Current Issues in Auditing American Accounting Association

Volume One
2007
Pages C3–C9

COMMENTARY
Top 10 Wish List for Audit Research
Edward E. Nusbaum

INTRODUCTION
Not since Franklin Roosevelt was in the White House has this country experienced the present
level of tumult in the financial and regulatory underpinnings of the capital markets. With the
real-time speed, and the massive, complex data-gathering and management capabilities afforded
by new technologies, the global markets are fast becoming the market. The resulting level of
change has spawned both enormous opportunity and equally enormous risk exposure.
As is always the case in a creative society, it is to scholars that we turn when we want to
explore what we could and should be doing to facilitate change and enhance the service we
provide as part of our larger calling. In the case of the auditing profession, that service is protec-
tion of investors and support of a concurrent level of confidence to stabilize the capital markets.
Indeed, now, more than ever, professional auditors need scholars and researchers to continue a
partnership that furthers the understanding of the audit and thereby identifies new ways to make
the process and related assurance services ever more effective and efficient.
In the summer of 2005, Grant Thornton LLP launched an academic outreach program to
formalize the dialogue that we have always had with the country’s top auditing academics and
institutions. Our outreach is designed to engage the practitioners in our firm with research that
improves our ability to do our job—to the satisfaction of clients, investors, and regulators. Our
outreach also is designed to honor our profession by moving it forward through discovery, analy-
sis, and public commentary. We offer the following “wish list” of the top 10 areas where Grant
Thornton would welcome audit research. I will share my thoughts by raising key questions.
To what extent will recent and any forthcoming institutional changes affect auditing
and audit quality?
In the United States, the Public Company Accounting Oversight Board 共PCAOB兲 emerged
post-Enron as part of the Sarbanes-Oxley Act of 2002 共the Act兲. With the fifth anniversary of that
landmark legislation on July 30, 2007, it was noted that in the intervening years, the PCAOB has
provided two incarnations 共i.e., AS No. 2 and AS No. 5兲1 of standards for describing what it means
共and does not mean兲 to attest to an organization’s internal control over financial reporting. For the
past five years, professional auditors have been interacting as well with inspection teams from the
PCAOB.

Edward E. Nusbaum is the Chief Executive Officer of Grant Thornton LLP.

Mr. Nusbaum delivered this top 10 list during his luncheon address to members of the Auditing Section at the 2007 American
Accounting Association Annual Meeting, August 6, Chicago, Illinois. Grant Thornton LLP is the U.S. member firm of Grant
Thornton International, one of the six global accounting, tax, and business advisory organizations.

1
Auditing Standard No. 2 共PCAOB 2004兲 and Auditing Standard No. 5 共PCAOB 2007兲.

Accepted: 25 September 2007

Published: 10 December 2007
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Many are now asking, “Are there ways in which performing financial statement audits within
the structure of these new institutional relationships could fail to attain the objective of enhancing
investor confidence in our capital markets?” Research addressing this question would be very
helpful to the profession in reducing the risk of such failure.
What does it mean to improve audit quality?
In answering this question, we need to begin by addressing more fundamental questions:
What is quality? What does it mean to bring quality to an audit? Only by defining what quality is in
terms of an audit can we then begin to improve it.
At this point in time, there are many voices chiming in on this topic as practitioners attempt to
restore public confidence in the profession. Does quality mean more assurance or better commu-
nication of the degree of assurance? Is the same audit quality expected from every audit firm
regardless of size and constitution? To what extent is society willing to pay for enhanced audit
quality?
Is a quality audit one that detects material financial fraud, or one that makes sure that all of the
accounting and documentation are right? Should it be both? What are companies and investors
willing to pay for?
Some research guiding us on what quality in the audit process means to both the investing
public and auditors would be very valuable. Giving people what we’ve got with what we can get
will not instill the confidence of giving them what they need. Closing that gap in expectations is the
path to trust and robust capital markets.
With a passion for revision akin to that of poets, auditors will always be searching for ways to
improve the audit process. Nineteenth-century poet Robert Browning, well known in literary circles
for obsessive revision, once defended himself by observing that “What’s come to perfection per-
ishes.” Browning’s point is that thoughtful process is what retains vibrancy, value, and meaning. In
much the same spirit, I hope that we never really arrive at true consensus on what constitutes
audit quality because we can always do a better job, particularly as the world and business needs
change.
With that in mind, I should mention the Washington, D.C.-based Center for Audit Quality
共CAQ兲, established in January 2007.2 The Center’s mission is to foster confidence in the audit
process and to aid investors and the capital markets by advancing constructive suggestions for
change rooted in the profession’s core values of integrity, objectivity, honesty, and trust. To ac-
complish this mission, the CAQ works to make public company audits even more reliable and
relevant for investors in a time of growing financial complexity and market globalization. It will also
undertake research, offer recommendations to enhance investor confidence and the vitality of the
capital markets, issue technical support for public company auditing professionals, and help fa-
cilitate the public discussion about modernizing reporting.
One major initiative of the CAQ, already under way, is a series of public forums with stake-
holders around the country. Serving as facilitator, the CAQ opens conversations in their “Public
Dialogue Tour” about how the core needs of all market participants can be met more fully, now and
in the future. The broad objective of these dialogues is to engage key stakeholders in the capital
markets—including investors, issuers, thought leaders, and policy makers—in a focused dialogue
about the future of business reporting and how it can evolve to meet more effectively investors’
business information needs. These sessions allow for an open exchange on how to improve the

2
The information presented here on the Center for Audit Quality has been adapted from details posted on its web site:
http://www.thecaq.org.

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audit process, and based on the ideas generated, make recommendations to modernize public
company audits with an emphasis on making them more transparent, easier to understand, and
ever more reliable.
For example, all firms recognize the need to look at improved ways to detect fraud. As a result,
on July 30, 2007, the fifth anniversary of the landmark Sarbanes-Oxley legislation, a recent CAQ
event in our nation’s capital looked at implementation issues, progress, and roadblocks in meeting
the Act’s objectives, as well as proposed refinements to the legislation from the perspective of
various stakeholders. Clearly, research aimed at defining and improving quality in terms of the
audit will always be very valuable to the profession and the capital markets—never more so than
today as globalization continues apace.

How can we conduct more efficient audits?

No one wins if audits of a given quality cost too much. In the wake of widespread public outcry
from companies that audits cost too much, the Securities and Exchange Commission 共SEC兲, the
PCAOB, and various investor constituencies have been calling for more efficient audits in the
name of maintaining the competitiveness of U.S. capital markets.
Clearly, if we are to keep U.S. capital markets robust for investors, then it cannot cost too
much for companies to procure audits conducted under existing auditing standards. Initial at-
tempts to address the problem have resulted in the shift from AS No. 2 to AS No. 5, the latter of
which was designed to make audits more efficient.
Research in this area might focus on a number of areas including: 共1兲 what indicators repre-
sent sound measures of audit efficiency; 共2兲 what audit procedures in the course of a normal audit
do not contribute sufficiently to the value of an audit; and 共3兲 what factors are thought to be
indicative of efficiency in the audit process, but, in actual practice, are not? Identifying such
“pseudo-indicators” is especially important with the shift from AS No. 2 to AS No. 5 because costly
“red herrings” waste time and unnecessarily increase audit fees.
In this regard, a cost-benefit analysis of each step in the current audit process would be very
useful. Such an analysis would enable auditors to allocate resources by priority; i.e., assign a
value to each audit step. Dissecting the audit in this way could guide an audit team in prioritizing
steps and making assertions on those steps that would add the greatest value.
A specific example might be to explore whether it is more valuable to spend more time on risk
assessment and less time doing specific audit tests later in the process. We have not arrived at
the answer to that and similar audit process questions. Research shedding more light on these
issues would guide auditors in bringing greater efficiency and cost-effectiveness to the audit
process.

How should we model audit risk assessment?

The topics of cost-benefit analysis and risk management bring us to the question of how best
to model audit risk assessment. The audit risk model in professional guidance can be improved.
Beyond an understanding of standards and technical skills, perhaps the most important ability an
auditor can exercise is judgment. What risk factor patterns elevate the risk of material misstate-
ment? What affects how quickly and likely it is that an organization’s business risks will translate
to misstatement risks? Also, because assessing risk is complex at best and inherently approxi-
mate at worst, how can we model the risk of auditor judgment error? What precautions would help
to ensure the accuracy of our risk assessments and the effectiveness of the audit procedures we
design to address them?

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Research in this area could explore further the role that internal control—and assessment of
it—does or should play in the overall assessment of risk. The assumption has always been that a
stronger internal control structure should reduce the need for substantive testing due to a greater
reliance on control testing to reduce risk. In practice, however, we need to look at what auditors
are using and what they should be using in terms of assessing controls and relating the assess-
ment of controls to the rest of the audit.

How do we enhance fraud risk assessment, and how do we test for it?
Never off the radar for auditors, fraud has become a major hot button in this post-Enron era.
Every one of us worries about fraud detection—about trying to verify assertions of an unscrupu-
lous CEO 共or management team兲 determined to hide or distort some material fact.
In addition, due to the current investor climate, the expectation has grown that the auditors will
do more relative to the detection of fraud. Thus, a number of questions are raised. What audit
steps, beyond those currently followed, really detect material financial fraud? What are some of
the steps—historically and empirically—that have detected material financial fraud? What have
auditors missed? Are there behavioral and other signs that someone is committing fraud, and
what can an auditor learn from those signs? What are some of the steps that auditors have not
done, that, had they done them, would have detected material financial fraud?
An ideal study approach might be to investigate how different accounting firms approach fraud
detection. The sharing of best practices on the most effective ways for an auditor to improve the
likelihood of detecting fraud 共from both behavioral and empirical perspectives兲 can only benefit all
constituents in executing their respective responsibilities—from auditors and corporate manage-
ment teams to investors and regulators.
Because it is impossible to guarantee detection of material financial fraud, any research that
helps us to improve the statistical probability of detecting it would be very valuable. In the end, it
will boil down to the cost-benefit ratio. It will be important to 共1兲 identify what steps the auditor can
take to increase the probability that material financial fraud will be detected, and then 共2兲 assess
whether the benefits of taking those steps exceed the cost. Clearly, additional research could
highlight the conditions under which more forensic testing 共e.g., electronic or automated testing兲
and professional skepticism would add value to audits.

What is the best way to address auditor liability?

As long as there are audits and accounting firms, there will be liability issues. Even if all audits
were performed perfectly, there would be liability issues because our social and psychological
construct is that “someone’s got to pay.” Determining appropriate levels of professional liability will
continue to be an issue for auditors as long as we live in this country, and as long as businesses
fail.
There is no disagreement that auditors need to be accountable for shoddy audits; however,
the current U.S. system for handling liability against auditors is perilously close to holding entire
firms hostage to spurious litigation. Among the major concerns is that—at this moment—each one
of the major accounting firms has pending litigation with claims in damages and penalties that
easily exceed its entire capital. A successful major lawsuit could jeopardize the very existence of
an audit firm, and further contraction in the number of audit firms has far-reaching implications for
audit competition and the health of the capital markets.
Liability reform has been on the front burner in the United Kingdom 共U.K.兲 for some time. In the
U.S., we are watching developments closely to see how the U.K. leads on reform unfold, and
whether projected plans pan out. At this juncture, the U.K. is on the brink of imposing a system of

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contractual capping 共in the engagement letter兲 against claims made by investors who have suf-
fered a loss as a result of a failure in the audit process. 共In the U.K., the auditor has no duty of care
other than to investors兲.
In the proposed U.K. arrangement, firms and clients would negotiate caps on claims that
would result from audit failures. The precise date of commencement is unclear—but current
reports put it at April 2008. It is also unclear whether that date applies to audits of accounting
periods commencing on or after that date. The U.K. Department for Business Enterprise and
Regulatory Reform 共DBERR兲, formerly the Department of Trade and Industry 共DTI兲, has yet to
confirm what the law means. Clearly, additional research in this country could help to address
what is already an urgent concern for the profession and the global capital markets.
What is the best method for auditing fair-value assertions?
Like liability reform, another perpetual topic for research in the profession lies in auditing
fair-value assertions. The subject has reared its head most recently in the context of Financial
Accounting Standards Board 共FASB兲 pronouncements No. 157 and No. 159, both of which pertain
to fair-value accounting. Staunch fair-value proponent and former FASB and Financial Accounting
Standards Advisory Council 共FASAC兲 member Katherine Schipper supports using only fair value
and that treatment alternatives “are inherently undesirable” and would “add to the confusion by
allowing servicers to use different treatments for different parts of the servicing portfolio” 共Shenn
and Davenport 2006兲.
Historically and predominantly, auditors have attested to verifiable assertions. Although, as a
profession, we have addressed issues related to impairment in value, to date, nothing as broad in
scope as auditing fair value in the absence of a ready market has been asked of us. Assessing the
reasonableness of fair values under such conditions requires an abundant supply of valuation
experts. It is unlikely going forward that we can rely exclusively on the work of outside specialists
if fair-value assertions become endemic to an increasing number of management assertions.
Research studying these and other aspects of fair-value accounting would be both welcome and
helpful 共see Martin et al. 2006兲.
How should financial statement users and our equity markets understand
the recent wave of restatements?
It is evident to me that not all restatements are created equal. In the U.S., we see nearly 2,000
restatements annually, while in Europe we are seeing less than 100 restatements over the same
period. Further, our equity markets seem to react precipitously to some of these high-profile
restatements by pounding the organization’s stock price or by calling for a change in manage-
ment. The market seems to take other restatements in stride without resulting in much of a stock
price drop.
Bad press following spectacular financial crises has lent new—and perhaps unintended—
resonance to the term “restatement.” The voice of reason seems to be asking hard questions
about whether a particular restatement was addressed as a material misstatement in the first
place. For example, a study exploring the causes behind the recent rash of restatements in some
given number of the top companies, U.S. versus worldwide, would demonstrate to the public 共and
reporters兲 that all restatements are not created equal and should not become immediate cause for
marketplace jitters or, worse, panic.
Recent reports suggest the number of restatements for accelerated filers seems to be declin-
ing, whereas the number of restatements for non-accelerated filers seems to be holding or slightly
on the rise. It has been speculated that there are two main reasons behind this emerging dispar-
ity: 共1兲 the effects of Section 404 of the Sarbanes-Oxley Act of 2002, and 共2兲 the relative size of
accelerated filers 共i.e., typically accelerated filers are larger companies with greater resources and

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often better or more sophisticated accounting groups兲. Indeed, any analysis of restatement
trends—perhaps segregated by accelerated versus non-accelerated filers, or by various other
parameters—would be revealing and helpful.
How can we improve audit instruction?
An audit research area that is somewhat unconventional, if not overlooked, by researchers to
date lies in the way in which we train future auditors. Education professors have written exten-
sively on how to enhance instruction and how students acquire knowledge and skills and develop
judgment. We can be better stewards of the profession if those in academia and we within the
practice community continue to ask whether you in your schools and we in our training optimally
leverage, apply, and contribute to this literature when designing and delivering our auditing and
financial reporting instruction.
Two areas that need special attention are fraud detection, and, more broadly, risk assessment.
Although these topics already cross over into the classroom, it is interesting to note that, in
general, I do not believe that we are teaching risk analysis in accounting classes. One size never
fits all in our business, and the ability to understand both risk and how to analyze it is critical for
future generations of auditors. Perhaps beyond technical skills and knowledge of standards, the
most important ability an auditor can have is the ability to reason—to make judgments where
there are not bright red lines. Researchers who also teach might look for ways to include such
training and experience in the curriculum. They might also test the new curriculum to see which
methods for doing so are most effective.
How we can further ongoing understanding of international auditing issues?
Worldwide standards are being brought into harmony, yet there remain many and significant
disparities in global business customs and practices. In Japan and many other Asian countries, for
example, the business culture generally tends to be less skeptical of management. Such a climate
stems from deeply entrenched ideas and expressions of respect. Questioning someone in a
position of authority can be tantamount to questioning his or her integrity. From a behavioral
standpoint, this cultural bias, which might be subtle or unconscious and unintentional, could in-
terfere with the absolute objectivity required by auditors to perform an audit.
Thus, an interesting subject for study might be how cultural differences could affect an audit—
e.g., given the exact same set of procedures, how would audit approaches differ from country to
country? Exploring the behavioral aspects would be fascinating, as well as helpful. A single ex-
ample might be to explore how interview techniques differ between the U.S. and China or Japan.
The overall point here is that the position of the U.S. in the global marketplace has shifted. In
the past, this country has set the pace and taken the lead; other countries have followed. Today
there is increasingly less dependence on the U.S. to propel and sustain international growth. As
demonstrated by the results of the recent International Business Report 共Grant Thornton Interna-
tional 2007兲, the economies of Asia are becoming the new global drivers of growth.

CONCLUSION
In conclusion, I want to emphasize the important position held by auditing academics in this
country and around the world. The research that you do—and the analysis that you bring—is of
critical importance to our profession and to society. As practitioners, we share with those of you in
research and academia the exciting responsibility of being stewards of the profession. We count
upon you—and the excellent and often groundbreaking work you do—for your research, your
insight, your guidance, and your encouragement.

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REFERENCES
Grant Thornton International. 2007. International Business Report 2007: Global Overview 共June兲. London, United
Kingdom.
Martin, R. D., J. S. Rich, and T. J. Wilks. 2006. “Auditing fair value measurements: A synthesis of relevant research.”
Accounting Horizons 20 共3兲: 287–303.
Public Company Accounting Oversight Board 共PCAOB兲. 2004. An Audit of Internal Control over Financial Reporting
Performed in Conjunction with an Audit of Financial Statements. Auditing Standard No. 2. Washington, D.C.:
PCAOB. Available at: http://www.pcaobus.org/Rules/Rules_of_the_Board/Auditing_Standard_2.pdf
PCAOB. 2007. An Audit of Internal Control Over Financial Reporting That Is Integrated with an Audit of Financial
Statements. Auditing Standard No. 5. Washington, D.C.: PCAOB. Available at: http://www.pcaobus.org/Rules/
Docket_021/2007_05_24_Release_No_2007_005.pdf
Shenn, J., and T. Davenport. 2006. “Mortgages pipeline.” American Banker 171 共56兲.

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