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Auditors work in hierarchical teams in which effective upward communication is critical to audit quality. In these teams, subordinates choose both the content, as well as the style, of their communications. We report survey and experimental evidence of the importance of communication style in the context of audit team culture. Our first two studies provide evidence that audit staff perceive assertive upward communication as risky and prefer to communicate passively, especially in less autonomous team cultures. Our third study provides evidence that audit seniors consider more follow-up procedures and rate staff higher when staff communicate assertively, especially in more autonomous team cultures. Combined, these studies indicate a disconnect between audit seniors, who reward and follow up more on assertive communication, and their staff, who prefer passive communication. Our results suggest the potential for audit quality improvements by better alignment of supervisor-subordinate communication-style preferences, especially in more autonomous team cultures. Data Availability: Contact the authors.

Investments that are classified as Level 2 within the fair value hierarchy account for approximately 92 percent of US banks' fair value assets. We report an experiment that examines how experienced auditors apply current PCAOB guidance when auditing portfolios of these assets. We hypothesize and find that, depending on how overstatement is distributed within a portfolio, current PCAOB guidance leads auditors to make adjustments that are predictably larger or smaller than the aggregate overstatement in the portfolio. Auditors are more likely to follow PCAOB guidance when doing so leads to lower audit adjustments and higher client income. We also predict and find that auditors identify some patterns of overstatement as indicative of management bias, but not others. However, management-bias assessments do not affect auditors' adjustment decisions as standards imply they should, even when auditors are prompted to consider management bias. Together, these results highlight a potential deficiency in current auditing guidance that managers could exploit by strategically locating overstatements within securities with larger book values or by spreading those overstatements across many securities within a portfolio. We suggest changes to current PCAOB guidance which may reduce these effects.

This paper examines audit team leader reactions to auditors who speak up about potentially important audit issues. Study 1 is a survey of interacting audit teams and provides evidence of higher performance evaluations for auditors who speak up. Studies 2, 3, and 4 are experiments examining team leader reactions to speaking up, both at the time speaking up occurs (Study 2) and later, during performance evaluation (Studies 2, 3, and 4). Results provide evidence that team leaders react with irritation at the time speaking up occurs, particularly if a team member raises an audit effectiveness issue that could increase audit effort. However, team leaders reward speaking up in performance evaluations, particularly when team members speak up about issues that align with the effectiveness or efficiency focus of the team. While supervisors' performance evaluations exhibit outcome effects, supervisors also reward speaking up, regardless of outcome. Data Availability: Contact the authors.

Auditors must ensure that their audit plans budget sufficient time for key audit steps. Research has shown that insufficient audit time budgets can be detrimental to audit quality. We examine whether framing audit steps negatively (e.g., assess whether management's assumptions are not appropriate) increases time budgets—particularly for steps in which the auditor perceives that performance quality is less verifiable, and thus most at risk of being performed with low quality. First, we report the results of analyses indicating that, in practice, audit steps are predominantly framed positively, potentially resulting in smaller time budgets. We then report the results of an experiment in which 50 experienced audit managers budget time for an audit program that tests a Level-3 fair-value estimate. Prior research and Public Company Accounting Oversight Board (PCAOB) inspections indicate that this is a challenging audit area, vulnerable to allegations of low audit quality. The results support our predictions and suggest that reframing audit steps negatively would increase audit time budgets—an audit quality indicator—particularly for less-verifiable steps.

U.S. GAAP and IFRS require full disclosure of the effects of an accounting change in the year the change is made, but not in future years. However, some accounting changes have multi-period effects. We conduct an experiment to examine whether investors forget to adjust for an accounting change in periods subsequent to the change, and examine the effectiveness of interventions designed to mitigate that tendency. In the experiment, a company changed how it accounts for pension gains and losses, and investors value the company over three consecutive reporting periods. Results indicate that investors gradually forget to adjust for the accounting change over time under the current approach used to disclose accounting changes. These effects are mitigated in post-change periods when investors receive full disclosure of the current effect of the prior accounting change, and to a lesser extent when investors receive a disclosure that includes a simple non-quantitative disclosure that the accounting change occurred. Supplemental analyses indicate that investors rely more on memory-aiding disclosures as the time delay between valuation judgments increases.

Accountants making judgments with respect to a particular set of standards are increasingly aware of standards from other reporting regimes that offer additional or conflicting guidance. In fact, IFRS encourages reliance on out-of-regime standards when IFRS lacks guidance. This paper reports the results of two experiments which provide evidence that auditors in such circumstances are vulnerable to contrast effects, whereby reporting judgments under IFRS are systematically influenced away from the accounting treatment supported by standards from another regime (U.S. GAAP). Contrast effects are observed (1) when out-of-regime standards are considered before making a reporting judgment under IFRS, and (2) when out-of-regime standards are applied as local GAAP for a subsidiary of a foreign parent that reports under IFRS. We also find that contrast effects are reduced when auditors believe IFRS lacks guidance. These results have implications for financial statement preparers and auditors in the current incomplete-convergence environment. This article is protected by copyright. All rights reserved.

International audience; Changes to our climate and oceans are already affecting living marine resources (LMRs) and the people, businesses, and economies that depend on them. As a result, the U.S. National Marine Fisheries Service (NMFS) has developed a Climate Science Strategy (CSS) to increase the production and use of the climate-related information necessary to fulfill its LMR stewardship mission for fisheries management and protected species conservation. The CSS establishes seven objectives: (1) determine appropriate, climate-informed reference points; (2) identify robust strategies for managing LMRs under changing climate conditions; (3) design decision processes that are robust to climate-change scenarios; (4) predict future states of ecosystems, LMRs, and LMR-dependent human communities; (5) determine the mechanisms of climate-change related effects on ecosystems, LMRs, and LMR-dependent human communities; (6) track trends in ecosystems, LMRs, and LMR-dependent human communities and provide early warning of change; and (7) build and maintain the science infrastructure required to fulfill NMFS mandates under changing climate conditions. These objectives provide a nationally consistent approach to addressing climate-LMR science needs that supports informed decision-making and effective implementation of the NMFS legislative mandates in each region. Near term actions that will address all objectives include: (1) conducting climate vulnerability analyses in each region for all LMRs; (2) establishing and strengthening ecosystem indicators and status reports in all regions; and (3) developing a capacity to conduct management strategy evaluations of climate-related impacts on management targets, priorities, and goals. Implementation of the Strategy over the next few years and beyond is critical for effective fulfillment of the NMFS mission and mandates in a changing climate.

Trait-based climate vulnerability assessments based on expert evaluation have emerged as a rapid tool to assess biological vulnerability when detailed correlative or mechanistic studies are not feasible. Trait-based assessments typically view vulnerability as a combination of sensitivity and exposure to climate change. However, in some locations, a substantial amount of information may exist on system productivity and environmental conditions (both current and projected), with potential disparities in the information available for data-rich and data-poor stocks. Incorporating this level of detailed information poses challenges when conducting, and communicating uncertainty from, rapid vulnerability assessments. We applied a trait-based vulnerability assessment to 36 fish and invertebrate stocks in the eastern Bering Sea (EBS), a data-rich ecosystem. In recent years, the living marine resources of the EBS and Aleutian Islands have supported fisheries worth more than US $1 billion of annual ex-vessel value. Our vulnerability assessment uses projections (to 2039) from three downscaled climate models, and graphically characterizes the variation in climate projections between climate models and between seasons. Bootstrapping was used to characterize uncertainty in specific biological traits and environmental variables, and in the scores for sensitivity, exposure, and vulnerability. The sensitivity of EBS stocks to climate change ranged from "low" to "high," but vulnerability ranged between "low" and "moderate" due to limited exposure to climate change. Comparison with more detailed studies reveals that water temperature is an important variable for projecting climate impacts on stocks such as walleye pollock (Gadus chalcogrammus), and sensitivity analyses revealed that modifying the rule for determining vulnerability increased the vulnerability scores. This study demonstrates the importance of considering several uncertainties (e.g., climate projections, biological, and model structure) when conducting climate vulnerability assessments, and can be extended in future research to consider the vulnerability of user groups dependent on these stocks.

This experimental study examines whether requiring auditors to report risks of material misstatement (and related auditor findings) affects audit adjustments. Experienced audit partners and senior managers in the United Kingdom proposed audit adjustments under three different reporting regimes: (a) an audit report where no risks are disclosed, (b) a report where risks of material misstatement are disclosed, and (c) a report where risks of misstatement are disclosed, augmented with the auditor’s findings with respect to those risks. Our results indicate that disclosing risks of material misstatement without findings has no effect on audit adjustments, but that lower audit adjustments occur when the disclosure also includes findings, and that this result is driven by auditors requiring particularly low adjustments when they indicate a finding that the post-audit account balance is “mildly optimistic” (as opposed to “reasonable”). Results also suggest that this tendency is unintentional. Overall, these findings indicate that auditors unintentionally trade off audit adjustments for disclosures, consistent with increased detailed disclosure providing an opportunity for “moral licensing” that enables auditors to satisfy client demands while also complying with professional standards. From a practice perspective, these results suggest that disclosure of critical or key audit matters as recently required by U.S. and international standard setters may not affect auditor behavior, but that allowing disclosure of additional findings as done voluntarily in some jurisdictions may have the unintended consequence of reducing the size of audit adjustments that auditors require.

In the published proceedings of the first Journal of Accounting Research Conference, Vatter [1966] lamented that “Gathering direct and original facts is a tedious and difficult task, and it is not surprising that such work is avoided.” For the fiftieth JAR Conference, we introduce a framework to help researchers understand the complementary value of seven empirical methods that gather data in different ways: prestructured archives, unstructured (“hand-collected”) archives, field studies, field experiments, surveys, laboratory studies, and laboratory experiments. The framework spells out five goals of an empirical literature and defines the seven methods according to researchers’ choices with respect to five data gathering tasks. We use the framework and examples of successful research studies in the financial reporting literature to clarify how data gathering choices affect a study's ability to achieve its goals, and conclude by showing how the complementary nature of different methods allows researchers to build a literature more effectively than they could with less diverse approaches to gathering data.

We report the results of four experiments investigating the relationship between (1) the quality of an audit, (2) jurors' assessments of the standard of prudent care (SOC) against which audit quality is compared, and (3) jurors' negligence verdicts. Experiment 1 operationalizes audit quality by varying the sample size used in audit testing, and provides evidence that jurors anchor their assessment of SOC on audit quality, producing a “competitive mediation” in which audit quality reduces the potential for a negligence verdict directly, but increases that potential indirectly by increasing SOC. Experiment 2 generalizes this finding to a setting that operationalizes audit quality by varying the size of adjustment the auditor required. Experiments 3 and 4 extend these results to a setting in which SOC is elicited after jurors make negligence verdicts. Overall, these experiments provide insight into the role of SOC in constraining and justifying negligence verdicts. Data Availability: Contact the authors.

This paper reports five studies examining audit team members' willingness to raise audit issues. The first study is a survey of interacting audit teams that provides evidence that team members are more willing to speak up when they view their leader as team-oriented (i.e., emphasizing team success as opposed to the leader's own personal advancement). Experiments 1–3 provide converging evidence that audit seniors are more willing to speak up to a team-oriented leader and about issues that are aligned with that leader's concerns. Experiment 4 provides evidence that the effect of team-oriented leadership on willingness to speak up is mediated by team members' commitment to the team leader and, to a lesser extent, by their identification with their team, but not by concerns about the immediate or eventual repercussions of speaking up. Together, these studies provide evidence that auditors' willingness to raise audit issues is affected by what the auditor has to say and how they think their message will be received, potentially affecting audit effectiveness and audit efficiency. Data Availability: Contact the authors.

Anderson, Brown, Hodder, and Hopkins (ABHH, in press) provide experimental evidence that investors are better able to assess management stewardship and firm value when financial statements highlight fair-value information rather than amortized-cost information. We focus our discussion on five methodological choices that the authors make. We consider how those choices affect the generality of ABHH’s results, consider an alternative theoretical explanation for those results, and suggest opportunities for future research that build on ABHH’s work.

We report the results of two experiments that provide evidence that investors' risk judgments are affected by the numerical format used to describe outcomes within accounting disclosures. Consistent with prior research in psychology, investors assess higher risk in response to dollar-formatted disclosures than to equivalent percentage-formatted disclosures. Consistent with the Persuasion Knowledge Model (Friestad and Wright 1994), this effect is moderated when investors have both (1) awareness that management has discretion over format, and (2) sufficient cognitive capacity to consider its implications. Our results provide insight about the effects of current disclosure formats and suggest implications for managers who choose formats, investors who interpret formatted information, and regulators who consider whether to further prescribe the formats that are used in financial disclosures.

Henry Gaylord Wilshire, the developer and namesake of Los Angeles’s Wilshire Boulevard, has often been referred to as a “millionaire socialist.” This article explores Wilshire’s understanding of and commitment to socialism. It also looks at his attitudes toward women, race, and labor, while illuminating the contradictions implicit in the conduct of his business enterprises on the one hand and his espousal of socialism on the other.

Major ecological realignments are already occurring in response to climate change. To be successful, conservation strategies now need to account for geographical patterns in traits sensitive to climate change, as well as climate threats to species-level diversity. As part of an effort to provide such information, we conducted a climate vulnerability assessment that included all anadromous Pacific salmon and steelhead (Oncorhynchus spp.) population units listed under the U.S. Endangered Species Act. Using an expert-based scoring system, we ranked 20 attributes for the 28 listed units and 5 additional units. Attributes captured biological sensitivity, or the strength of linkages between each listing unit and the present climate; climate exposure, or the magnitude of projected change in local environmental conditions; and adaptive capacity, or the ability to modify phenotypes to cope with new climatic conditions. Each listing unit was then assigned one of four vulnerability categories. Units ranked most vulnerable overall were Chinook (O. tshawytscha) in the California Central Valley, coho (O. kisutch) in California and southern Oregon, sockeye (O. nerka) in the Snake River Basin, and spring-run Chinook in the interior Columbia and Willamette River Basins. We identified units with similar vulnerability profiles using a hierarchical cluster analysis. Life history characteristics, especially freshwater and estuary residence times, interplayed with gradations in exposure from south to north and from coastal to interior regions to generate landscape-level patterns within each species. Nearly all listing units faced high exposures to projected increases in stream temperature, sea surface temperature, and ocean acidification, but other aspects of exposure peaked in particular regions. Anthropogenic factors, especially migration barriers, habitat degradation, and hatchery influence, have reduced the adaptive capacity of most steelhead and salmon populations. Enhancing adaptive capacity is essential to mitigate for the increasing threat of climate change. Collectively, these results provide a framework to support recovery planning that considers climate impacts on the majority of West Coast anadromous salmonids.

The management of marine fisheries is often based on a system of target and limit reference points, and contains significant amounts of scientific and management uncertainty that need to be interpreted and reconciled by managers. While scientific uncertainty has been thoroughly studied, described, and techniques have been developed to address this type of uncertainty; studies of management uncertainty are lacking and of the few studies available most are theoretical in nature. We evaluated 17 U.S. fisheries to describe how management uncertainty varies among management regimes and identify some potential factors that drive these variances. Our analysis found that a manager's ability to keep a fishery at or under the targeted catch level can vary substantially among fisheries, depending on the sector of the fishery, the management regime being used, the frequency at which landings are reported, and the magnitude of inter-annual target variability. Within our study, reporting frequency and the type of management regime being used seemed to describe the majority of the variance we observed among fisheries.

Climate change and decadal variability are impacting marine fish and invertebrate species worldwide and these impacts will continue for the foreseeable future. Quantitative approaches have been developed to examine climate impacts on productivity, abundance, and distribution of various marine fish and invertebrate species. However, it is difficult to apply these approaches to large numbers of species owing to the lack of mechanistic understanding sufficient for quantitative analyses, as well as the lack of scientific infrastructure to support these more detailed studies. Vulnerability assessments provide a framework for evaluating climate impacts over a broad range of species with existing information. These methods combine the exposure of a species to a stressor (climate change and decadal variability) and the sensitivity of species to the stressor. These two components are then combined to estimate an overall vulnerability. Quantitative data are used when available, but qualitative information and expert opinion are used when quantitative data is lacking. Here we conduct a climate vulnerability assessment on 82 fish and invertebrate species in the Northeast U.S. Shelf including exploited, forage, and protected species. We define climate vulnerability as the extent to which abundance or productivity of a species in the region could be impacted by climate change and decadal variability. We find that the overall climate vulnerability is high to very high for approximately half the species assessed; diadromous and benthic invertebrate species exhibit the greatest vulnerability. In addition, the majority of species included in the assessment have a high potential for a change in distribution in response to projected changes in climate. Negative effects of climate change are expected for approximately half of the species assessed, but some species are expected to be positively affected (e.g., increase in productivity or move into the region). These results will inform research and management activities related to understanding and adapting marine fisheries management and conservation to climate change and decadal variability.

INTRODUCTION AND SUMMARY This paper reviews research that examines professional skepticism (hereafter, PS) in auditing. Consistent with much research and with recent regulatory concerns, the paper defines PS as ‘‘indicated by auditor judgments and decisions that reflect a heightened assessment of the risk that an assertion is incorrect, conditional on the information available to the auditor.’’ In many circumstances the assertion in question will be a client’s assertion that the financial statements are free of material misstatement, but the definition could apply to other assertions as well (e.g., attesting to the effectiveness of a client’s internal controls). This definition reflects more of a ‘‘presumptive doubt’’ than a ‘‘neutral’’ view of PS, implying that auditors who exhibit high PS are auditors who need relatively more persuasive evidence (in terms of quality and/or quantity) to be convinced that an assertion is correct. Depending on how an auditor’s decisions are evaluated, it is possible under this definition for an auditor to exhibit too much PS, in that they could design overly inefficient and expensive audits. The paper provides a model that describes how audit evidence combines with auditor knowledge, traits, and incentives to produce judgments that reflect PS. The model also describes how, given a judgment that reflects some level of PS, the judgment combines with auditor knowledge, traits, and incentives to produce actions that reflect relatively more or less PS. The model highlights that auditors’ pre-existing knowledge, traits, and incentives all combine (and potentially trade off or interact) to affect the amount of PS in audit judgment and audit actions. This perspective also facilitates understanding how audit firms can influence PS in practice via hiring, training, performance appraisal, review, decision aids, incentives, and changes in tasks and institutions. For example, prior research suggests the following about particular elements of the model

This paper examines interpretation of accounting standards that provide implementation guidance via affirmative or counter examples. Based on prior psychology research, we predict that practitioners engage in "example-based reasoning" such that they are more likely to conclude that their case qualifies for the same treatment as the example. We test our predictions in two experiments in which participants judge the appropriateness of income-statement recognition. Experiment 1 uses Masters of Business Administration (MBA) students and varies example type (affirmative, counter) and case (revenue recognition, expense recognition) in a 2 x 2 design. Experiment 1 supports our predictions. Experiment 2 uses more experienced practitioners, and varies example type (affirmative, counter, both) in a 1 x 3 design. Experiment 2 supports the use of example-based reasoning, and indicates that practitioners in the "both" condition respond as if they had only received an affirmative example. These results have implications for understanding how guidance that accompanies accounting standards can result in aggressive or conservative application of standards.

Prior research provides evidence that information affects financial statement users' judgments less when that information is provided in a less accessible format (e.g., information disclosed in a footnote or less prominent financial statement rather than being recognized on the income statement [Maines and McDaniel 2000]). We provide evidence that, conditional on users performing the analysis necessary to transform the financial statements to appear as if disclosed information had been recognized, that information may affect users' judgments more than it would have if it had been recognized initially. Our experiments are set in the context of constructive capitalization of operating leases. The first experiment manipulates three variables that we hypothesize will contribute to this effect: choice to use transformed financial statements, effort spent on the transformation process, and reconciliation of pre- and post-transformation numbers. We provide evidence that, in the constructive-capitalization setting we operationalize, information has a greater effect on judgments when effort was expended to obtain the information and the information is displayed in a reconciled format. The second experiment focuses on the effort effect and replicates it with additional controls. These results have implications for standard-setters who consider the relative benefits of recognition and disclosure, and for financial statement users who transform financial statements as part of their analyses.

In the published proceedings of the first Journal of Accounting Research Conference, Vatter [1966] lamented that “Gathering direct and original facts is a tedious and difficult task, and it is not surprising that such work is avoided.” For the fiftieth JAR Conference, we introduce a framework to help researchers understand the complementary value of seven empirical methods that gather data in different ways: prestructured archives, unstructured (“hand-collected”) archives, field studies, field experiments, surveys, laboratory studies, and laboratory experiments. The framework spells out five goals of an empirical literature and defines the seven methods according to researchers’ choices with respect to five data gathering tasks. We use the framework and examples of successful research studies in the financial reporting literature to clarify how data gathering choices affect a study’s ability to achieve its goals, and conclude by showing how the complementary nature of different methods allows researchers to build a literature more effectively than they could with less diverse approaches to gathering data.

Estimates of fair value present a formidable audit challenge. We report an experiment that examines how experienced auditors apply current PCAOB guidance when auditing portfolios of investments that are classified as Level 2 within the fair value hierarchy. We hypothesize and find that, depending on how overstatement is distributed within a portfolio, current PCAOB guidance leads auditors to make adjustments that are predictably too large or small relative to the aggregate overstatement in the portfolio. We also find that auditors sometimes diverge from this guidance in order to correct overstatement that otherwise would remain in the portfolio, particularly when doing so increases their client’s net income. We also predict and find that auditors identify some patterns of overstatement as indicative of management bias, but not others. However, management-bias assessments do not affect auditors’ adjustment decisions, even when auditors are prompted to consider management bias. Together, these results highlight a potential deficiency in current auditing guidance that managers could exploit by strategically locating overstatements within securities with larger book values or by spreading those overstatements across many securities within a portfolio.

We examine whether information in footnotes might lack reliability because auditors permit more misstatement in disclosed, as opposed to recognized, amounts. In both the stock-compensation and lease settings, audit partners require greater correction of misstatements in recognized amounts than in the equivalent disclosed amounts. Debriefing questions indicate that the partners make these decisions knowingly, even though they expect greater client resistance to correcting recognized amounts, because they view recognized amounts as more material. Partners also spend more time on correction decisions for recognized information. While prior literature suggests that amounts are often relegated to footnotes because they are less reliable, our results suggest that the actual choice to disclose versus recognize can also reduce information reliability. These results have implications for the interpretation of prior research on the reliability of recognized and disclosed numbers, for financial-accounting standard setters who may want to consider the reliability effects of their recognition versus disclosure decisions, and for auditing standard setters who may wish to clarify auditors' responsibilities for preventing misstatements in disclosed amounts.

Two alternative approaches are used in audit practice to provide quantitative materiality assessments about proposed audit adjustments. The cumulative approach compares to net income the total amount of misstatement existing at the end of the current period, while the current-period approach compares to net income the amount of misstatement added in the current period. Depending on the relation between total misstatement and current-period misstatement, either the cumulative approach or the current-period approach can calculate higher quantitative materiality. This paper reports an experiment that varies materiality approach between auditors by providing auditors with either the current-period or cumulative formats used by their firm to summarize proposed audit adjustments. Results indicate that, across a variety of experimental contexts (varying misstatement size, subjectivity, precision, and income effect, and varying whether auditors document effects on their client's quality of earnings), auditors are more likely to require their client to book the misstatement under the approach that makes the misstatement appear more material. These results suggest that standard setters mandate that auditors require adjustment whenever a misstatement is material under either approach.

Numerous archival papers indicate that investors can generate profit by following disciplined trading strategies that exploit the market's incomplete adjustment for various accounting data. Even assuming efficient markets in which securities are not mispriced, evidence suggests that both individual and professional investors could improve their returns via disciplined trading strategies like market indexing. Yet, investors rarely follow such strategies. We use two experiments to examine factors that we believe affect reliance on trading strategies by affecting whether investors have more confidence in their own judgment or the recommendation of a trading strategy. We find that MBA-student investors deviate from a trading strategy more when the strategy is less accurate (but still more accurate than most well-known trading strategies), when they trade individual securities instead of portfolios, and when they receive positive feedback on trading decisions made prior to learning about the strategy. Thus, investors may lack the discipline to rely on profitable trading strategies, particularly when recent trading success has increased their confidence in their own judgment (as might occur in a sustained bull market like that experienced over the past decade). Our results also suggest ways that individual investors and portfolio managers can increase reliance on profitable trading strategies.

This paper reports an experiment demonstrating that MBA students overrely on old earnings performance when predicting future earnings performance in a laboratory setting. In the experiment, MBA students relied too heavily on old annual ROE information to predict future annual ROE. The experiment shows how a common cognitive error (overreliance on unreliable information) interacts with the structure of the earnings time series to create particular patterns of prediction errors. The results also suggest directions for research on two well-known anomalies, long-run overreactions (De Bondt and Thaler 1985, 1987) and post-earnings-announcement drift (Bernard and Thomas 1990).

INTRODUCTION The Sarbanes-Oxley Act requires the SEC to study the feasibility of shifting to a more "principles-based" financial reporting system, and the FASB has proposed changes designed to create a more principles-based approach to standard setting (FASB 2002a). This commentary reviews research relevant to predicting how the behavior of various participants in the financial reporting process is affected by principles-based and rules-based standards. The "Incremental" Perspective Because U.S. accounting standards typically are written to operationalize the FASB's underlying conceptual framework, they are based on principles. The standards also provide guidance as to correct accounting or disclosure treatment, so they include rules. As a consequence, an immediate challenge in writing this commentary is to define exactly what it means for a standard to be "principles-based" or "rules-based." I restate the "principlesbased vs. rules-based standards" question in a way that is more conducive to extracting insights from the existing research literature. Assuming that the FASB continues to base standards on the framework of principles articulated in the FASB's concepts statements, all standards can be viewed as principles-based, and the issue is the incremental effect on behavior when standards include relatively more elaborate rules. Therefore, in this commentary I discuss standards in terms of being more or less rules-based, acknowledging that less rules-based standards must rely more on p rinciples to guide behavior. I define "rules" broadly to include specific criteria, "bright line" thresholds, examples, scope restrictions, exceptions, subsequent precedents, implementation guidance, etc. A "standard" is the total body of principles and rules that apply to a given accounting issue. This incremental perspective is useful in at least two ways. First, it focuses the review on the incremental effects of increasing the number of rules in a standard. I argue that adding rules affects the precision and complexity of an accounting standard, and consider the implications of studies that examine the effects of precision and complexity on the behavior of participants in the financial reporting process. Second, the incremental perspective may provide insight about the effect of varying the extent to which different standards appear to be principles-based or rules-based. Some accounting topics involve complex transactions with predictable characteristics, so it is possible to write standards that contain very specific thresholds. For example, leases typically involve physical assets and a contractually defined sequence of cash flows, and SFAS No. 13 (FASB 1976) uses numerical thresholds to specify criteria regarding the proportion of lease life and the amount of fair value. These sorts of accounting topics are amenable to rules, but do not necessarily require them, so standard setters must choose the extent to which the standard is to be rules-based. Other accounting topics have less predictable characteristics and more inherent judgment. For example, SFAS No. 5 (FASB 1975) involves estimates of probability and amounts that are not defined contractually. Because these topics are less amenable to rules or brig ht line thresholds, the standards that govern them are more principles-based by default. Finally, including precedents and implementation guidance in the definition of rules highlights that the extent to which a standard appears rules-based changes over time, as a particular standard accretes implementation guidance, interpretations, and technical rulings. One reason why relatively younger standard-setting regimes like the IAS appear more principles-based is that they have not had as much time to accrete rules. I review the incremental effects of rule precision and complexity on performance with respect to two important functions of financial accounting standards: communication and constraint. …

SYNOPSIS: This paper reports descriptive evidence about how managers attempt to manage earnings, based on a sample of 515 earnings-management attempts obtained from a survey of 253 experienced auditors (and also analyzed by Nelson et al. 2002). We classify attempts first according to primary approach: expense recognition, revenue recognition, issues unique to business combinations, and other issues. Then, within each of those broad categories, we subclassify attempts by the particular approach used in the attempt. For each specific approach, we report the accounts involved, the frequency with which the approach increased or decreased current-period income (and the frequency of adjustments required by the auditor), and provide descriptions by auditors of income-increasing and income-decreasing examples of the more frequent approaches. We also link our findings to recent SEC Accounting and Auditing Enforcement Releases (AAERs) that illustrate extreme versions of the specific approaches identified by our participants. This experienced-based, example-rich framework and frequency data should assist investors, auditors, audit committees, and other participants in the financial reporting process who need to be vigilant for earnings-management approaches.

This paper uses recent experimental studies of financial accounting to illustrate our view of how such experiments can be conducted successfully. Rather than provide an exhaustive review of the literature, we focus on how particular examples illustrate successful use of experiments to determine how, when and (ultimately) why important features of financial accounting settings influence behavior. We first describe how changes in views of market efficiency, reliance on the experimentalist’s comparative advantage, new theories, and a focus on key institutional features have allowed researchers to overcome the criticisms of earlier financial accounting experiments. We then describe how specific streams of experimental financial accounting research have addressed questions about financial communication between managers, auditors, information intermediaries, and investors, and indicate how future research can extend those streams. We focus particularly on (1) how managers and auditors report information; (2) how users of financial information interpret those reports; (3) how individual decisions affect market behavior; and (4) how strategic interactions between information reporters and users can affect market outcomes. Our examples include and integrate experiments that fall into both the “behavioral” and “experimental economics” literatures in accounting. Finally, we discuss how experiments can be designed to be both effective and efficient.

This paper reports analyses of data obtained using a field-based questionnaire in which 253 auditors from one Big 5 firm recalled and described 515 specific experiences they had with clients who they believe were attempting to manage earnings. This approach enables us to analyze separately managers' decisions about how to attempt earnings management and auditors' decisions about whether to prevent earnings management by requiring adjustment of the financial statements. Our results indicate that managers are more likely to attempt earnings management, and auditors are less likely to adjust earnings management attempts, which are structured (not structured) with respect to precise (imprecise) standards. We also find that managers are more likely to make attempts that increase current-year income, but auditors are more likely to require that those attempts be adjusted, that managers are more likely to make attempts that decrease current-year income with unstructured transactions and/or when standards are imprecise, and that auditors are more likely to require adjustment of attempts that they identify as material or that are attempted by small clients.

This paper reports five studies examining audit team members’ willingness to raise audit issues. The first study is a survey of interacting audit teams that provides evidence that team members are more willing to speak up when they view their leader as team oriented (i.e., emphasizing team success as opposed to the leader’s own personal advancement). Experiments 1-3 provide converging evidence that audit seniors are more willing to speak up to a team-oriented leader and about issues that are aligned with that leader’s concerns. Experiment 4 provides evidence that the effect of team-oriented leadership on willingness to speak up is mediated by team members’ commitment to the team leader, and to a lesser extent by their identification with their team, but not by concerns about the immediate or eventual repercussions of speaking up. Together these studies provide evidence that auditors’ willingness to raise audit issues is affected by what the auditor has to say and how they think their message will be received, potentially affecting audit effectiveness and audit efficiency.

We report the results of four experiments investigating the relationship between (a) the quality of an audit, (b) jurors’ assessments of the standard of prudent care (“SOC”) against which audit quality is compared, and (c) jurors’ negligence verdicts. Experiment 1 operationalizes audit quality by varying the sample size used in audit testing, and provides evidence that jurors anchor their assessment of SOC on audit quality, producing a “competitive mediation” in which audit quality reduces the potential for a negligence verdict directly but increases that potential indirectly by increasing SOC. Experiment 2 generalizes this finding to a setting that operationalizes audit quality by varying the size of adjustment the auditor required. Experiments 3 and 4 extend these results to a setting in which SOC is elicited after jurors make negligence verdicts. Overall, these experiments provide insight into the role of SOC in constraining and justifying negligence verdicts.

Griffin and Tversky (1992) explain evidence of individual over- and underconfidence as resulting from attending too much to the strength (i.e., extremity) of information and not enough to the weight (i.e., statistical reliability) of information. We report two experiments that demonstrate how information strength and weight affect confidence, trading, prices, and wealth in laboratory markets. Our results indicate that information strength and weight affect individual over- and underconfidence and that market participants lack sufficient self-insight to avoid trading when they are biased. As a consequence, market prices are biased, and market participants with high-strength, low-weight information systematically transfer wealth to participants with low-strength, high-weight information.

This paper presents a model in which a representative investor has only a noisy signal of the reliability of his information. This noise causes prices to underreact to reliable information and overreact to unreliable information. We call this phenomenon `moderated confidence', because in both cases, the investor's confidence is moderated toward his prior expectation of reliability. Although moderated confidence can be consistent with rationality, we construct a laboratory setting in which it is not. Still, we find strong support for both types of price errors. We also find that tests of weak-form efficiency can indicate overreactions, even when tests of semi-strong-form efficiency indicate underreactions using exactly the same data. These results can help empirical researchers develop specific alternative hypotheses to market efficiency, by helping them predict ex ante whether a given research study is likely to reveal over- or underreactions.

Prior research indicates that inexperienced auditors lack knowledge of basic auditing categories (e.g. transaction cycles, audit objectives), instead developing this knowledge over time. As a consequence, learning from early experiences may be hampered because these experiences are not stored with respect to the category structures that are needed for important audit decisions. We performed an experiment which demonstrates that: 1. (1) providing transaction cycle and audit objective category knowledge through instruction prior to experience facilitates one particular type of subsequent learning from experience learning of category-level error frequencies), and 2. (2) this learning advantage cannot be duplicated by providing listings and explanations of category memberships after experience. In addition, actual experience consequently has a greater influence on later audit decisions when category knowledge is acquired prior to experience.

U.S. accounting standards require full disclosure of the effects of an accounting change in the year the change is made, but not in future years. However, some accounting changes have multi-period effects. We conduct an experiment in which investors value a company that changed how it accounts for pension gains and losses. We examine investors’ valuation judgments over three consecutive reporting periods, and provide evidence that investors gradually forget to adjust for the accounting change over time under the current approach used to disclose accounting changes. These effects are mitigated in post-change periods when investors receive full disclosure of the current effect of the prior accounting change, and to a lesser extent when investors receive a disclosure that includes a simple reminder that the accounting change occurred. Supplemental analyses indicate that investors rely more on memory-aiding disclosures as the time lag between valuation judgments increases, and that disclosures of income-increasing accounting changes affect valuation adjustments in part by affecting investors’ trust in management.

The performance of interacting groups is often viewed as a function of the groups' ability to identify and weight their better members' judgments (Einhorn, Hogarth, & Klempner, 1977). Accurate identification of the best group member is facilitated by individuals accurately assessing confidence in their own individual judgments and accurately communicating their confidence during group interaction (Sniezek & Henry, 1989). This paper examines the communication of confidence in interacting groups in two ways: by observing the performance of interacting groups for which confidence is anticipated to be communicated with high accuracy, and by observing the effects of changes in the group interaction setting that vary group members' ability to communicate confidence. This is achieved by examining the performance of a special type of interacting group, a laboratory financial market, that encourages relatively accurate communication of confidence and that can be modified to manipulate the extent to which confidence can be communicated. Results reveal generally high performance of groups which interact in settings that are conducive to communication of confidence, and significant learning from the interaction process by all group members (including the best member). Results also indicate a significant decrease in the performance of groups whose ability to communicate confidence during interaction is reduced.

Recent categorization research set in abstract medical diagnosis contexts has demonstrated an ‘inverse base rate effect’, whereby subjects make diagnoses which are consistent with base rates when presented with some sets of symptoms, but inconsistent with base rates when presented with other sets of symptoms. This paper reports three experiments which demonstrate that whether or not the inverse base rate effect is observed depends on the context in which categorization takes place. Inverse base rate effects are replicated in the abstract medical diagnosis context used in prior research, but not in a relatively realistic financial auditing setting, a less realistic financial auditing setting, or a very abstract generic setting. These results indicate that the inverse base rate effect may not generalize to applied settings, suggesting that interventions designed to mitigate the inverse base rate effect should not be instituted without first determining the existence of the effect in the particular setting in question.

Statement of Financial Accounting Standards (SFAS) No. 5 requires accrual of contingent losses which are deemed probable. This disclosure criterion is intended to be applied uniformly across a variety of contexts. We performed an experiment which examined whether audit managers' interpretations of the SFAS No. 5 probability expressions are influenced by one contextual feature, event base rate. Counter to the intention of the Financial Accounting Standards Board (FASB), interpretations of the expression probable were positively associated with event base rate. Resume. Le SFAS no 5 exige l'imputation a l'exercice des pertes eventuelles qui sont jugees «probables». La regle ainsi etablie veut que ce critere de presentation d'information soit applique uniformement dans des contextes tres divers. Les auteurs procedent a une experience dans le cadre de laquelle ils examinent si la facon dont les responsables de mission interpretent la gamme de probabilites, au sens du SFAS no 5, est influencee par une caracteristique contextuelle, la frequence relative de l'evenement. Contrairement au resultat vise par le FASB, les interpretations du terme «probable» sont en relation positive avec la frequence relative de l'evenement.

High Purity Germanium (HPGe) Detectors are the gold-standard sensor for nuclear spectroscopy applications. In order to make spectroscopic measurements, the detectors must be maintained at cryogenic temperatures. Cryogenic temperatures can be achieved using either liquid nitrogen or piston driven cryocoolers. Because of the bulky and transient nature of liquid nitrogen, the piston driven cryocoolers are preferable for remote, long term, or portable detector applications. These cryocoolers are a promising alternative due to the fact they only require a power source and heat dissipation for continuous operation. A major drawback however is that microphonic noise induced by the vibration of the piston reduces the resolution of the spectroscopic measurements. Passive damping techniques have been applied to this problem, An active damping control system is under development to significantly reduce the vibrations of the cryocooler by adapting to changes in boundary conditions and mass loading through time. Mitigating these vibrations will increase the resolution of portable HPGe detectors and facilitate the identification of nuclear materials.

Accountants making judgments with respect to a particular set of standards are increasingly aware of standards from other reporting regimes that offer additional or conflicting guidance. In fact, IFRS encourages reliance on out-of-regime standards when IFRS lacks guidance. This paper reports the results of two experiments which provide evidence that auditors in such circumstances are vulnerable to contrast effects, whereby reporting judgments under IFRS are systematically influenced away from the accounting treatment supported by standards from another regime (U.S. GAAP). Contrast effects are observed (1) when out-of-regime standards are considered before making a reporting judgment under IFRS and (2) when out-of-regime standards are applied as local GAAP for a subsidiary of a foreign parent that reports under IFRS. We also find that contrast effects are reduced when auditors believe IFRS lacks guidance. These results have implications for financial statement preparers and auditors in the current incomplete-convergence environment.

We provide experimental evidence that investors’ risk judgments are affected by the numerical format of sensitivity-analysis disclosures, with investors assessing higher risk in response to dollar-formatted disclosures than percentage-formatted disclosures. We also provide evidence that this effect is moderated by whether format is mandated or at the discretion of management. Specifically, investors respond to management discretion over numerical format by increasing risk assessments in response to percentage formats and decreasing risk assessments in response to dollar formats. In a second study we again support the moderating role of format discretion and provide evidence that the effect of discretion is not due to the extent of investors’ knowledge of alternative formats. Our results provide insight about the effects of current disclosure formats and suggest implications for managers who choose formats, investors who interpret formatted information, and regulators who consider whether to further prescribe the formats that are used in financial disclosures.

A process improvement initiative reduced the immediate preoperative wait time for patients undergoing spinal surgery by 30 minutes. Data from spinal surgeries occurring before and after the initiative were compared with patients arriving 2 hours vs 1.5 hours prior to surgery, respectively. In this study, we describe the association between reduced preoperative wait time and 3 clinical end points-postoperative pain, use of anxiolytics in the preoperative waiting period, and length of time in surgical recovery. The reduction in preoperative wait time did not compromise clinical outcomes and likely made a positive difference for patients in terms of convenience.

WHEN MORE THAN 100 COUNTRIES gathered in September in Accra, Ghana, to discuss the effectiveness of the $100-billion-a-year international aid business, one topic permeated nearly all the discussions: capacity development. This article looks at the changing approach to capacity development in light of the Paris Declaration of 2005 and the Accra Action Agenda of 2008.

We examine whether information in footnotes might lack reliability because auditors permit more misstatement in disclosed, as opposed to recognized, amounts. In both the stock-compensation and lease settings, audit partners require greater correction of misstatements in recognized amounts than in the equivalent disclosed amounts. Debriefing questions indicate that the partners make these decisions knowingly, even though they expect greater client resistance to correcting recognized amounts, because they view recognized amounts as more material. Partners also spend more time on correction decisions for recognized information. While prior literature suggests that amounts are often relegated to footnotes because they are less reliable, our results suggest that the actual choice to disclose versus recognize can also reduce information reliability. These results have implications for the interpretation of prior research on the reliability of recognized and disclosed numbers, for financial-accounting standard setters who may want to consider the reliability effects of their recognition versus disclosure decisions, and for auditing standard setters who may wish to clarify auditors' responsibilities for preventing misstatements in disclosed amounts.

Prior research provides evidence that financial-statement users weight information less heavily in judgment when that information is provided in a less accessible format (e.g., information disclosed in a footnote or less important financial statement rather than being recognized on the income statement (Maines and McDaniel 2000)). We provide evidence that, conditional on users performing the analysis necessary to transform the financial statements to appear as if disclosed information had been recognized, users may weight that information more heavily than it would have been if it had been recognized. Our experiments are set in the context of constructive capitalization of operating leases. The first experiment manipulates three variables that we hypothesize will contribute to this effect: choice to use transformed financial statements, effort spent on the transformation process, and disaggregation of the transformed financial statements. We provide evidence that, in the constructive-capitalization setting we operationalize, effort and disaggregation encourage greater weight on transformed information. The second experiment focuses on the effort effect and replicates it with additional controls. These results have implications for standard setters who consider the relative benefits of recognition and disclosure, and for financial-statement users who transform financial statements as part of their analyses.