Identifying Audit Adjustments with Attention-Directing Procedures

Author(s): Arnold Wright and Robert H. Ashton

Source: The Accounting Review, Vol. 64, No. 4 (Oct., 1989), pp. 710-728
Published by: American Accounting Association
Stable URL: https://www.jstor.org/stable/247857
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THEACCOUNTING REVIEW
Vol. LXIV, No. 4
October 1989

Identifying Audit Adjustments with

Attention- Directing Procedures
Arnold Wright and Robert H. Ashton

ABSTRACT: Studies of the error-detection performance of audit procedures have found that
three attention-directing procedures-client inquiry, expectations based on prior-year errors,
and analytical review-signal almost half of the material errors detected. Further, the cost of
performing such procedures appears to be relatively low, suggesting a positive cost/effective-
ness relation. The primary purpose of the present study is to report detailed results of apply-
ing these attention-directing procedures when errors are identified. The sample consists of
186 engagements involving 368 proposed audit adjustments of a Big Eight audit firm. The
results corroborate prior studies in that about half of the errors were signaled by the three
attention-directing procedures and the simplest forms of these procedures (e.g., analytical
reviews comparing current- and prior-year balances) identify many errors. Moreover, internal
controls appear to condition the diagnosticity of audit procedures. When controls are strong,
procedures involving internal accounting data are more diagnostic, while with weak controls
evidence external to the accounting records signals relatively more errors.

UDTNG standards emphasize that au-
dit procedures should be planned
such that the risk of failing to de-
tect material error is held to an accept-
able level (e.g., SAS No. 47 [AICPA,
1983]). To achieve this objective, audi-
tors rely on many types of procedures,
some of which can be described as "at-
tention-directing" -e.g., analytical re-
view, verbal inquiry of client personnel,
and expectations based on errors found
in prior years. Attention-directing pro-
cedures focus on the identification of
amounts, relations, and events that are
unusual or unexpected. Potential errors
and Felix, 1980]. However, an empirical
study by Hylas and Ashton [1982] sug-
gested that attention-directing proce-
dures can be quite useful in identifying
material adjustments. In that study, 45.6
percent of a sample of 281 adjustments
from 152 audits of Peat Marwick Mitch-
ell & Co. (PMM) were initially signaled
by such procedures.
Support for this project was provided by the Peat,
Marwick, Mitchell Foundation's Research Opportuni-
ties in Auditing Program. The views expressed, however,
are ours and do not necessarily reflect those of the foun-
dation. We are indebted to several people at PMM for
advice on the project, especially John Willingham and
John Kielich. We also are indebted to the editor and three

initially signaled by attention-directing anonymous reviewers for useful comments.

procedures are then investigated by using

Arnold Wright, Northeastern Univer-
other, often more detailed, audit pro-
sity; and Robert H. Ashton, Duke Uni-
cedures.
versity.
With the exception of analytical re-
view, attention-directing procedures have
Manuscript received June 1987.
received little attention in the auditing Revisions received March 1988 and October 1988.
research literature [Kinney, 1987; Kinney Accepted February 1989.

710

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Wright and Ashton 711

The study reported here extends Hylas A second motivation is to explore

and Ashton [1982] in several ways. Spe-
cifically, it (1) provides detailed informa-attention-directing procedures may be
tion on circumstances surrounding the
use of the three attention-directing pro-
cedures, (2) examines the extent to which
the proportion of errors signaled by vari- the auditor's experience, and the motiva-
ous procedures is conditional on internal
control strength, (3) uses the participat- [Mock and Wright, 1982; Wright and
ing firm's explicit audit planning mate-
riality measure, (4) examines a larger set finding that financial statement errors
of detected errors drawn from a differ-
ent time period, and (5) uses more rigor-
ous and systematic data collection and
analysis methods. The paper is organized
in four parts. The following section pre-
sents the motivation for the present
study. This is followed by a description
of the study's design. The results are
then presented and some conclusions are
offered.
MOTIVATION
One motivation for the present study
is the possible effect of changes in the
professional auditing environment since
the Hylas and Ashton [1982] study. The
prior sample was from financial state-
ments with December 1978 closings,
while the present sample was selected
from September 1984 to March 1985
closings. The six intervening years saw
increased governmental activities em-
phasizing audit effectiveness and greater
competitive pressures emphasizing audit
efficiency [Ashton and Willingham,
1989], as well as movement toward more
"structured" audit technologies by
many large auditing firms [Cushing and
Loebbecke, 1986]. Indeed, the firm in
which this and the earlier study were
conducted is known to be one of the
most highly structured firms in the pro-
fession (e.g., Kinney [1986]). Because of
these changes, there may be changes in
the relations observed by Hylas and Ash-
ton. I
some of the conditions under which
useful in identifying errors. Possible
conditioning factors include materiality,
assessments of internal control strength,2
tions of those providing the evidence
Mock, 1985]. Consider, for example, the
often are perpetuated from year to year
[Hylas and Ashton, 1982; Kinney, 1979].
Knowing the conditions under which
perpetuation occurs should help auditors
refine their expectations about errors in
the current audit. Expectations based on
errors found in prior years is one of three
attention-directing procedures investi-
gated here. The other two are analytical
review and verbal inquiry of the client.
Note that analytical review includes,
among other things, comparisons of
balances with those of prior years (e.g.,
SAS No. 56 [AICPA, 1988]), but does
not overlap with expectations based on
errors of prior years. Little is known
about the extent to which various analyt-
ical review techniques identify errors
(e.g., ratio analysis, account balance
comparisons, regression analysis). Simi-
larly, little is known about the nature of
auditors' verbal inquiries. The useful-
ness of this procedure may depend on
the individuals questioned, their posi-
' Other studies have also examined error characteris-
tics of accounting populations (e.g., Kinney [1979],
Kreutzfeldt and Wallace [1986], Ham et al. [1985], John-
son et al. [1981], Ramage et al. [1979], and Willingham
and Wright [1985]), although only Kreutzfeldt and Wal-
lace [1986] have considered the nature, causes, and detec-
tion of such errors. Kreutzfeldt and Wallace [1986] in-
vestigated error detection by examining more than 1,500
errors from 260 engagements of Arthur Andersen & Co.
2 A study of clients from the same auditing firm found
no relation between errors detected in accounts receiv-
able and inventory and the auditors' assessments of in-
ternal control effectiveness [Willingham and Wright,
19851.

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712 The Accounting Review, October 1989

tions within the client firm, the context
of the inquiry, or other factors.
An additional motivation is explora-
tion of the implications of an ordering
bias. That is, since attention-directing
procedures are often applied early in an
audit, other procedures have a lower
likelihood of initially signaling errors.
The effect of this bias was investigated
by asking the auditors whether they be-
lieved the adjustments would have been
signaled by a procedure other than the
one applied and, if so, to identify the
most likely procedure.
Finally, by including proposed audit
adjustments regardless of whether they
were subsequently "booked" or waived,
the present study examines a sample of a
broader nature than did Hylas and Ash-
ton [1982], who included data only on
individually material adjustments that
were booked. Waived adjustments were
included based on the presumption that
the auditors' first concern is to detect
errors; then a subsequent decision may
be made about whether to waive the ad-
justment due to considerations such as
materiality.3
METHOD
The Hylas and Ashton [1982] results
were used as a starting point, particularlyThus, only errors that have a reasonable
the categories of initial events and error likelihood of aggregating to an amount
causes. "Initial events" refers to the
audit procedure, circumstances, or event
that initially led the auditor to suspect justments
that an error had occurred, and includes
the three attention-directing procedures. each
"Error causes" refers to the auditor's
judgment as to the likely cause of the
error. Nine categories of initial events
and seven categories of error causes were adjustments in the analyses below. Further information
used (see Tables 4 and 5). A question-
naire specified the categories and asked
the auditors to simply "check off" their
responses-instead of providing narra-
tive descriptions as in Hylas and Ashton
[1982]. The questionnaire and related in-
structions were sent in February 1985 to
the auditors working on a random sam-
ple of 630 U.S. audits of PMM. The
auditors were asked to return the (un-
completed) materials to the firm's execu-
tive office if the client chosen was no
longer a client of the firm or if the
client's year-end fell outside the period
of November 1984 to February 1985.4
The auditors were asked to provide the
requested information for only the four
largest proposed adjustments and, in
any case, only for adjustments that
equaled or exceeded 20 percent of plan-
ning materiality. Planning materiality, or
"gauge," is defined as 1.6(X)67, where
X is the larger of total assets at the bal-
ance sheet date or net revenues for the
year. Gauge (G) was developed by PMM
to represent an average level of precision
for audit planning purposes [Elliott,
1983], and it provides a common bench-
mark for expressing the relative sizes of
audit adjustments for different clients.
Responses were limited to the four larg-
est adjustments to maintain a reasonable
response time, since detailed informa-
tion on each adjustment was requested,
and because larger errors are of greater
concern to auditors than smaller ones.
greater than G were studied. The audi-
tors were further asked to exclude ad-
of a "bookkeeping" nature
that are performed as a client service
year, such as anticipated adjust-
3 Since the present paper focuses on error detection in-
stead of the ultimate resolution of the proposed adjust-
ments, we do not distinguish between booked and waived
on the waived adjustments is provided by Wright [19881.
4 A total of 220 uncompleted questionnaires was re-
turned for these reasons. However, the materials for 16
clients having September 1984 and March 1985 year-ends
were completed and are included in the results reported
below.

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Wright and Ashton 713

ments to deferred and accrued income at least twice as large as the number of
taxes, since such adjustments are not adjustments. Table 2 reveals a total of
viewed as errors and involve little or no 792 errors, while Table 3 (discussed later)
exposure for the auditor. indicates that these errors involved 368
The materials sent to the auditors con- proposed adjustments. The number of
sisted of five parts: (1) a cover letter engagements with one, two, three, and
from the executive office to the man- four adjustments was 43, 18, 15, and 61,
aging partner of the office conducting respectively. Forty-nine engagements
the engagement; (2) a more detailed had no proposed adjustments that met
cover letter to the partner in charge of the .2G criterion.8
that particular engagement; (3) instruc-
tions for the engagement manager re-
sponsible for conducting the audit; (4) I Copies of all materials are available from the
authors.
more detailed instructions for all person-
6 Hylas and Ashton [1982] did not report the mean or
nel assigned to that audit; and (5) the range of size measures for their sample. Instead, they re-
questionnaire. The engagement manager ported that their sample was almost equally divided
was asked to coordinate completion of among three asset size categories-greater than $50
million (32 percent), between $10 and $50 million (34 per-
the questionnaire, consulting with the in- cent), and less than $10 million (34 percent). In the pres-
charge auditor and the audit staff to ent sample, 51 percent of the clients are in the "greater
obtain the detailed information re- than $50 million" category, while only 29 percent (20
percent) are in the "between $10 and $50 million" ("less
quested on specific adjustments. Ques- than $10 million") category. Thus, clients in the present
tionnaires were distributed either during sample are, on average, larger than those in the Hylas
field work or soon thereafter.' and Ashton [1982] sample. While inflation over the
period 1978 to 1984-1985 undoubtedly explains some of
RESULTS this difference, another important factor is likely to be
differences in sample selection procedures. The Hylas
Responses were received from 186 en- and Ashton sample was chosen to yield a relatively uni-
gagements, 92 percent of which are in six form distribution of client sizes within each industry re-
ported in Hylas and Ashton [1982]. In contrast, the pres-
broad industry categories: manufactur- ent sample was selected randomly from PMM's client list
ing, merchandising, commercial bank- without imposing size and industry constraints. A differ-
ent sample of clients-selected in 1981-1982 using pro-
ing, savings and loan, insurance, and
cedures similar to ours-produced mean asset and reve-
natural resources. The proportion of nue values comparable to those reported in Table 1 (see
sample clients in each industry categoryAshton et al. [1987]).
is comparable to that of Hylas and Ash- 7 In examining errors by account, a difficulty is that
the financial statement accounts vary by industry; e.g., a
ton [1982]. Eighty-three percent of the manufacturing company's balance sheet differs from a
clients have December year-ends. The bank's. Rather than forcing auditors working in differ-
clients are extremely variable in terms ofent industries to use the same group of accounts, based
on a pilot study and discussions with PMM personnel, it
size. For example, Table 1, which pro- was decided to provide industry-specific sets of accounts.
vides summary data on the clients, shows Accordingly, four sets of accounts were used: "stan-
that total assets range from $180,000 to dard" accounts (for manufacturing, merchandising, and
natural resources clients); accounts for insurance com-
$12.8 billion and gauge ranges from panies; banks; and savings and loan clients. Partners at
$7,000 to $8.4 million.6 PMM's executive office matched various accounts for
The number of errors affecting vari- insurance companies, banks, and savings and loans to
the standard set of accounts in Table 2.
ous accounts is shown in Table 2.7 Note 8 Auditors were also asked to indicate the total number
that the number of errors is not the same of adjustments detected regardless of their size or nature.
as the number of proposed adjustments. About 12 percent of the engagements found one or zero
adjustments; 16 percent found two to five; 24 percent
Since an adjustment affects at least two found six to ten; and 48 percent found more than ten ad-
accounts, the number of errors must be justments.

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714 The Accounting Review, October 1989

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716 The Accounting Review, October 1989

TABLE 3
EFFECT OF ADJUSTMENTS ON INCOME: 1984-1985
(RESULTS FROM HYLAS AND ASHTON [1982] IN PARENTHESES)

Average Size Average Income Effect

Amount Percent of Percent of Amount Percent of

Effect Number Percentage ($000's) Assets Gauge ($OOO's) Gauge

Reduce income 158 42.9% 398 2.2 141 313 146

(144) (51.2) (235) (1.4) (160)

Increase income 104 28.3 418 .6 86 347 72

(102) (36.3) (192) (1.2) (154)

No effect, i.e., 106 28.8 1,889 1.5 169 - -

reclassifications (35) (12.5) (158) (1.2)

General Description of the Errors found substantially higher error rates for
inventory than for accounts receivable,
Great variability in the distribution of
there are slightly fewer inventory errors.
errors across both accounts and indus-
Table 2 indicates that errors affecting
tries is evident in Table 2. Fifty-two per-
asset accounts were split about evenly
cent of the errors occurred in eight of the
between overstatement (138) and under-
23 accounts listed: accounts receivable;
statement (150), while those affecting
inventory; prepaid expenses; property,
liability accounts tended more toward
plant and equipment; deferred charges;
understatement (109) than overstatement
accounts payable; revenue; and cost of
(63). Over- and understatements were
goods sold. As expected, the pattern of
roughly equal for revenue accounts, but
errors by account differed across indus-
more understatements (122) than over-
tries. There were a relatively large num-
statements (98) were reported for ex-
ber of inventory and cost of goods sold
pense accounts. Inventory errors tend to
errors in manufacturing and merchan-
be fairly evenly divided between over-
dising companies; receivables and mar-
and understatements, while accounts
ketable securities/investments errors in
receivable errors tend to be overstate-
commercial banks and savings and
ments. While data on error direction
loans; accrued liabilities and long-term
were not reported by Hylas and Ashton
liabilities errors in insurance companies;
and property, plant, and equipment er-
[1982], the present results generally
parallel those of other studies [Kreutz-
rors in natural resources companies. The
feldt and Wallace, 1986; Ramage et al.,
variability in the present sample is com-
1979; Kinney, 1979; and Ham et al.,
parable to that in Hylas and Ashton
1985].
[1982]. It is also similar to Kinney [1979],
who found many adjustments to inven-
Income Effects
tory and cost of goods sold, and to Ham
et al. [1985], who found a high incidence As mentioned earlier, the 792 errors
of errors in inventory and accounts pay- resulted in 368 proposed adjustments.
able. However, unlike Ramage et al. The income effect of these adjustments
[1979] and Johnson et al. [1981], who is shown in Table 3, which indicates that

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 Wright and Ashton 717

TABLE 4
AUDITORS' ASSESSMENTS OF ERROR CAUSES: 1984-1985
(RESULTS FROM HYLAS AND ASHTON [1982] IN PARENTHESES)

Adjustments

Total Small* Moderate** Large***

Cause (n =334)a (n =236) (n =50) (n =48)

Personnel problems 6.3% 7.2 07o 6.0% 2.1 1o

(26.3)b

Insufficient accounting knowledge 28.6 26.8 36.0 31.2

(15.0)

Judgment 20.1 22.9 10.0 16.7

(15.3)
Cut-off or accrual 18.6 17.8 20.0 20.8
(38.1)

Mechanical 12.9 12.7 16.0 10.4

(12.5)

Inadequate control,
follow-up, or review 12.6 11.4 12.0 18.8
(9.3)
Other .9 1.2 - -
(19.2)

a In this and other tables that report breakdowns of the 368 adjustments, the totals sometimes do not add to 368
because of the failure of some respondents to answer a few of the detailed questions we asked.
bThe percentages for the Hylas and Ashton [1982] study sum to more than 100 percent because more than one
factor was identified as causes of some errors.
* Greater than or equal to .2 x Gauge but less than Gauge
** Greater than or equal to Gauge but less than 2 x Gauge
*** Greater than or equal to 2 x Gauge

43 percent of the adjustments would re- Error Causes

duce income (i.e., the effect of the errors
Auditors were asked to indicate what,
was to overstate income) and that 28
in their judgment, was the cause of the
percent would increase income (the er-
error that led to each proposed adjust-
rors understated income). The remaining
ment. They could choose from six types
29 percent, although they met the .2G
of causes identified in the Hylas and
criterion, would have no effect on in-
Ashton study. The results, shown in
come, i.e., they were reclassification
Table 4, indicate that three related
adjustments. The present sample of en-
causes-personnel problems, insuffi-
gagements entails substantially more ad-
cient accounting knowledge, and judg-
justments that have no income effect
ment errors-accounted for 55 percent
than does the Hylas and Ashton [1982]
of the errors.9 This compares with 51
sample. Like the prior study, however,
the income-overstatement errors in the 9"Personnel problems" include, for example, inex-
present study are larger as a percentage perience, carelessness, and time pressures, while "insuf-
fient accounting knowledge" refers to insufficient
of assets, than are the income-under- awareness of generally accepted accounting principles
statement and no-effect errors. and specific client policies. "Judgment errors" refer to

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 718 The Accounting Review, October 1989

TABLE 5
INITIAL EVENTS THAT IDENTIFIED ADJUSTMENTS: 1984-1985
(RESULTS FROM HYLAS AND ASHTON [1982] IN PARENTHESES)

Adjustments

Total Small* Moderate** Large***

Initial Event (n=362) (n=250) (n=56) (n=56)

Analytical review 15.507o 12.8%o 21.4%o 21.40%o

(27. 1)a
Tests of detail-
analysis and review' 28.7 32.4 21.4 19.6
(17.4)

Test of detail-checks for

mathematical accuracy 9.7 10.4 9.0 7.2
(10.7)

Tests of detail-documentation 9.1 8.8 8.9 10.7

(19.2)

Client inquiry 13.3 12.8 17.9 10.7

(8.2)

Expectations from the prior year 21.5 20.4 21.4 26.8

(10.3)

General audit procedures 2.2 2.4 - 3.6

(2.1)

a The percentages for the Hylas and Ashton [1982] study sum to only 95 percent because a category used in that
study ("estimates of value") was not used here.
I "Tests of detail-analysis and review" should not be confused with "analytical review." The former category
refers to "examination of transaction amounts and descriptions, account balance details, 'work-ups' to support ac-
count balances, and data appearing on various types of reconciliations," while the latter refers to "comparisons of
current unaudited balances with balances of prior years, predictions of current balances based on exogenous data,
and analyses of interrrelationships among account balances" [Hylas and Ashton, 1982, p. 753].
* Greater than or equal to .2 x Gauge but less than Gauge
** Greater than or equal to Gauge but less than 2 x Gauge
*** Greater than or equal to 2 x Gauge

percent in Hylas and Ashton [1982, pp.
760-761]. It is also consistent with the
results of Kreutzfeldt and Wallace [1986]
who found similar factors to be the pre-
dominant causes of errors in their sam-
ple. The results for two other error
causes-inadequate control, follow-up
or review procedures, and mechanical
errors-are also consistent with Hylas
and Ashton, while substantially fewer
cutoff or accrual problems were noted in
the present sample of engagements. 10
Initial Events
Nine categories of initial events were
listed in the questionnaire, and the au-
ditors were asked to indicate which
was relevant to the error underlying
each proposed adjustment. The results,
shown in Table 5, indicate that the three
attention-directing procedures-expecta-
tions from the prior year, client inquiry,
and analytical review-initially signaled
items that must be estimated because exact dollar
amounts cannot be determined, e.g., uncollectible ac-
counts, obsolete inventory, and contingencies.
10 In Table 4 and in other tables that report break-
downs of the 368 adjustments, the totals sometimes do
not add to 368 because some respondents' failure to
answer a few of the detailed questions asked.

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Wright and Ashton
a total of 50.3 percent of the adjustments
in this study, which is comparable to the
45.6 percent found by Hylas and Ash-
ton. It is also consistent with the results
of Kreutzfeldt and Wallace [19861 who
found that attention-directing pro-
cedures signaled a large proportion of
errors.
Both Hylas and Ashton [1982] and the
present study find that expectations sig-
nal more larger than smaller adjust-
ments, and that client inquiry is not
related to the size of the adjustment. In
contrast, the present results suggest that
analytical review signals more larger
than smaller adjustments, whereas Hylas
and Ashton found that analytical review
was not related to adjustment size. Tests
of detail signaled 47.5 (47.3) percent of
all adjustments in the present (prior)
study. In addition, tests of detail sig-
naled more smaller than larger adjust-
ments in the samples of both studies.
Finally, few adjustments were initially
signaled by confirmations or inventory
observation in either study.
Another comparison between the pres-
ent study and Hylas and Ashton [1982] is
the detection frequency of initial events
for clients in different size categories.
Hylas and Ashton found that the per-
centage of errors signaled by the various
initial events differed little across three
asset size categories-greater than $50
million ("large"), between $10 and $50
million ("moderate"), and less than $10
million ("small"). Our results agree,
with the exceptions that (1) the three
attention-directing procedures identify
slightly more adjustments in large than
in moderate/small clients (55 vs. 45 per-
cent), and (2) tests of detail identify
slightly fewer adjustments in large than
in moderate/small clients (39 vs. 49 per-
cent).
Materiality (Gauge)
Information about materiality is pro-
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719
vided in Tables 1-5. Recall that pro-
posed adjustments smaller than 20 per-
cent of gauge (.2G) are not included in
our analyses. The mean adjustment size in
our sample (1.24G) is much larger than
this cutoff, and the range of adjustment
size as a percentage of G is substantial
(see Tables 1 and 2). Adjustments affect-
ing asset and liability accounts are, on
average, about equal in size, while ad-
justments affecting expense accounts are
substantially larger than those affecting
revenue accounts. The fact that expense-
account errors tend to be understate-
ments while revenue-account errors are
about evenly split between under- and
overstatements largely explains the find-
ing that income-increasing errors tend to
predominate in the sample (see Tables 2
and 3). Gauge was largely unrelated to
the auditors' judgments of error causes
(see Table 4), but it was related to the
proportion of adjustments identified by
various audit procedures. On the later
point, Table 5 reveals that expectations
and analytical review identified a greater
proportion of large than small adjust-
ments, while tests of detail identified a
greater proportion of small than large
adjustments.
Internal Control Strength
One client-specific factor that may
affect the usefulness of audit procedures
is internal control strength. The reliabil-
ity of accounting records and financial
statement data should be enhanced as in-
ternal controls are strengthened. Thus,
when controls are strong the auditor
should be able to place greater reliance
on internal accounting records and ana-
lytical review. Conversely, when controls
are weak the auditor should place less
reliance on such evidence [Cushing and
Loebbecke, 1983]. We collected infor-
mation on the relation between control
strength and error detection by asking
the auditors to indicate the strength of
 720 The Accounting Review, October 1989

TABLE 6
INITIAL EVENTS IN DIFFERENT INTERNAL CONTROL ENVIRONMENTS
(1984-1985)

Internal Control Strengtha

Not
Strong Moderate Weak Relied On
(n = 43) (n = 153) (n = 44) (n = 509)

Analytical review 14.0%o 27.4%o 4.5q70 13.2%70

Tests of detail-
analysis and review 39.4 21.6 11.4 30.2
Tests of detail-checks for
mathematical accuracy 9.3 5.9 4.5 5.1

Tests of detail-documentation 11.6 4.6 13.6 10.0

Confirmation 4.7 5.2 4.5 1.4

Inventory observation 4.7 - - .8

Client inquiry 9.3 6.5 22.7 17.7

Expectations from the prior year 7.0 22.5 38.8 20.4

General audit procedures - 3.3 - 1.2

a Internal control strength is based on

occurred.

controls over each account to which an
adjustment was proposed. The controls
were rated as strong, moderate, weak, or
"not relied on," based on the auditors'
earlier assessments of controls and the
results of compliance tests. We did not
collect control information when adjust-
ments were not proposed. The results are
shown in Table 6.
The auditors rated controls as strong
for only six percent of the accounts in
which the particular errors were found,
while controls were not relied on in 68
percent of the cases in which errors were
detected. Table 6 shows that when con-
trols were moderate or strong, more er-
rors were signaled by procedures that
focused on internal accounting records
and data. Analytical review and tests of
detail-analysis and review were the pre-
dominant means of signaling errors
when controls were moderate or strong.
In contrast, with weaker controls more
errors were signaled by prior-year expec-
tations and client inquiry. Overall, atten-
tion-directing procedures signaled more
errors as controls deteriorated.
Since we did not ask the auditors why
they chose not to rely on controls, we
cannot rule out the possibility that in
some cases controls were judged to be
strong and the nonreliance decision was
made on cost-benefit grounds. " Even in
those cases where controls were con-
sidered too weak to justify reliance, the
finding that many errors are detected by
" The percentage of discovered errors for which con-
trols were not relied on is unrelated to the client size cate-
gories discussed above. The percentages are 66.7, 66.2,
and 73.5 for the large, moderate, and small size cate-
gories, respectively.

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Wright and Ashton 721

attention-directing procedures in such and partners identified 38 percent of the

circumstances may not be surprising adjustments signaled by inquiry, but
since weak controls may lead to more only 27 percent (12 percent) of those sig-
(and larger) errors that are relatively easy naled by analytical review (expectations).
to detect. Moreover, in the latter case it This may reflect the fact that managers
is not clear whether attention-directing and partners, who have greater experi-
procedures signal more errors in weak ence, are the ones who normally make
control environments because they are inquiries, especially of upper manage-
used to a greater extent or simply be- ment.
cause more errors exist. More specific information about each
procedure is also provided in the tables.
Detailed Results for Attention- For example, for expectations (Table 7),
Directing Procedures the auditors were asked to indicate the
More detailed information on the na- specific source of evidence that created
ture of the three attention-directing pro- their expectations, as well as the audit
cedures is presented in Table 7 (Expecta- procedure that signaled the need for an
tions), Table 8 (Inquiry), and Table 9 adjustment in the prior year. Prior audit
(Analytical Review). The last four items differences and prior working paper
in each table are the same; they focus on schedules were the principal sources of
the phase of the audit in which the need expectations, accounting for 72 and 23
for an adjustment was signaled and the percent of the adjustments, respectively.
position and experience level of the per- Moreover, tests of details signaled most
son who identified the underlying error. of the errors in the prior year, but ana-
The remaining items in each table relate lytical review and client inquiry orig-
specifically to only one of the three pro-inally signaled about one quarter of the
cedures. prior-year errors.
First, consider information that is Detailed information on adjustments
common to the three tables. Errors couldsignaled by client inquiry (Table 8) indi-
be identified in one of three broad cates that 40 percent of such adjustments
phases of the audit-planning, perfor- were identified by inquiries made during
mance, or review. Tables 7-9 indicate work on a specific audit area, while 50
that approximately two-thirds of the ad- percent were identified during casual
justments that were signaled by each conversations with clients. Most of the
procedure were identified in the perfor- client personnel who responded occupied
mance phase. However, in the case of accounting or finance positions and were
expectations (inquiry), about 20 percent at upper or middle management levels.
(30 percent) were identified in the plan- In most cases their responses were cor-
ning phase. In addition, about 30 per- roborated by detailed tests, but in about
cent of the adjustments signaled by ana- 38 percent of the cases responses were
lytical review were identified in the corroborated by one of the three atten-
review phase. tion-directing procedures.
Tables 7-9 reveal that audit staff and Finally, almost 80 percent of the ad-
in-charge personnel identified almost justments signaled by analytical review
half of the adjustments signaled by ex- resulted from simply comparing the cur-
pectations and analytical review, but rent year's account balance with that of
only 17 percent of the adjustments sig- the preceding year (see Table 9). Judg-
naled by inquiry. In contrast, managers mental estimates of account balances sig-

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722 The Accounting Review, October 1989

TABLE 7
INFORMATION ON ADJUSTMENTS SIGNALED BY
EXPECTATIONS FROM THE PRIOR YEAR
(1984-1985)
(n = 78)

Adjustments Signaled
by Expectations

Form of evidence:
Prior year correspondence files 1.4%
Prior year working paper schedules 22.5
Notes for subsequent audit 0
Prior audit differences 71.9
Prior financial statements 2.8
Prior planning document 0
Other 1.4

Procedure originally signaling the error in the prior year:

Analytical review 11 .6q7o
Analysis and review 40.7
Mathematical checks 1.4
Documentation 11.6
Confirmation 2.9
Inventory observation 7.2
Client inquiry 14.5
Other procedure 8.7
Don't know 1.4

Phase of audit when error was detected:

Initial planning 20.5q7o
Evaluation of internal control 0
Preparing audit program 1.3
Performing procedures 66.7
Evaluating results of procedures 5.1
Review of field work-
By assistant staff 0%q0
By senior 1.3
By manager 5.1
By partner 0
By second partner 0

Person initially detecting error:

Assistant/staff 30.8qo
Assistant/staff-in-charge 15.4
Senior 42.3
Manager 7.7
Partner 3.8

Industry experience
Extensive (more than four prior engagements) 16.7qo
Moderate (two to four engagements) 48.7
Little (one engagement) 19.2
No experience 15.4
Average experience in public accounting 3.6 years

naled another 18 percent, while regres- nize, however, that the firm participat-
sion and time series analysis signaled no ing in this study does not use regression
adjustments. It is important to recog- or formal time-series analysis in analyt-

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 Wright and Ashton 723

TABLE 8

DETAILED INFORMATION ON AD
(1984-1985)
(n = 48)

Adjustments Signaled
by Inquiry

Primary Context:
During work on an account/area 40.0%o
Inquiries from a standardized questionnaire 3.3
Questions at conclusion of work on an account 6.7
Castial conversation 50.0
Follow-up of discrepancies resulting
from audit procedures .0

Client personnel responding:

VP Finance/controller 53.6%o
Accounting/clerks/staff accountants 10.7
Internal auditor 7.1
Assistant controller 3.6
Treasurer 17.9
President .0
Other 7.1

Accounting or finance position-yes 87.5 '7o

no 12.5

Level-Upper management 57.5qo

Middle management 32.5
Lower management 5.0
Employee 5.0

Inquiry corroborated by:

Analytical review 7.7 7o
Analysis and Review 25.7
Mathematical accuracy 2.6
Documentation 20.5
Confirmation 5.1
Inventory observation 0
Further inquiry 25.6
Expectations from prior year 5.1
General audit procedures 7.7

ical review. Firms that routinely use
more sophisticated analytical procedures
might have discovered the same errors
with these methods. However, the avail-
able evidence indicates that the use of
sophisticated analytical procedures is
rare [Spires and Yardley, forthcoming].
Ordering Bias
To investigate the possible ordering
bias noted by Hylas and Ashton [1982],
the auditors were asked whether they be-
lieved the adjustments would have been
signaled by some other procedure. All
those responding with yes were asked to
identify the alternative procedure that
most likely would have signaled the ad-
justment. The results are shown in Table
10.
Overall, the auditors believed that
48.9 percent of all adjustments would
have been signaled by some alternative

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 724 The Accounting Review, October 1989

TABLE 8-Continued

Adjustments Signaled
by Inquiry

Phase of audit when error was detected:

Initial planning 29.2%
Evaluation of internal controls 0
Preparing audit program 2.1
Performing procedures 56.2
Evaluating results of procedures 2.1
Review of field work-
By assistant staff 0%
By senior 0
By manager 8.3
By partner 2.1
By second partner 0

Person initially detecting error:

Assistant/staff 8.5%
Assistant/staff-in-charge 8.5
Senior 44.7
Manager 34.0
Partner 4.3

Industry experien
Extensive (more than four prior engagements) 61.7%
Moderate (two to four engagements) 29.8
Little (one engagement) 8.5
No experience 0

Average experience in public accounting 4.5 years

procedure. The percentages were higher
for adjustments signaled by the three
attention-directing procedures than for
any of the other six: 48.2 percent, 66.7
percent, and 80.8 percent for analytical
review, inquiry, and expectations, re-
spectively. For these three procedures
combined, the auditors believed that 122
of 182 adjustments signaled (67.0 per-
cent) would have been identified by an
alternative procedure.
As to the phase of the audit (planning,
performance, or review) in which adjust-
ments were signaled, the data show that
the proportion of adjustments that would
be identified by other than attention-
directing procedures is greater in earlier
than in later phases of the audit. Of the
32 adjustments identified by attention-
directing procedures in the (early) plan-
ning phase, the auditors believed that 28
(87.5 percent) would have been identified
by some other procedure; for the perfor-
mance phase, the proportion fell to 67.2
percent (82 of 122), and for the (late)
review phase it fell again to 42.9 percent
(12 of 28). Thus, it appears that an
ordering bias is relevant to the interpre-
tation of the present results and those of
Hylas and Ashton [19821.12
Analytical review was considered the
alternative procedure most likely to iden-
tify errors that were signaled by expecta-
12 We also examined the errors initially signaled by the
three attention-directing procedures, but which the au-
ditors believed would not have been identified by an al-
ternative procedure. Of particular interest was the per-
ceived causes of those errors. More than half (55 percent)
of such errors were believed to have been caused by insuf-
ficient accounting knowledge or misapplication of client
judgment.

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 Wright and Ashton 725

TABLE 9

DETAILED INFORMATION ON ADJU

(1984-1985)
(n = 56)

Adjustments Signaled by
Analytical Review

Analytical Review Procedure:

Ratio analysis 1.8%
Time-series analysis 0
Comparisons with prior year 78.6
Comparisons to industry 0
Regression analysis 0
Judgmental estimates of account balance 17.8
Other 1.8
Phase of audit wh
Initial planning 3.70/o
Evaluation of internal controls 0
Preparing audit program 0
Performing procedures 64.7
Evaluating results of procedures 0
Review of field work-
By assistant staff 3.7
By senior 13.0
By manager 13.0
By partner 1.9
By second partner 0

Person initially detecting error:

Assistant/staff 30.3%
Assistant/staff-in-charge 14.3
Senior 28.6
Manager 25.0
Partner 1.8

Industry experience of that person:

Extensive (more than four prior engagements) 46.4%
Moderate (two to four engagements) 28.6
Little (one engagement) 16.1
No experience 8.9

Average experience in public accounting 3.9 years

tions, inquiry, and two additional pro-
cedures. Overall, the auditors believed
that analytical review would have identi-
fied 39.6 percent of all adjustments that
would have been identified by alternative
procedures. Moreover, they believed
that 19.4 percent of the adjustments sig-
naled by an analytical review technique
would have been identified by some
other analytical review technique. Thus,
analytical review was regarded as a
promising initial event for this sample of
engagements.
SUMMARY AND CONCLUSION
The potential usefulness of attention-
directing audit procedures as suggested
by Hylas and Ashton [1982] is corrobo-
rated by the present study, which
involved a larger sample of audit adjust-

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726 The Accounting Review, October 1989

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 Wright and Ashton 727

ments, clients of larger average size, a to prior-year audit differences. Another

time period encompassing different tech- 23 percent could be traced to prior-year
nology and competitive conditions, and working paper schedules. In other
more rigorous research methods. In words, financial statement errors often
addition, the study provides descriptive are perpetuated from year to year (cf.
information about materiality, internal Kinney [19791). It seems apparent that
control strength, the timing of proce- auditors should be (and are) aware of the
dures, and other factors that may aid positive association between the prior
audit planning and facilitate the design and the current year's errors.
of further research on attention-direct- The third attention-directing proce-
ing procedures. dure investigated-client inquiry-ini-
While the present study suggests that tially signaled more than 13 percent of
two-thirds of the selected adjustments the adjustments. Fifty percent of this
signaled by attention-directing proce- number were signaled through casual
dures would have been signaled by some conversations with client personnel in ac-
alternative procedure, the auditors who counting or finance positions. In con-
responded believed that a substantial trast, client inquiries based on standard
number of such adjustments would not audit questionnaires signaled only three
have been signaled by other procedures. percent of the adjustments identified by
Moreover, they believed that analytical this procedure. This result confirms
review likely would have signaled many something that practicing auditors have
errors if some other procedure had not. known for years-that asking appropri-
Analytical review initially signaled 16 ate questions of the client is an impor-
percent of the adjustments in this study. tant aspect of auditing.
Our results show that more than 30 per- A principal feature that characterizes
cent of the adjustments signaled by this our results is that the simplest types of
procedure were identified during the re- attention-directing procedures initially
view of field work, thus confirming the signal many errors. Expectations based
importance of the review phase of the on prior-year errors, analytical reviews
audit. Moreover, the types of analytical comparing prior- and current-year bal-
review techniques that signaled errors ances, and client inquiries involving
throughout the audit were the simpler casual conversations identified the need
techniques-judgmental estimates of ac- for one-third of the adjustments. On the
count balances and, especially, compari- other hand, because of the ordering bias,
sons with balances of the prior year. one cannot infer that other procedures
The importance of the link between are ineffective in signaling errors. The
the prior audit year and the current one fact remains, however, that attention-
can be seen in the analytical review re- directing procedures did signal a large
sults. This link is also related to another number of errors. Therefore, if the costs
attention-directing procedure-expecta- of applying such procedures is relatively
tions based on prior-year errors. Ex- low, then the results support a strong
pectations initially signaled almost 22 emphasis on the use of attention-direct-
percent of all the adjustments, and 72 ing procedures.
percent of that number could be traced

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 728 The Accounting Review, October 1989

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