Risk Disclosure Preceding Negative Outcomes: The Effects of - - PowerPoint PPT Presentation

Risk Disclosure Preceding Negative Outcomes: The Effects of Reporting Critical Audit Matters on Judgments of Auditor Liability

Kelsey Brasel, Ball State University Marcus Doxey, The University of Alabama Jonathan Grenier, Miami University Andrew Reffett, Miami University

Summary

• We examine the impact of critical audit matters on

jurors’ auditor negligence judgments.

– Comparing current practice with three instances of the proposed standards

• We find NO evidence that CAMs increase the

likelihood of juror negligence assessments.

• We find some evidence that CAMs reduce the

likelihood of juror negligence assessments.

• Consistent with Decision Affect Theory, negative

reactions to the auditors are reduced by CAM disclosures.

2

Background

• FRC (UK) - Extensive Communication
• IAASB – KAMs - From a limited subset of

information

• PCAOB – CAMs

– Critical Audit Matters – the areas of an audit that involved the most difficult, subjective, or complex judgments OR posed the greatest difficulty in

• btaining sufficient appropriate evidence OR posed

difficulty in forming an opinion (PCAOB 2013)

3

Background

• Sources to consider

– Engagement Completion Memo – Items communicated to the AC – Items considered by the quality control reviewer

• Required Disclosure

– Define a CAM and reiterate scope of assurance – Identify the CAM – Describe the basis for the CAM identification – Refer to applicable accounts and disclosures

4

Motivation: Litigation Barrier

• Richard Murray former head of legal affairs at a

Big 4 firm

– “Wave of litigation”(Katz 2014)

• Russell Kranzler chair of NYSSCPAs litigation

services committee

– Will increase lawsuits with auditors being second- guessed (Gaetano 2014)

• U.S. Chamber of Commerce (Rapoport 2013),

various others (PCAOB 2011, 2014) have expressed similar concerns.

5

Background

• Prior research shows that when auditors identify

and document areas of concern, but do not subsequently modify the opinion, negligence assessments increase:

– Reffett 2010 (fraud) – Backof 2014 (alternative accounting treatments)

• Key distinction – modification of the opinion

– Decision Affect Theory

6

Research Questions

• Will disclosing CAMs change evaluators’

assessments of auditor liability when auditors fail to detect a material misstatement?

– Compared to current practice – Compared to No CAM statement – When the CAM directly relates to the misstatement (Match) – When the CAM is unrelated to the misstatement (Mismatch)

7

Theory and Hypotheses

• Decision Affect Theory (Mellers et al. 1997,

Shepperd and McNulty 2002) indicates that affective reactions to negative outcomes are less severe when given advance warning.

• Evaluators’ affective reactions to the auditors are

a key determinant of liability judgments (Kadous 2000, 2001, Reffett 2010, Reffett et al. 2012).

• Volenti fit non injuria (to the consenting, no harm

is done)

8

Hypotheses - Affect

• Affective reactions to negative outcomes are less

severe with advance warning.

• H1a: When auditors fail to detect a material

misstatement, evaluators’ affective reactions to the auditors will be less negative when the audit report discloses a CAM that relates to the undetected misstatement compared to when the audit report is silent regarding CAMs.

• H1b: …explicitly states that the auditors did not

identify any CAMs.

9

Hypotheses - Responsibility

• Volenti fit non injuria
• H2a: When auditors fail to detect a material

misstatement, evaluators’ assessments of the plaintiff’s responsibility for losses incurred will be greater when the audit report discloses a CAM that relates to the undetected misstatement compared to when the audit report is silent regarding CAMs.

• H2b: …explicitly states that the auditors did not

identify any CAMs.

10

Hypotheses – End Result

• H3a: When auditors fail to detect a material

misstatement, evaluators’ assessments of auditor liability will be less severe when the audit report discloses a CAM that relates to the undetected misstatement compared to when the audit report is silent regarding CAMs.

• H3b: …explicitly states that the auditors did not

identify any CAMs.

11

Formal Research Questions

• Richard Murray argued at a PCAOB panel

discussion that: “if the company’s problem (i.e., misstatement) doesn’t concern any previously reported CAMs, shareholders can claim that many concerns were expressed by the auditor but not the right one, leaving the auditor and the company to defend a multitude of judgments that have none of the established decision criteria that exist for the single pass/fail judgment” (Katz 2014).

12

Formal Research Questions

• RQ1a: When auditors fail to detect

misstatements, how do evaluators’ assessments

• f auditor liability compare when the audit report

discloses CAMs unrelated to the undetected misstatement versus when the audit report is silent regarding CAMs?

• RQ1b: …explicitly states that the auditors did not

identify any CAMs.

13

Design and Methods

• 4x2
• CAM

– Control (current practice) – CAM (Inventory) – CAM (Liability) – No CAM (allowed under the proposal)

• Misstatement (fraud)

– Inventory – Liability for Land Restoration (LLR)

• Based on Kadous’ (2000, 2001) Big Time Gravel case

and Reffett’s (2010) adaptation of the case (LRL)

14

Design and Methods

• Participants

– Recruited through Mechanical Turk – N=528

• Previous juror studies have used Mechanical Turk

workers to proxy for jurors (Grenier, Pomeroy, and

Stern 2014; Grenier et al. 2014; Maksymov and Nelson 2014; Peecher, Reffett, and Zimbleman 2014)

• More diverse and representative than undergrads

(Paolacci et al. 2010, Horton et al. 2011, Buhrmester et al. 2011, Farrell et al. 2014)

15

Design and Methods

• Primary DV: Verdict (Negligent or Not)
• Other Measures:

– Gross negligence, auditor fraud, punitive damages

• Process variables

– Affect (H1) – Plaintiff fault (H2) – Counterfactual thoughts (Reffett 2010)

16

Results

• Manipulation checks

– CAM identification (combined 93% pass rate) – Misstatement Identification (96.6% pass rate) – Comprehension: Clean Opinion (97.9% pass rate)

• Participants failing one manipulation check do not

affect the inferences from the results.

17

Results – H1a & H1b (Affect)

18

Contrast Value Misstatement (+ = less negative) F1,520 p H1a Control vs. Match Inventory 10.17 9.01 0.002 Restoration Liability

• 4.83

2.17 0.141 Either 2.40 1.28 0.129 H1b None vs. Match Inventory 6.24 3.34 0.034 Restoration Liability 5.42 2.76 0.049 Either 5.48 6.10 0.007 RQ1a Control vs. Mismatch Inventory 8.45 6.27 0.013 Restoration Liability

• 2.43

0.53 0.468 Either 3.02 1.60 0.206 RQ1b None vs. Mismatch Inventory 4.51 1.76 0.185 Restoration Liability 7.83 5.51 0.019 Either 6.10 6.72 0.010

(-1.21 vs. 8.97) (5.97 vs. 1.14) (2.30 vs. 4.70) (2.73 vs. 8.97) (-4.29 vs. 1.14) (-0.78 vs. 4.70) (-1.21 vs. 7.24) (5.97 vs. 3.54) (2.30 vs. 5.32) (2.73 vs. 7.24) (-4.29 vs. 3.54) (-0.78 vs. 5.32)

Results – H1a & H1b (Affect)

19

Contrast Value Misstatement (+ = less negative) F1,520 p H1a Control vs. Match Inventory 10.17 9.01 0.002 Restoration Liability

• 4.83

2.17 0.141 Either 2.40 1.28 0.129 H1b None vs. Match Inventory 6.24 3.34 0.034 Restoration Liability 5.42 2.76 0.049 Either 5.48 6.10 0.007 RQ1a Control vs. Mismatch Inventory 8.45 6.27 0.013 Restoration Liability

• 2.43

0.53 0.468 Either 3.02 1.60 0.206 RQ1b None vs. Mismatch Inventory 4.51 1.76 0.185 Restoration Liability 7.83 5.51 0.019 Either 6.10 6.72 0.010

(-1.21 vs. 8.97) (5.97 vs. 1.14) (2.30 vs. 4.70) (2.73 vs. 8.97) (-4.29 vs. 1.14) (-0.78 vs. 4.70) (-1.21 vs. 7.24) (5.97 vs. 3.54) (2.30 vs. 5.32) (2.73 vs. 7.24) (-4.29 vs. 3.54) (-0.78 vs. 5.32)

Results – H1a & H1b (Affect)

20

Contrast Value Misstatement (+ = less negative) F1,520 p H1a Control vs. Match Inventory 10.17 9.01 0.002 Restoration Liability

• 4.83

2.17 0.141 Either 2.40 1.28 0.129 H1b None vs. Match Inventory 6.24 3.34 0.034 Restoration Liability 5.42 2.76 0.049 Either 5.48 6.10 0.007 RQ1a Control vs. Mismatch Inventory 8.45 6.27 0.013 Restoration Liability

• 2.43

0.53 0.468 Either 3.02 1.60 0.206 RQ1b None vs. Mismatch Inventory 4.51 1.76 0.185 Restoration Liability 7.83 5.51 0.019 Either 6.10 6.72 0.010

(-1.21 vs. 8.97) (5.97 vs. 1.14) (2.30 vs. 4.70) (2.73 vs. 8.97) (-4.29 vs. 1.14) (-0.78 vs. 4.70) (-1.21 vs. 7.24) (5.97 vs. 3.54) (2.30 vs. 5.32) (2.73 vs. 7.24) (-4.29 vs. 3.54) (-0.78 vs. 5.32)

Results – H1a & H1b (Affect)

21

Contrast Value Misstatement (+ = less negative) F1,520 p H1a Control vs. Match Inventory 10.17 9.01 0.002 Restoration Liability

• 4.83

2.17 0.141 Either 2.40 1.28 0.129 H1b None vs. Match Inventory 6.24 3.34 0.034 Restoration Liability 5.42 2.76 0.049 Either 5.48 6.10 0.007 RQ1a Control vs. Mismatch Inventory 8.45 6.27 0.013 Restoration Liability

• 2.43

0.53 0.468 Either 3.02 1.60 0.206 RQ1b None vs. Mismatch Inventory 4.51 1.76 0.185 Restoration Liability 7.83 5.51 0.019 Either 6.10 6.72 0.010

(-1.21 vs. 8.97) (5.97 vs. 1.14) (2.30 vs. 4.70) (2.73 vs. 8.97) (-4.29 vs. 1.14) (-0.78 vs. 4.70) (-1.21 vs. 7.24) (5.97 vs. 3.54) (2.30 vs. 5.32) (2.73 vs. 7.24) (-4.29 vs. 3.54) (-0.78 vs. 5.32)

Results – RQ1a & RQ1b (Affect)

22

Contrast Value Misstatement (+ = less negative) F1,520 p H1a Control vs. Match Inventory 10.17 9.01 0.002 Restoration Liability

• 4.83

2.17 0.141 Either 2.40 1.28 0.129 H1b None vs. Match Inventory 6.24 3.34 0.034 Restoration Liability 5.42 2.76 0.049 Either 5.48 6.10 0.007 RQ1a Control vs. Mismatch Inventory 8.45 6.27 0.013 Restoration Liability

• 2.43

0.53 0.468 Either 3.02 1.60 0.206 RQ1b None vs. Mismatch Inventory 4.51 1.76 0.185 Restoration Liability 7.83 5.51 0.019 Either 6.10 6.72 0.010

(-1.21 vs. 8.97) (5.97 vs. 1.14) (2.30 vs. 4.70) (2.73 vs. 8.97) (-4.29 vs. 1.14) (-0.78 vs. 4.70) (-1.21 vs. 7.24) (5.97 vs. 3.54) (2.30 vs. 5.32) (2.73 vs. 7.24) (-4.29 vs. 3.54) (-0.78 vs. 5.32)

Results H2a & H2b (Plaintiff Responsibility)

23

Contrast Value Misstatement (+ = more responsible) F1,520 p H2a Control vs. Match Inventory 0.64 13.81 < 0.001 Restoration Liability 0.07 0.15 0.349 Either 0.36 8.65 0.002 H2b None vs. Match Inventory 0.49 7.76 0.003 Restoration Liability 0.24 2.00 0.079 Either 0.36 8.94 0.002 RQ1a Control vs. Mismatch Inventory 0.14 0.65 0.419 Restoration Liability

• 0.17

1.04 0.308 Either

• 0.01

0.02 0.885 RQ1b None vs. Mismatch Inventory

• 0.02

0.01 0.917 Restoration Liability 0.00 0.00 0.982 Either

• 0.01

0.01 0.928

(-0.34 vs. 0.30) (0.18 vs. 0.24) (-0.09 vs. 0.27) (-0.19 vs. 0.30) (0.01 vs. 0.24) (-0.09 vs. 0.27) (-0.34 vs. -0.20) (0.18 vs. 0.00) (-0.09 vs. -0.10) (-0.19 vs. -0.20) (0.01 vs. 0.00) (-0.09 vs. 0.10)

Results H2a & H2b (Plaintiff Responsibility)

24

Contrast Value Misstatement (+ = more responsible) F1,520 p H2a Control vs. Match Inventory 0.64 13.81 < 0.001 Restoration Liability 0.07 0.15 0.349 Either 0.36 8.65 0.002 H2b None vs. Match Inventory 0.49 7.76 0.003 Restoration Liability 0.24 2.00 0.079 Either 0.36 8.94 0.002 RQ1a Control vs. Mismatch Inventory 0.14 0.65 0.419 Restoration Liability

• 0.17

1.04 0.308 Either

• 0.01

0.02 0.885 RQ1b None vs. Mismatch Inventory

• 0.02

0.01 0.917 Restoration Liability 0.00 0.00 0.982 Either

• 0.01

0.01 0.928

(-0.34 vs. 0.30) (0.18 vs. 0.24) (-0.09 vs. 0.27) (-0.19 vs. 0.30) (0.01 vs. 0.24) (-0.09 vs. 0.27) (-0.34 vs. -0.20) (0.18 vs. 0.00) (-0.09 vs. -0.10) (-0.19 vs. -0.20) (0.01 vs. 0.00) (-0.09 vs. 0.10)

Results H2a & H2b (Plaintiff Responsibility)

25

Contrast Value Misstatement (+ = more responsible) F1,520 p H2a Control vs. Match Inventory 0.64 13.81 < 0.001 Restoration Liability 0.07 0.15 0.349 Either 0.36 8.65 0.002 H2b None vs. Match Inventory 0.49 7.76 0.003 Restoration Liability 0.24 2.00 0.079 Either 0.36 8.94 0.002 RQ1a Control vs. Mismatch Inventory 0.14 0.65 0.419 Restoration Liability

• 0.17

1.04 0.308 Either

• 0.01

0.02 0.885 RQ1b None vs. Mismatch Inventory

• 0.02

0.01 0.917 Restoration Liability 0.00 0.00 0.982 Either

• 0.01

0.01 0.928

(-0.34 vs. 0.30) (0.18 vs. 0.24) (-0.09 vs. 0.27) (-0.19 vs. 0.30) (0.01 vs. 0.24) (-0.09 vs. 0.27) (-0.34 vs. -0.20) (0.18 vs. 0.00) (-0.09 vs. -0.10) (-0.19 vs. -0.20) (0.01 vs. 0.00) (-0.09 vs. 0.10)

Results RQ1a & RQ1b (Plaintiff Responsibility)

26

Contrast Value Misstatement (+ = more responsible) F1,520 p H2a Control vs. Match Inventory 0.64 13.81 < 0.001 Restoration Liability 0.07 0.15 0.349 Either 0.36 8.65 0.002 H2b None vs. Match Inventory 0.49 7.76 0.003 Restoration Liability 0.24 2.00 0.079 Either 0.36 8.94 0.002 RQ1a Control vs. Mismatch Inventory 0.14 0.65 0.419 Restoration Liability

• 0.17

1.04 0.308 Either

• 0.01

0.02 0.885 RQ1b None vs. Mismatch Inventory

• 0.02

0.01 0.917 Restoration Liability 0.00 0.00 0.982 Either

• 0.01

0.01 0.928

(-0.34 vs. 0.30) (0.18 vs. 0.24) (-0.09 vs. 0.27) (-0.19 vs. 0.30) (0.01 vs. 0.24) (-0.09 vs. 0.27) (-0.34 vs. -0.20) (0.18 vs. 0.00) (-0.09 vs. -0.10) (-0.19 vs. -0.20) (0.01 vs. 0.00) (-0.09 vs. 0.10)

Results – H3

27

Results – H3 (Verdicts)

28

Results – H3a & H3b (Verdicts)

29

Contrast Misstatement Value Chi-Square p H3a Control vs. Match Inventory

• 16.8%

4.16 0.021 Restoration Liability

• 4.2%

0.34 0.281 Either

• 9.7%

2.87 0.045 H3b None vs. Match Inventory

• 24.0%

7.99 0.003 Restoration Liability

• 13.3%

2.47 0.058 Either

• 17.9%

8.82 0.002 RQ1a Control vs. Mismatch Inventory

• 7.4%

0.78 0.377 Restoration Liability

• 3.6%

0.25 0.616 Either

• 5.4%

0.88 0.347 RQ1b None vs. Mismatch Inventory

• 14.7%

2.89 0.089 Restoration Liability

• 12.7%

2.17 0.141 Either

• 13.6%

4.89 0.027

(39.7% vs. 23.0%) (43.9% vs. 39.7%) (41.8% vs. 32.1%) (47.0% vs. 23.0%) (53.0% vs. 39.7%) (50.0% vs. 32.1%) (39.7% vs. 32.3%) (43.9% vs. 40.3%) (41.8% vs. 36.4%) (47.0% vs. 32.3%) (53.0% vs. 40.3%) (50.0% vs. 36.4%)

Results – H3a & H3b (Verdicts)

30

Contrast Misstatement Value Chi-Square p H3a Control vs. Match Inventory

• 16.8%

4.16 0.021 Restoration Liability

• 4.2%

0.34 0.281 Either

• 9.7%

2.87 0.045 H3b None vs. Match Inventory

• 24.0%

7.99 0.003 Restoration Liability

• 13.3%

2.47 0.058 Either

• 17.9%

8.82 0.002 RQ1a Control vs. Mismatch Inventory

• 7.4%

0.78 0.377 Restoration Liability

• 3.6%

0.25 0.616 Either

• 5.4%

0.88 0.347 RQ1b None vs. Mismatch Inventory

• 14.7%

2.89 0.089 Restoration Liability

• 12.7%

2.17 0.141 Either

• 13.6%

4.89 0.027

(39.7% vs. 23.0%) (43.9% vs. 39.7%) (41.8% vs. 32.1%) (47.0% vs. 23.0%) (53.0% vs. 39.7%) (50.0% vs. 32.1%) (39.7% vs. 32.3%) (43.9% vs. 40.3%) (41.8% vs. 36.4%) (47.0% vs. 32.3%) (53.0% vs. 40.3%) (50.0% vs. 36.4%)

Results – H3a & H3b (Verdicts)

31

Contrast Misstatement Value Chi-Square p H3a Control vs. Match Inventory

• 16.8%

4.16 0.021 Restoration Liability

• 4.2%

0.34 0.281 Either

• 9.7%

2.87 0.045 H3b None vs. Match Inventory

• 24.0%

7.99 0.003 Restoration Liability

• 13.3%

2.47 0.058 Either

• 17.9%

8.82 0.002 RQ1a Control vs. Mismatch Inventory

• 7.4%

0.78 0.377 Restoration Liability

• 3.6%

0.25 0.616 Either

• 5.4%

0.88 0.347 RQ1b None vs. Mismatch Inventory

• 14.7%

2.89 0.089 Restoration Liability

• 12.7%

2.17 0.141 Either

• 13.6%

4.89 0.027

(39.7% vs. 23.0%) (43.9% vs. 39.7%) (41.8% vs. 32.1%) (47.0% vs. 23.0%) (53.0% vs. 39.7%) (50.0% vs. 32.1%) (39.7% vs. 32.3%) (43.9% vs. 40.3%) (41.8% vs. 36.4%) (47.0% vs. 32.3%) (53.0% vs. 40.3%) (50.0% vs. 36.4%)

Results – H3a & H3b (Verdicts)

32

Contrast Misstatement Value Chi-Square p H3a Control vs. Match Inventory

• 16.8%

4.16 0.021 Restoration Liability

• 4.2%

0.34 0.281 Either

• 9.7%

2.87 0.045 H3b None vs. Match Inventory

• 24.0%

7.99 0.003 Restoration Liability

• 13.3%

2.47 0.058 Either

• 17.9%

8.82 0.002 RQ1a Control vs. Mismatch Inventory

• 7.4%

0.78 0.377 Restoration Liability

• 3.6%

0.25 0.616 Either

• 5.4%

0.88 0.347 RQ1b None vs. Mismatch Inventory

• 14.7%

2.89 0.089 Restoration Liability

• 12.7%

2.17 0.141 Either

• 13.6%

4.89 0.027

(39.7% vs. 23.0%) (43.9% vs. 39.7%) (41.8% vs. 32.1%) (47.0% vs. 23.0%) (53.0% vs. 39.7%) (50.0% vs. 32.1%) (39.7% vs. 32.3%) (43.9% vs. 40.3%) (41.8% vs. 36.4%) (47.0% vs. 32.3%) (53.0% vs. 40.3%) (50.0% vs. 36.4%)

Results – H3a & H3b (Verdicts)

33

Contrast Misstatement Value Chi-Square p H3a Control vs. Match Inventory

• 16.8%

4.16 0.021 Restoration Liability

• 4.2%

0.34 0.281 Either

• 9.7%

2.87 0.045 H3b None vs. Match Inventory

• 24.0%

7.99 0.003 Restoration Liability

• 13.3%

2.47 0.058 Either

• 17.9%

8.82 0.002 RQ1a Control vs. Mismatch Inventory

• 7.4%

0.78 0.377 Restoration Liability

• 3.6%

0.25 0.616 Either

• 5.4%

0.88 0.347 RQ1b None vs. Mismatch Inventory

• 14.7%

2.89 0.089 Restoration Liability

• 12.7%

2.17 0.141 Either

• 13.6%

4.89 0.027

(39.7% vs. 23.0%) (43.9% vs. 39.7%) (41.8% vs. 32.1%) (47.0% vs. 23.0%) (53.0% vs. 39.7%) (50.0% vs. 32.1%) (39.7% vs. 32.3%) (43.9% vs. 40.3%) (41.8% vs. 36.4%) (47.0% vs. 32.3%) (53.0% vs. 40.3%) (50.0% vs. 36.4%)

Implications/Contributions

• Within the settings studied, legal liability does

not increase under the PCAOB’s currently proposed CAM regime.

• We find no reason to strategically report CAMs

– Match (helps in some instances) – Mismatch (never hurts, and helps compared to None) – No CAM (no different than control)

• Generally, results suggest evaluators do not

punish, and sometimes reward, professionals for disclosing difficulties encountered

34

Thank You!

35

Addendum Slides

36

Design and Methods

• Participant requirements:

– 18 yrs old – U.S. Citizens – Not employed in banking, mining, accounting, law, EPA – Had not served as a juror for a financial case

• Mean earnings of $1.46/hour > $1.38 reservation

wage (Horton and Chilton 2010)

• Mean age 37, 89% attended some college,

employed with mean income of $55,246)

• Included comprehension and attention checks.

37

Results Summary

38

• H1a – Partial Support (Inventory driven)
• H1b – Full Support
• H2a – Partial Support (Inventory driven)
• H2b – Full Support
• H3a – Partial Support (Inventory driven)
• H3b – Full Support

Results Summary

39

• RQ1a

– Compared to the Control, Mismatch is associated with less negative affect for inventory. – Do not differ in assessments of plaintiff responsibility

• r liability judgments.
• RQ1b

– Compared to None, Mismatch is associated with less negative affect for LRL. – Do not differ in assessments of plaintiff responsibility. – Associated with fewer negligence judgments.

Results H1a & H1b

Misstate. CAM

Control Match Mismatch None Inventory Mean

• 1.21

8.97 7.24 2.73 Std Dev 19.28 20.34 18.26 19.97 n 68 61 62 66 Restoration Mean 5.97 1.14 3.54

• 4.29

Liability Std Dev 19.01 20.70 17.59 18.27 n 65 73 67 66 Either Mean 2.30 4.70 5.32

• 0.78

Std Dev 19.41 20.83 17.94 19.39 n 133 134 129 132

40

Results H2a & H2b – Plaintiff Resp.

Misstate. CAM

Control Match Mismatch None Inventory Mean

• 0.34

0.30

• 0.20
• 0.19

Std Dev 0.89 1.04 1.13 0.88 n 68 61 62 66 Restoration Mean 0.18 0.24 0.00 0.01 Liability Std Dev 0.99 1.02 0.95 0.93 n 65 73 67 66 Either Mean

• 0.09

0.27

• 0.10
• 0.09

Std Dev 0.97 1.03 1.04 0.91 n 133 134 129 132

41

Limitations/Future Research

• We only examine two specific misstatements/CAMs and

we find differences. - Why?

• We use an audit report with a maximum of one CAM.

– The effect of multiple matching and/or mismatching CAMs is unknown.

• Implementation in the U.K. is much more extensive than

that proposed in the U.S. and tested herein.

• Simultaneous changes are proposed (clarifying language,

audit partner identification).

• We don’t examine the likelihood of legal action, so the net

cost to the firms may still be higher despite lower negligence findings.

42

CAM Examples

“The standards of the PCAOB require that we communicate in our report critical audit matters relating to the audit of the current period's financial statements or state that we determined that there are no critical audit matters. [definition] The

critical audit matters communicated below do not alter in any way our opinion on the financial statements, taken as a whole.”

(PCAOB 2013)

43

CAM Examples

“The standards of the PCAOB require that we communicate in our report critical audit matters relating to the audit of the current period's financial statements or state that we determined that there are no critical audit matters. [definition] We determined that there are no critical audit matters.” (PCAOB 2013)

44

CAM Examples

We determined that our evaluation of the Company's allowance for sales returns was a critical audit matter in the audit of the Company's financial statements as of and for the

fiscal year ended January 31, 2013. The Company developed a new on-line sales channel. This new sales channel could have significantly different return experience than sales through its more established retail stores. In addition, the Company simultaneously lengthened its return policy. The Company developed new models with different assumptions to reflect these changes in its estimate of the allowance for sales returns, a key element in recording revenue. The lack of historical experience with the new assumptions resulted in a high degree of measurement uncertainty in estimating the allowance for sales returns.

45

CAM Examples

We determined that our evaluation of the Company's allowance for sales returns was a critical audit matter in the audit of the Company's financial statements as of and for the fiscal year ended January 31, 2013. The Company

developed a new on-line sales channel. This new

sales channel could have significantly different return experience than sales through its more established retail

• stores. In addition, the Company simultaneously lengthened

its return policy. The Company developed new models with different assumptions to reflect these changes in its estimate

• f the allowance for sales returns, a key element in recording
• revenue. The lack of historical experience with the new

assumptions resulted in a high degree of measurement uncertainty in estimating the allowance for sales returns.

46

CAM Examples

We determined that our evaluation of the Company's allowance for sales returns was a critical audit matter in the audit of the Company's financial statements as of and for the fiscal year ended January 31, 2013. The Company developed a new on-line sales channel. This new sales channel could have significantly different return experience than sales through its more established retail stores. In addition, the

Company simultaneously lengthened its return

• policy. The Company developed new models with different

assumptions to reflect these changes in its estimate of the allowance for sales returns, a key element in recording

• revenue. The lack of historical experience with the new

assumptions resulted in a high degree of measurement uncertainty in estimating the allowance for sales returns.

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CAM Examples

We determined that our evaluation of the Company's allowance for sales returns was a critical audit matter in the audit of the Company's financial statements as of and for the fiscal year ended January 31, 2013. The Company developed a new on-line sales channel. This new sales channel could have significantly different return experience than sales through its more established retail stores. In addition, the Company simultaneously lengthened its return policy. The Company developed new models with different assumptions to reflect these changes in its estimate of the allowance for sales returns, a key element in recording revenue. The lack

• f historical experience with the new assumptions

resulted in a high degree of measurement uncertainty in estimating the allowance for sales returns.

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CAM Examples

…our audit of the Company's allowance for sales

returns (1) involved our difficult and subjective judgments in evaluating whether the Company had a sufficient

basis to make a reasonable estimate of sales returns and (2) posed

difficulty to us in obtaining sufficient appropriate evidence to support management's adjustments to the allowance for sales returns. We consulted with our

national office on (1) the design and performance of audit procedures to test the data underlying management's assumptions used to estimate future sales returns and (2) our evaluation of the results of those procedures, including our assessment of the reasonableness of management's judgments regarding the effect that changes in the Company's return policies and practices, as well as changes in economic and buying trends that affect customer behavior, have on the estimate of future sales returns. The Company's accounting policy for sales returns is discussed in Note 1 to the financial statements.

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CAM Examples

…our audit of the Company's allowance for sales returns (1) involved our difficult and subjective judgments in evaluating whether the Company had a sufficient basis to make a reasonable estimate of sales returns and (2) posed difficulty to us in obtaining sufficient appropriate evidence to support management's adjustments to the allowance for sales returns.

We consulted with our national office on (1) the design and performance of audit procedures to test the data underlying management's assumptions used to estimate future sales returns and (2) our evaluation of the results of those procedures, including our assessment of the reasonableness of

management's judgments regarding the effect that changes in the Company's return policies and practices, as well as changes in economic and buying trends that affect customer behavior, have on the estimate of future sales returns. The Company's accounting policy for sales returns is discussed in Note 1 to the financial statements.

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