An empirical investigation of context-dependent
communications between auditors and bankers
Keywords
Auditors, Communications,
Banking, Financial statements
Abstract
Despite attempts to close the
expectation gap, researchers in
the USA and other countries
continue to demonstrate the
existence of differences between
auditors' beliefs about their
responsibilities and the public's
understanding of the audit
function. This study considers how
ambiguous language in auditor
communications, and the context
in which it occurs, contribute to
the expectation gap. An
experiment examined auditors' and
bankers' understandings of the
phrase ``substantial doubt'' used in
a going concern audit report. It
was predicted and found that
auditors and bankers had different
general understandings of the
meaning of ``substantial doubt''
and their understandings were
conditioned on ownership
structure, a contextual variable.
The results demonstrate the
potentially crucial role of context in
ambiguous communications with
users. Implications of these results
are discussed, as are suggested
areas for future research.
Managerial Auditing Journal
17/8 [2002] 478±486
# MCB UP Limited
[ISSN 0268-6902]
[DOI 10.1108/02686900210444815]
[ 478 ]
Elizabeth Dreike Almer
School of Business Administration, Portland State University, Oregon, USA
Richard G. Brody
Accounting Department ± School of Business, University of New Haven,
West Haven, Connecticut, USA
Investors and financial statement users often
have differing beliefs about the responsibility
of an independent accounting firm
performing an audit of a client's financial
statements. The difference between the
assurances auditors provide and the
expectations of investors and other financial
statement users has been termed the
``expectation gap'' (Guy and Sullivan, 1988).
While in the early years of the auditing
profession, auditors verified all transactions
in an attempt to provide almost absolute
assurance that there was no fraud or
intentional mismanagement by the auditee,
there has long since been a shift away from
this notion of absolute assurance. As
companies have grown in both size and
complexity, auditors can no longer verify
each and every transaction. Further,
auditors must place some reliance on the top
management of their clients to provide
assurances that the information being
presented to them is accurate and complete.
Thus, as reflected in Statement on Auditing
Standards (SAS) No. 82, Consideration of
Fraud in a Financial Statement Audit,
auditors are required to provide only
``reasonable assurance'' that the financial
statements are free from material
misstatements (American Institute of
Certified Public Accountants (AICPA, 1997).
The Auditing Standards Board (ASB) of the
AICPA recognized that the presence of an
expectation gap could adversely impact the
perceived value of the audit function. As
such, the ASB has attempted to minimize
misunderstandings about management's
responsibilities for the financial statements
versus the auditor's responsibility to express
an opinion on those statements. In 1988, the
ASB issued nine new auditing standards
(SAS No. 53 through 61) which were designed
to address the perceived causes of the
expectation gap by:
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. increasing the auditor's responsibility to
detect errors, irregularities and illegal
acts;
. improving audit efficiency; and
. improving auditor communications with
users and preparers (Guy and Winters,
1993).
At the same time, the audit profession
attempted to educate users through such
means as the 1989 AICPA publication,
Understanding Audits and the Auditor's
Report: A Guide for Financial Statement Users
(AICPA, 1989).
These clarification and educational efforts
certainly appear to be an appropriate remedy
for some aspects of the expectation gap. For
example, misunderstandings about
management's responsibility for the
financial statements versus the auditor's
responsibility to express an opinion on the
financial statements should be minimized by
the implementation of SAS No. 58, Reports on
Audited Financial Statements (AICPA, 1988).
This standard addresses the expectation gap
by mandating a clear and unambiguous
communication with users to delineate these
responsibilities.
Efforts to address the expectation gap have
not been limited to the USA. For example, the
Australian Accounting Research Foundation
issued a revised AUP 3, which proposed new
wording for audit reports. Research has also
been conducted by the Australian Society of
Certified Practising Accountants and The
Institute of Chartered Accountants in
Australia (1994). Academic researchers (e.g.
Gay and Schelluch, 1993; Monroe and
Woodliff, 1994) have also investigated the
issue. Similar work has also been undertaken
in the UK where the expectation gap was
found to exist (e.g. Holt and Moizer, 1990;
Hatherly et al., 1991, 1992).
However, while the profession has grown
and adapted to changes in the corporate
world, the general public (including users
such as investors and creditors) often
continues to hold auditors to the highest
Elizabeth Dreike Almer and
Richard G. Brody
An empirical investigation of
context-dependent
communications between
auditors and bankers
Managerial Auditing Journal
17/8 [2002] 478±486
possible standard of absolute assurance.
Business failures are becoming more
prevalent and, as evidenced by the multitude
of lawsuits against auditing firms, it is often
the auditor who receives the blame. Despite
attempts by the profession to clarify the role
of the auditor in a financial statement audit
(i.e. by changing the wording of the standard
auditor's report), it has failed to eliminate the
gap between the auditors' and the users'
interpretation of responsibility for providing
information about whether a company will
continue in the future. To complicate matters
further, auditor communications with users
still exist that are, by nature, ambiguous and
lawsuits often focus on this ambiguity. In
short, when a company fails, investors and
creditors tend to sue the auditor irrespective
of whether an appropriate audit was
conducted.
The purpose of the current study is to
examine how ambiguous language in auditor
communications, and the context in which
that communication occurs, contribute to the
expectation gap. While a number of studies
have examined the going concern expectation
gap from either the perspective of the
auditors (e.g. LaSalle and Anandarajan, 1996)
or the perspective of the users (e.g. Epstein
and Geiger, 1994), only one published study
(Kinney and Nelson, 1996) has considered the
two perspectives simultaneously. However, it
is somewhat surprising that no prior
research has simultaneously considered the
potential importance of context and the
perspective of both auditors and a common
group of users, bankers. Examining how
bankers understand modified audit reports is
of interest because they are likely capital
providers for troubled companies and
because they rely, in part, on financial
information to make lending decisions
(Danos et al., 1989).
Specifically, this paper reports the results
of an experiment that was conducted to
examine auditors' and bankers'
understandings of the phrase ``substantial
doubt about the entity's ability to continue as
a going concern'' used in a modified audit
report to signal the auditors' belief about the
troubled state of an entity. Given the
inherently ambiguous nature of this phrase
(there are no numerical guidelines associated
with its use), miscommunication between
auditors and users is possible. If the users do
not extract the same meaning about an
entity's ability to continue from the phrase as
auditors intend to communicate with it, an
element of the expectation gap persists. Thus,
the results are to be of interest to both
auditing and banking professionals.
The remainder of the paper is organized as
follows. Prior literature is reviewed and
hypotheses are developed in the next section.
The methodology and results are discussed in
the following two sections. The final section
provides a discussion of and conclusions
about the implications of the current study.
Literature review and hypothesis
development
Ambiguous communications
Despite the attempts to close the expectation
gap, it persists and researchers continue to
investigate the causes. Prior research
examining the expectation gap has
commonly attributed it to several factors:
. auditors' failure to communicate
sufficient information (e.g. Guy and
Sullivan, 1988);
. a lack of understanding on the part of
financial statement users (e.g. Epstein and
Geiger, 1994); and
. the effect of outcome information on
users' assessments of auditors' judgments
(Kinney and Nelson, 1996).
However, another potential cause of the
expectation gap is the effect of contextual
features on how ambiguous auditor
communications are understood by users.
As stated previously, some auditor
communications with users are, by nature,
ambiguous. One example of this relates to the
issue of going concern reporting. SAS No. 59,
The Auditor's Consideration of an Entity's
Ability to Continue as a Going Concern
(AICPA, 1988) attempts to reduce the
expectation gap by increasing the auditors'
responsibility for evaluating the going
concern status of an entity. If the auditors
have serious concerns, then SAS No. 64
(AICPA, 1990), a related amendment, requires
that they be communicated to users by
modifying the audit report with the phrase
``substantial doubt about the entity's ability
to continue as a going concern''. But neither
SAS No. 59 nor SAS No. 64 provide any
information such as numerical guidelines to
make the phrase more precise to either
auditors or users. As a result, when
``substantial doubt'' is used in an audit
report, the potential exists for the phrase to
be interpreted differently by auditors and
users, which can subsequently result in
miscommunication between the two groups.
A consistent pattern of miscommunication
about audit reports in general has also been
found by research outside of the USA. For
example, Monroe and Woodliff (1994)
addressed the issue in Australia by
conducting a study with auditors,
[ 479 ]
Elizabeth Dreike Almer and
Richard G. Brody
An empirical investigation of
context-dependent
communications between
auditors and bankers
Managerial Auditing Journal
17/8 [2002] 478±486
[ 480 ]
accountants, creditors, directors,
shareholders and students. Results
confirmed that there was in fact an
expectation gap between auditors and the
various user groups about the auditors'
responsibility for financial statement
presentation and fraud, the level of assurance
provided and the predictive value of the
financial statements. They also found that
while modified wording eliminated some of
the problems with respect to the expectation
gap, it also created some new ones. Similar
findings have also been reported in the UK
(e.g. Holt and Moizer, 1990; Hatherly et al.,
1991, 1992) and it is apparent that the
expectation gap issue is not restricted to the
USA.
Prior accounting research has also
demonstrated that individuals'
understandings of ambiguous phrases are
affected by features of the context in which
the phrase is used, such as industry health
(Amer et al., 1995), aggressiveness of client
(Cuccia et al., 1995) and engagement risk
(Hackenbrack and Nelson, 1996; Knapp et al.,
1991). Thus, to understand why auditors and
bankers in the ``real world'' may have
different understandings of an ambiguous
phrase like ``substantial doubt'', it must be
studied within the context of an entity
receiving a modified report.
Interpreting ambiguous communications
When interpreting an ambiguous phrase, an
individual implicitly assigns it a numeric
value (e.g. Wallsten et al., 1986). For example,
when auditors use the term ``substantial
doubt'' in a modified audit report, they are
signaling information about their evaluation
of the troubled entity's ability to continue.
Users read this modified report and will
assign some probability of failure to the
entity based on their understanding of the
signal provided. The extent of
miscommunication between auditors and
bankers about what is meant by ``substantial
doubt'' can therefore be measured by
comparing each groups' numeric estimate
(hereafter the ``numeric association'') of the
probability that the entity receiving a
modified report cannot continue. In the
current study, this miscommunication will be
decomposed into differences in how the two
groups generally understand the term
(general numeric association) and differences
due to contextual features associated with the
entity receiving the modified report (context-
specific numeric association).
In the case of interpreting what is meant by
the term ``substantial doubt'', there are two
possible interpretation errors: incorrectly
believing it means the company is less
troubled than it actually is (i.e. under-
conservative) and incorrectly believing it
means the company is more troubled than it
actually is (i.e. over-conservative). When
individuals display under (over)
conservative behavior, their numeric
associations shift in a downward (upward)
direction. For example, an under-
conservative individual may assign a 30 per
cent probability of failure to a company for
which a modified audit report (including the
phrase ``substantial doubt'') was issued while
an over-conservative individual may assign a
70 per cent probability of failure based on the
same report. In other words, as individuals
are more (less) conservative, they believe
``substantial doubt'' means an entity is more
(less) likely to fail.
Context-free interpretations
Prior research provides insight into why
auditors and bankers may have different
understandings of ``substantial doubt''. Lewis
(1980) suggested that differences in utility for
different outcomes affect auditors' disclosure
decisions when the decision hinges on
interpretation of ambiguous phrases in the
professional standards. Related to differences
in utility for outcomes, an individual's
decision position (i.e. auditor, banker, etc.) is
expected to carry with it the consequences of
incorrectly interpreting an ambiguous
phrase. For example, Kinney and Nelson
(1996) speculate that, in general, auditors and
Government Accounting Office (GAO)
personnel both face consequences such that
they would not want to be either under- or
over-conservative. Because GAO personnel
act as investigators and advisors to Congress
about federal regulatory processes, Kinney
and Nelson argue that they want to help
ensure a sufficiently high level of disclosure
to ensure useful financial information, yet
not so high as to interfere with the
functioning of financial markets. While this
line of reasoning is helpful in understanding
the expectation gap, not all user groups share
the GAO's relatively equal concern about
under- versus over-conservative errors.
Relevant to the current study, prior
research suggests that bankers view under-
conservative errors much more seriously
while auditors tend to be more balanced in
their concern for over- and under-
conservative errors (Holt and Morrow, 1992).
Applied to the current setting, this finding
suggests that bankers worry about
interpreting ``substantial doubt'' as indicating
a company is less troubled than it actually is,
whereas auditors worry about believing
``substantial doubt'' indicates a company is
more or less troubled than it actually is.
Elizabeth Dreike Almer and
Richard G. Brody
An empirical investigation of
context-dependent
communications between
auditors and bankers
Managerial Auditing Journal
17/8 [2002] 478±486
These concerns stem from the consequences
that auditors and bankers face if they
incorrectly interpret ``substantial doubt''.
For auditors, believing a company is less
troubled than it actually is would likely
result in litigation losses (e.g. Palmrose,
1987). If auditors believe a company is more
troubled than it actually is, loss of a client
and related audit fees would likely result (e.g.
Farmer et al., 1987; Kida, 1980; Nagle, 1994).
Thus, there are potential harmful effects for
any type of judgment error on the part of the
auditor. Bankers, on the other hand, face
specific loan losses if they interpret
``substantial doubt'' as indicating a company
is less troubled than it actually is, but only
opportunity costs associated with turning
down a potentially profitable loan if they
believe a company is more troubled than it
actually is. The specific loan losses should be
more salient to bankers than unspecified
opportunity costs.
Thus, when bankers receive a modified
audit report, they are expected to be
conservative and make a ``worst case''
interpretation of ``substantial doubt''. This
causes upward pressure on their numeric
associations resulting in a higher estimated
probability that the company will fail.
Alternatively, auditors have incentives to be
neither overly or under-conservative so they
would have both upward and downward
pressure on their numeric associations. This
leads to the conclusion that auditors should
have lower general numeric associations
than bankers.
In examining general interpretations of
``substantial doubt'', Ponemon and
Raghunandan (1994) found this pattern of
results. On a 0 to 100 scale with endpoints
``complete certainty that the company will
continue its business operations as a going
concern for at least one year'', Ponemon and
Raghunandan asked auditors and several
user groups to indicate the point where they
believed there would be ``substantial doubt''
about the ability of an entity to continue as a
going concern. On average, auditors reported
56 per cent while bankers reported 72 per
cent. One interpretation for this result is that
bankers typically interpret ``substantial
doubt'' in the context of a modified audit
report issued for an entity and, thus, they
may have been providing an estimate that an
entity will fail given a modified report was
issued, rather than providing their opinion of
what the auditors' decision threshold should
be. This suggests that bankers, relative to
auditors, view a modified audit report as
signaling a more troubled company.
Additionally, while it has been suggested
that the results also support the contention
that non-auditors believe that audit opinions
provide a higher level of assurance than
intended by the auditors (e.g. Epstein and
Geiger, 1994), it should be noted that
Ponemon and Raghunandan did not examine
the impact of the subjects' general numeric
associations on numeric associations within
context. Prior to examining the impact of
context on auditor and banker
interpretations, the current research first
clarifies how the auditors and bankers
establish their general (context-free) numeric
associations. Accordingly, the following
hypothesis is proposed:
H1. Auditors' general numeric
associations for a going concern
modification will be lower than
bankers' general numeric
associations for a going concern
modification.
Effect of context on interpretations
Specific contextual features associated with
an entity receiving the modified report are
expected to affect numeric associations by
shifting the relative importance of being
under- versus over-conservative. One such
feature is entity ownership structure (i.e. a
public versus privately held company). This
is an important contextual variable to
examine because it is part of the information
set available to any user. Specifically, both
auditors and bankers will be aware of this
variable and it is likely to be subjected to
differing interpretation and relevance
depending on the user group.
Entity ownership structure is expected to
affect the relative importance to auditors of
being under- versus over-conservative.
Empirical audit research has found that,
controlling for size, litigation against
auditors is most often associated with the
failure of public companies (Palmrose, 1987).
In part, this is because auditors are less
likely to be liable to third parties with a
privately held company (Simunic and Stein,
1996). Likewise, public ownership is
associated with higher audit fees (Palmrose,
1988). Behavioral evidence also reveals that
the litigation risk associated with public
companies is important to auditors (Krogstad
et al., 1984), affecting how an audit is
conducted (Walo, 1995) as well as how
auditing standards are interpreted
(Hackenbrack and Nelson, 1996; Knapp et al.,
1991). Hackenbrack and Nelson and Knapp et
al. both found that auditors' interpretations
of vague disclosure requirements involving
verbal probabilities are more conservative
when they believe there is a greater
likelihood of being sued.
[ 481 ]
Elizabeth Dreike Almer and
Richard G. Brody
An empirical investigation of
context-dependent
communications between
auditors and bankers
Managerial Auditing Journal
17/8 [2002] 478±486
[ 482 ]
Auditors also face concern over the risk of
client loss (Nagle, 1994). This risk of client
loss provides an incentive to make less
conservative decisions to avoid the negative
consequences of lost fees. However, a number
of studies suggest that concern of risk over
client loss ``nets'' with concern over risk of
litigation. This ``net'' concern only favors
aggressive reporting when the risk of
litigation is sufficiently low. For example, in
the context of SFAS No. 5 and SFAS No. 77
(reporting by transferors for transfers of
receivables with recourse), Hackenbrack and
Nelson (1996) examined auditors' numeric
associations of whether an amount can be
``reasonably estimated''. Under conditions of
low litigation risk, auditors' numeric
associations were more advantageous to the
client. Under conditions of high litigation
risk, however, auditors' numeric associations
were more conservative, and the threat of
client loss did not affect their judgments.
Therefore, auditors appear to be shifting
their numeric associations in a particular
situation in response to the level of risk of
either litigation associated with being under-
conservative or client loss associated with
being over-conservative. This pattern is
consistent with other research indicating
that features of context impact the relative
effect of risk of litigation and risk of client
loss on auditors' judgments (Farmer et al.,
1987; Trompeter, 1994). Since risk of litigation
is lower for private companies than for
public companies (Palmrose, 1987), risk of
client loss should have a relatively stronger
influence on decisions involving private
companies than public companies. Taken
together, these studies suggest auditors'
going concern numeric associations will
indicate a less conservative or lower
probability of failure for private companies
than for public companies.
On the other hand, entity ownership
structure is not expected to affect potential
losses perceived by bankers. Compared to
errors associated with being over-
conservative, bankers are expected to view
errors associated with being under-
conservative as having more serious
consequences (e.g. Holt and Morrow, 1992).
Specific loan losses associated with granting
a loan to a company which is believed to be
more healthy than it actually is, are more
serious than losses associated with failing to
grant a loan to a company because it was
believed to be less healthy. That is, bankers
are simply worried about suffering a loss on a
loan that is granted and subsequently not
repaid. This loss is a loss regardless of entity
ownership structure. Thus, to the extent that
entity ownership structure affects the
relative importance of risk of litigation and
risk of client loss for auditors, but does not
have similar effects on bankers, numeric
associations of the two groups will be
differentially affected. This discussion leads
to the following hypotheses:
H2A. Auditors' numeric associations for
a going concern modification will be
higher for public companies than
for private companies.
H2B. Bankers' numeric associations for a
going concern modification will not
be different for public companies
and private companies.
Method
Participants
Experimental materials were mailed to
contacts at 14 Big Six public accounting firm
locations and bankers at 13 bank locations.
Five of the Big Six firms and 12 major banks
were represented in the sample. A total of 57
and 69 useable responses were received from
experienced auditors and bankers, for a
response rate of 36 per cent and 55 per cent,
respectively. Auditors all had greater than
four years of experience and generally held
the rank of manager or above. Bankers were
either commercial loan officers or vice-
presidents. Demographic information for the
participants is detailed in Table I.
Experimental procedures
After reading a cover letter indicating that
some questions would be asked about audit
reports modified for a going concern,
participants were asked to provide a general
numeric association for ``substantial doubt''.
Next, auditors were asked to assume they
were contemplating the going concern status
of their audit client, while bankers were asked
to assume they had just received annual
financial statements and the related modified
audit report for an existing borrower. Both
groups were presented with the case about a
hypothetical distressed company, EDA Inc.
(EDA), including the going concern
explanatory language. Auditors were told this
language would be used if such a report were
issued for EDA, whereas the bankers were
told they received this report for their
borrower, EDA. Auditors were asked what
report they would issue for EDA and then
both groups provided a numeric association
for ``substantial doubt'' in the context of EDA.
Finally, other covariate and demographic
information was elicited.
Case materials
The case included a description of EDA, its
financial statements and a summary of
Elizabeth Dreike Almer and
Richard G. Brody
An empirical investigation of
context-dependent
communications between
auditors and bankers
Managerial Auditing Journal
17/8 [2002] 478±486
Table I
Participant demographics
Category
Experience (years)
Going concern modification
experience (number of times)
Electronic components or small
household appliance experience
(percent of total experience)
Age
Time to complete instrument
(minutes)
Percentage of males
financial ratios relevant to going concern
judgments ± profitability, leverage, liquidity,
capital intensiveness, and cash position.
Inclusion of these factors was based on a
review of practitioner literature (Ellingsen et
al., 1989) and behavioral (Kida, 1980) and
archival (Hopwood et al., 1994; Mutchler,
1986) research indicating factors that are
critical to going concern decisions. In order
to try to avoid a ``ceiling effect'' (i.e. the firm
is so troubled that participants are
completely certain it will not continue as a
going concern), the financial statements were
modeled after a company receiving a
modified audit report, but ``clean'' opinions
for the following three years.
The case also included both negative and
mitigating facts bearing on EDA's ability to
continue. The negative facts highlighted that
EDA has reported a net loss for the third
straight year, is in default of loan covenants,
is in a negative cash flow position and has
ratios below the lower quartile of similar
sized companies in the same industry. The
mitigating facts stated that top management is
experienced and has a track record of being
able to turn troubled companies around, there
is an agreement in substance to ship products
to a Pacific Rim country and interest rates
have been at a low level and are expected to be
relatively stable in the next year.
In order to ensure the case information
was realistic and portrayed a moderately
troubled company as intended, pretesting
was conducted using former Big Six and
national firm audit partners and commercial
loan officers from three different banks. On
completion of the experimental materials,
subjects were interviewed by one of the
researchers to discuss various issues
presented in the case information. Based on
these conversations, no significant changes
were deemed necessary.
Auditors Bankers
Mean Std Dev Mean Std Dev
(n = 57) (n = 69)
8.6 4.8 11.4 7.2
14.6 65.9 5.5 7.4
4.4 12.9 4.5 5.6
31.7 5.4 38.2 8.1
18.5 5.6 18.3 5.3
68 67
Independent variable
The relative importance of being over- versus
under-conservative may (i.e. for auditors) or
may not (i.e. for bankers) be affected by the
ownership structure of EDA. Subjects were
randomly assigned to one of two ownership
structure conditions. In the first condition,
EDA is publicly held while in the second,
EDA is privately held.
Dependent variables
If there is a misunderstanding about what is
meant by a modified audit report issued for
an entity, it could be a result of the auditors
and bankers having different general
understandings of the phrase ``substantial
doubt'' and/or by the two groups'
understandings being differentially affected
by context. The first dependent variable
therefore is participants' general numeric
associations for ``substantial doubt'',
measured on a scale anchored by ``Total
ability to continue/0 per cent probability of
failure'' and ``No ability to continue/100 per
cent probability of failure''. The second
dependent variable is participants' numeric
associations within the context of EDA. This
dependent variable is used to test the second
set of research hypotheses.
Covariates
The general numeric association discussed
above as the dependent measure for H1 is
also used as a covariate in testing H2A and
H2B to control for differences in pre-existing
beliefs with respect to the phrase
``substantial doubt''. Other potential
covariates related to demographics,
experience in auditing/lending, experience
with going concern audit reports, perception
issues, employer and time spent on the case
will also be examined.
Results
Manipulation and other checks
Two manipulation checks were incorporated
into the experimental materials. First, all
subjects were asked to identify the ownership
structure of EDA as being either public or
private. Four subjects (one auditor, three
bankers) failed this manipulation check and
were eliminated from further analyses. The
second manipulation check asked auditor
participants to identify the type of audit
report they would issue for EDA. Given the
results of the experienced subjects who
participated in the pilot test, it is clear that
the audit report provided is appropriate.
However, seven auditors failed to correctly
[ 483 ]
Elizabeth Dreike Almer and identify the correct type of report and were
Richard G. Brody excluded from further analysis.
An empirical investigation of Auditors and bankers rated case realism 5.0
context-dependent
communications between and 5.1, respectively, on a scale of 1 to 7 (with 1
auditors and bankers being unrealistic and 7 being realistic),
Managerial Auditing Journal indicating that the case is fairly representative
17/8 [2002] 478±486 of what would be encountered in practice and
was not perceived to have different realism
between groups. None of the other previously
listed potential covariates (i.e. demographic-
related, experience) were found to be
significant and they were, therefore,
eliminated from further consideration.
Tests of hypotheses
To test H1, auditors' and bankers' general
numeric associations were compared. Table
II presents the mean, standard error, and
results of the one-way ANOVA. As predicted,
auditors' numeric associations for a going
concern modification are significantly (p-
value < 0.0001) lower than bankers' numeric
associations. This result indicates that when
auditors issue a modified report, they believe
the entity has a lower probability of failure
than bankers believe when they receive the
audit report.
Given these differences in general numeric
associations, in order to test the effect of
context, participants' general numeric
associations (NA1) will be included as
covariates in subsequent analyses.
Table III presents the adjusted mean,
standard error and results of planned
comparisons to test H2A and H2B.
After controlling for participants' general
numeric associations (NA1), as predicted,
auditors' numeric associations were
significantly higher in a public ownership
context than in a private one (one-tailed p-
value < 0.0443) whereas the bankers' numeric
associations were not.
Discussion
Before discussing the results of the study,
certain limitations will be noted. First, it is
possible that auditors and bankers may not
Table II
Numeric associations: context-free
Dependent Auditors Bankers
variable (n = 57) (n = 69) Mean difference
Standard Standard audit managers
Mean error Mean error versus bankers p-valuea
H1. Numeric 56.35 (2.37) 73.19 (1.53) ±16.84 0.0001
association
Note: Numeric association elicited on a scale anchored by ``Total ability to continue/0
per cent probability of failure'' and ``No ability to continue/100 per cent probability of
failure''. a one-tailed
[ 484 ]
respond to a case from an experimental
approach in the same way they would
respond in practice. Second, although the
case materials included the information
necessary for performing the requested task,
additional information might be available
and requested in an actual decision-making
task. However, the amount of information
provided was similar to previous research,
and pretests indicated it was realistic and
sufficient for the task at hand. Third, since
auditors and bankers from 14 and 13
locations, respectively, participated in the
experiment, the results may not generalize to
the entire population of auditors and
bankers. Finally, the limitations inherent in
a mail survey are present. While early and
late respondents were analyzed separately
with no significant differences, the small
sample size and nature of a mail survey
further serve to limit the generalizability of
the results. However, those participants who
did complete the task appeared to take their
role very seriously and, thus, the significant
results may extend to a larger population of
auditors and bankers.
The current study makes a contribution to
the existing literature by demonstrating the
role of context in ambiguous
communications with users. Results indicate
that the ambiguous nature of the going
concern communication is problematic both
because auditors and bankers have different
context-free understandings of modified
audit reports and because their
understandings are differentially sensitive to
features of the context. Consistent with the
two groups' expected relative concerns about
over- versus under-conservative errors,
context-free, bankers reported higher
``substantial doubt'' numeric associations
than auditors. That is, bankers believe the
modified audit report communicates a higher
probability of the entity failing than the
auditors believe they are communicating. A
potential consequence of this
miscommunication is that the company
receiving the modified audit report may
unduly be denied access to capital.
As predicted, when examined in the
context of an entity, auditors' and bankers'
understandings of a modified audit report
were differentially affected by ownership
structure. Auditors reported higher (lower)
numeric associations under public (private)
ownership structure, whereas bankers did
not. This pattern of numeric associations is
consistent with the auditors' increased
business risk when associated with a
publicly held entity. Differential sensitivity
to ownership structure demonstrates that a
contextual variable, always present when a
Elizabeth Dreike Almer and
Richard G. Brody
An empirical investigation of
context-dependent
communications between
auditors and bankers
Managerial Auditing Journal
17/8 [2002] 478±486
Table III
Numeric associations within context: effect of ownership structure
H2A. Auditors H2B. Bankers
Public Private
(n = 30) (n = 27) Results of
Adjusted Std Adjusted Std planned Adjusted Std
mean error mean error Diff. comparisonsa mean
68.90 2.96 61.75 3.16 7.15 0.0443
a b
Notes: one-tailed test; two-tailed test
modified audit report is issued, has the
ability to cause differences in how the report
is understood by auditors, yet not by
bankers. Context operates by differentially
impacting how auditors and bankers
interpret a modified audit report. Ownership
structure is just one very small part of the
rich set of contextual variables commonly
surrounding auditors and users in the ``real
world''. The current finding suggests that to
the extent there are other variables which
also have a differential effect on auditors' and
bankers' numeric associations, the going
concern expectation gap will persist despite
previous efforts to eliminate it. Furthermore,
this finding highlights the importance of
accounting for context in research on issues
involving ambiguous communications.
In summary, the results of this study
indicate that despite the issuance of the
expectation gap standards, ambiguous
language in auditor communications is still a
problem. While these results highlight another
potential contributing cause to the expectation
gap, the study is subject to the same limitation
affecting previous research in that, ``it is not
clear what practical policy implications can be
drawn from the findings'' (Gwilliam, 1987, p.
62). That is, these results should not be taken to
indicate that, for example, using some other
phrase in these communications would
eliminate the expectation gap. Rather, it is
important to recognize that the signal the
auditors believe they are sending is not
necessarily the signal received by the users.
This result has implications for both the
accounting profession and accounting
researchers on an international level as the
expectation gap is not restricted to the USA.
First, the importance of context and
simultaneously examining the perspective of
both parties is critical when assessing the
causes, seriousness and any possible solutions
to the expectation gap. Second, in order to
further explore the robustness of context,
future research should consider additional
contextual variables. A particularly relevant
contextual variable to be considered is client
size since it is positively associated with
lawsuits against auditors (Carcello and
Public Private
(n = 33) (n = 36) Results of
Adjusted Std planned
error mean error Diff comparisonsb
65.82 2.78 66.23 2.75 ±0.41 0.9132
Palmrose, 1994; Stice, 1991). Auditors have
more conservative interpretations of
``substantial doubt'' as client size increases
(Knapp et al., 1991). On the other hand, since
entity size is inversely related to bankruptcy in
the population (e.g. Foster, 1986), bankers may
become less conservative as entity size
increases. Finally, future research should focus
on additional users of the information provided
by auditors. Financial analysts and investors
are two of the groups that warrant attention, as
they may or may not behave in a fashion
similar to the bankers in the current study.
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Elizabeth Dreike Almer and
Richard G. Brody
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Managerial Auditing Journal
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The authors wish to thank
Cindy Moeckel, Buck Pei,
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