study

examines only three types of documentation structures and, thus, cannot speak to the effects of

other documentation structures that may be found in practice. Investigating other structures may

merit further research. We also investigate only a single task/context (i.e., we examine the effects

of documentation structure and reviewer experience in a fraud risk/control weakness assessment

setting). Future research could consider reviewer task-specific experience in other contexts and

review tasks to determine under which tasks/contexts this experience is most critical. Further,

experimental studies typically constrain the amount of information they incorporate in the

experimental materials, and our study is no exception. While the case we provide our participants

is extensive, it does not represent the all the evidence auditors may have at their disposal when



24

making such decisions and, thus, cannot fully capture the complexity of judgments that occur in

practice.

The findings of this study have implications for practice and future research. From a

practice standpoint, given the increased expectations with respect to assessing controls facing

audit firms today, results of this study suggest that they should consider the effect of how their

workpapers relating to the assessment of control weaknesses are structured. For example, SAS

No. 99 (AICPA 2002) repeatedly cautions the auditor to maintain a healthy level of “professional

skepticism” and explicitly discusses potential weaknesses and fraud risk factors relating to the

control environment to be on the lookout for. The standard emphasizes the need to exercise

professional skepticism in gathering and evaluating evidence throughout the audit and to

continually be alert for information or conditions that indicate a material misstatement due to

fraud may have occurred. This heavy focus on identifying weaknesses may not be well suited to

a component documentation structure, as component documentation tends to result in more

detailed documentation (i.e., more evidence, in general, including strengths). Thus, component

documentation may actually result in both less effective and less efficient fraud risk workpapers

than other, less detailed approaches.

In addition, while few studies consider differences in reviewer reactions to experimental

manipulations within experience levels (e.g., Messier and Tubbs 1994), we find that experienced

reviewers react differently to their preparers’ workpapers depending on the documentation

structure employed. Future research could investigate whether factors other than documentation

structure affect the judgments/reactions of reviewers within specific experience levels. Also, our

results suggest that reviewer task-specific experience may help reduce the previously observed

“flow-through” effect of preparer workpaper deficiencies on reviewer judgments (e.g., Ricchiute



25

1999; Agoglia et al. 2003). Our findings indicate that reviewers with greater task-specific

experience (relative to those of lesser experience) appear better suited to overcome their

preparers’ potential control weakness omissions in the workpapers. SAS No. 99 specifies that

personnel should be assigned engagement responsibilities based on a match between the task-

specific requirements and the knowledge, skill, and abilities of the auditor. Consistent with this

guidance, our results suggest that firms should assign more experienced reviewers to fraud risk

assessment reviews, particularly when the risk of material misstatement due to fraud is high.

Thus, our results help reinforce that the emphasis on experience during the fraud risk and control

assessment processes prescribed by recent pronouncements (e.g., AICPA 2002; PCAOB 2004a)

is well placed. Further, given new requirements relating to internal controls, future research

could investigate the effect of documentation structure and reviewer experience on the auditor’s

internal controls opinion decision. Such research will further our understanding of the effect of

documentation quality and structure on auditor judgment.



26

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31

TABLE 1

Preparer Control Weakness Assessments

Panel A: Descriptive Statistics and Analysis of Variance

Variablea

Supporting

(n=18)

Balanced

(n=18)

Component

(n=18)

F

Statistic

p

Valueb

Mean Assessment of FourControl Weaknesses

Mean(SD)

3.891.65

3.941.50

5.611.25

7.930 .001

Management’s Attitude TowardOverriding Controls

Mean(SD)

3.661.78

3.721.60

5.391.85

5.640 .006

Degree of ManagementOversight of Control Structure

Mean(SD)

3.781.66

4.171.75

5.611.75

5.640 .006

Controls to Safeguard Assets Mean(SD)

3.161.58

3.441.75

5.161.75

7.309 .002

Segregation of Duties Mean(SD)

4.942.67

4.442.25

6.281.67

3.233 .048

Quality of Preparer Assessments Mean(SD)

1.691.19

1.641.06

2.891.24

6.602 .003

Panel B: Contrast Tests Between Groups

Variablea Supporting

vs.

Balanced

Supporting

vs.

Component

Balanced

vs.

Component

Supporting &

Balanced vs.

Component

Mean Assessment of Four ControlWeaknesses

t-statisticp-valueb

-0.113.910

-3.504< .001

-3.391< .001

-3.981< .001

Management’s Attitude TowardOverriding Controls

t-statisticp-value

-0.095.924

-2.955.003

-2.860.003

-3.357< .001

Degree of Management Oversight

of Control Structure

t-statisticp-value

-0.676.502

-3.187.001

-2.511.008

-3.290.001

Controls to Safeguard Assets t-statisticp-value

-0.490.626

-3.529< .001

-3.039.002

-3.792< .001

Segregation of Duties t-statisticp-value

0.671.505

-1.789.040

-2.460.009

-2.453.008

Quality of Preparer Assessments t-statisticp-value

0.143.887

-3.073.003

-3.216.002

-3.631< .001



32

a Auditors were asked to assess the likelihood that each fraud risk factor was likely or unlikely to be aproblem area with regard to the client’s control environment. Assessments were made on 10-point scales,ranging from “highly unlikely to be a problem area” (coded as 10) to “highly likely to be a problem area”(coded as 1). Thus, lower scores indicate control environment weaknesses. Mean Assessment representsparticipants’ mean responses for the four fraud risk factors (Overriding Controls, Oversight of Control

Structure, Controls to Safeguard Assets, and Segregation of Duties). Quality of Preparer Assessments iscomputed as the absolute deviation of participants’ assessments from expert assessments of the fourcontrol weaknesses.b All tests are two-tailed except those regarding contrast tests for supporting vs. component and balancedvs. component, which are one-tailed due to the directional nature of expectations.



______________________________________________________________________________TABLE 2

Regression Results

DIFF i = a0 + a1TSE + a2COM + a3TSE*COM + e

Expected Sign b t-statistic p-valuea

a0 N/A N/A -1.34 .187TSE N/A .13 0.96 .344COM N/A -.29 -0.81 .424TSE*COM (H2) + .88 2.49 .008_____________________

aOne-tailed p-values are reported where the expected sign is unidirectional.

DIFF = measured as preparer’s minus reviewer’s mean assessment for the four control

environment weaknesses;

TSE = reviewers’ task-specific experience; reviewers indicated their experience reviewingevaluations of the effectiveness of a client’s control environment. Responses were madeon a 9-point scale, with endpoints labeled “very extensive experience” (coded as 9) and“very limited experience” (coded as 1);

COM = coded 1 for component documentation structure, 0 otherwise;

TSE*COM = interaction between reviewer task-specific experience and supporting documentationstructure;

the effect of fraud assessment documentation structure

Documents