Libby 1990

Accounting Research Center, Booth School of Business, University of Chicago
Experience and the Ability to Explain Audit Findings

Author(s): Robert Libby and David M. Frederick
Source: Journal of Accounting Research, Vol. 28, No. 2 (Autumn, 1990), pp. 348-367
Published by: Wiley on behalf of Accounting Research Center, Booth School of Business,
University of Chicago
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Journal of Accounting Research
Vol. 28 No. 2 Autumn 1990
Printed in U.S.A.
Experience and the Ability to

Explain Audit Findings
ROBERT LIBBY* AND DAVID M. FREDERICKt
1. Introduction
This study investigates how experience-relateddifferencesin the con-
tent and structure of auditors' knowledge of financial statement errors
can contributeto the effectiveness and efficiency of their audit decisions.
Different audit decision tasks are performedby auditors with differing
levels of training and experience. Such differentialassignment is specif-
ically mandatedin the first standardof fieldwork(AU Section 210), and
observationsof practice (e.g., Haskins [1987]) indicate some consensus
in assignmentpatterns. The appropriatenessof these differentialassign-
ments has economic consequencesbecause of the higher salaries paid to
more experiencedauditors. The existence of differential costs and pre-
sumedperformancedifferencesincreasesthe importanceof appropriately
linking training, experience,and the promotionselection process. Never-
theless, researchershave yet to documentboth reliableexperience-related
performance differences and the ability' and knowledge differences2
* Cornell University: t University of Colorado. We are grateful to Alison Ashton, Bob
Ashton, Stan Biggs, Jane Butt, John Elliott, Vicky Heiman, Marlys Lipe, Garry Marchant,
Bill Messier, and especially Bill Wright, and the Accounting Workshops at Cornell, Duke,
Florida, Illinois, Minnesota, and Ohio State for helpful comments, and to Joan Luft for
her able assistance. Funding for this research was provided by a Research Opportunities in
Auditing Grant from the Peat Marwick Main Foundation.
1 Auditing studies to date of rank-related differences in intellectual ability (Marchant
[1989]) and consensus on abilities necessary for promotion (Jiambalvo, Watson, and
Baumler [1983]) have produced negative results. The homogeneity of the entry-level pool
limits the potential effects of these variables.
2 Knowledge differences may relate to technical aspects of accounting systems and audit
techniques; the organizational structure, operating characteristics, and external factors

affecting firms in a particular industry; the policies which reflect the audit firm's utility
function; and other areas.
348
Copyright (C, Institute of Professional Accounting 1990
ABILITY TO EXPLAIN AUDIT FINDINGS 349
which allow more experienced auditors to perform tasks better (see

Wright [1988] and Bedard [1989] for a review).
Cognitive psychology and artificial intelligence research examining the
determinants of skilled decision-making performance has shifted much
of its focus from general cognitive abilities to the characteristics and
impact of domain-specific knowledge acquired over years of training and
experience (Glaser and Chi [1988]). Two related changes have taken
place in recent studies of audit experience effects. The first involves
using the assignment of tasks to more and less experienced auditors in
order to identify tasks which require more or less knowledge and, there-
fore, should exhibit smaller or larger experience-related performance
differences (see Abdolmohammadi and Wright [1987] and Bonner [forth-
coming]). The second change goes further in attempting to understand
the causes of differential performance by explicitly specifying the nature
of the experience-related knowledge differences and the mechanisms
through which they affect judgment (Frederick and Libby [1986]). The
latter requires assessments of how the knowledge bases of more and less
experienced auditors differ and how they influence judgment perform-
ance.
While the performance of many actual procedures in an audit program
is left to less experienced auditors, explaining and interpreting the
implications of the results of those procedures for further testing and
possible audit adjustment is usually left to more seasoned auditors. This
less structured portion of audit decision making has been described by
Mautz and Sharaf [1961], Einhorn [1976], Libby [1985], and Butt [1988]
as a diagnostic process. Einhorn [1976] and Elstein, Shulman, and
Sprafka [1978] propose that the principal organizing element of diagnos-
tic decision making is the diagnostic hypothesis. In the audit context,
diagnostic hypotheses initially relate to the possible existence of financial
statement errors. Throughout the audit process, initial hypotheses about
the presence (or absence) of particular errors play a role in directing
information search by suggesting the additional audit evidence necessary
to test the hypotheses. They can then be accepted or rejected based on
the existence or nonexistence of these additional findings. Knowledge of
these error hypotheses is the focus of our study.
Following basic research in cognitive psychology, we hypothesize that
as auditors gain experience, (1) their knowledge of the set of potential
financial statement errors becomes more complete, (2) they learn error
occurrence rates, and (3) they organize their knowledge of financial
statement errors along different dimensions including their transaction
cycle. These differences should (1) increase the probability that more
experienced auditors will be able to detect the existence of potential
errors because their possible causes are more accessible from memory,
(2) increase the efficiency of the search pattern by allowing experienced
auditors to examine more likely explanations first, and (3) raise experi-
enced auditors' level of efficiency in evidence evaluation by permitting
350 JOURNAL OF ACCOUNTING RESEARCH, AUTUMN 1990
them to consider clusters of potential errors which have similar evidence

profiles.
We found that more experienced auditors exhibited more complete
knowledge of financial statement errors by generating a greater quantity
of accurate explanatory hypotheses. In addition, they had more accurate
knowledge of error occurrence rates, which allowed them to select more
commonly occurring explanations for audit findings. Finally, their reac-
tions to prompts or hints indicated that more experienced auditors
categorized their knowledge along different dimensions, and they devel-
oped gradations of errors within categories.
2. Auditing Diagnoses and the Related Memory Structure

We develop hypotheses using a general audit diagnosis framework and
related constructs from the memory literature. The auditor's basic deci-
sion problem is conceptualized as involving the diagnosis of financial
statement errors. After initial review of the unaudited statements and
inherent risk factors, the auditor develops a series of plausible diagnoses
and a strategy for gathering additional evidence which will be used to
test the hypotheses. Principal elements of the knowledge base necessary
to perform this task are the diagnostic hypotheses (potential financial
statement errors) and the associated inherent risk factors, internal con-
trol factors, and substantive test results. Following findings from studies
of medical diagnosis (e.g., Elstein et al. [1978]), we suggest that this
knowledge base will be organized around the potential financial state-
ment errors. Subtasks in the audit diagnosis process where financial
statement error knowledge plays a fundamental role include explaining
confirmation exceptions, estimating the effects of internal control com-
pliance deviations, and determining the cause of unexpected fluctuations
discovered in analytical review. The last setting is examined here; how-
ever, the results should be relevant to other subtasks as well.
The knowledge base used in auditing diagnoses is conceptualized based
on theories of semantic memory networks, which typically place an
emphasis on categoric organization of concepts (see, e.g., Smith [1978]).
In general, such an organization is a hierarchical structure in which the
concepts are interconnected based on class inclusion relations. With
regard to auditing knowledge, specific financial statement errors might
be categorized taxonomically, for example, on two dimensions: (1) by
cycle (sales, purchases, inventory, debt, etc.) and (2) by audit objective
(proper cutoff, valuation, classification, etc.). Likewise, categories (e.g.,
sales and receivables cycle) may be further divided into subcategories
(e.g., sales recording and collections). Categories and category members
are also associated in memory with their features or attributes. In the
auditing context, the features associated with the financial statement
errors are presumed to be the potential inherent risk factors, internal
control factors, and substantive test results discussed above. Retrieval of
knowledge from this network is often modeled as involving spreading of

activation across the category links to different category members (see,
e.g., Meyer and Schvaneveldt [1976], Anderson [1983], and Libby
[1985]). Thus, differences in how errors are categorized could allow the
experienced auditor to direct search activity so that it is efficient and
effective.
3. Experience and Knowledge Differences

No well-integrated theory of the nature of expertise exists at present
(see, e.g., Chi, Glaser, and Rees [1982]). However, as individuals gain
experience, certain basic changes in knowledge content and structure
have been observed which could have important audit consequences. In
the network model discussed above, learning would involve adding new
financial statement errors to the structure, adding to or changing the
perceived relation between audit findings and the financial statement
errors, and changing the way the errors are categorized (Chi and Rees
[1983]).
3.1 NUMBER OF EXPLANATIONS
The continuing process of formal education and experience which
begins in undergraduate school should add new financial statement errors
and linkages to audit findings to the auditor's knowledge structure and
correct improper linkages. As a result, the more experienced auditor-
diagnostician has access to a larger number of plausible3 potential errors
to. explain a given audit finding, and so has a greater likelihood of having
the actual cause of a series of audit findings accessible in memory. At
the same time, fewer errors which could not explain the audit findings
should be accessed because of correction of improper linkages. This
suggests our first hypothesis.
HI: More experienced auditors will generate a greater number of
plausible errors and fewer implausible errors than will less experienced
auditors.
The definition of plausible used here is very broad: interpretable
responses which are not inconsistent with the ratio changes presented.
However, within this class, errors vary greatly in probability of occur-
rence. The next two hypotheses relate to the effects of knowledge of
error prevalence on the subjects' responses.
3.2 ERROR PREVALENCE EFFECTS
In - udit situations such as the one we investigate, numerous alternative
explanations are available for a pattern of audit findings. A sequential
search starting from a random point in the set of plausible explanations
Plausible is defined here as consistent with the evidence.
352 ROBERT LIBBY AND DAVID M. FREDERICK
could be highly inefficient. Since error occurrence rates differ dramati-

cally, initial generation of more prevalent errors would be a more efficient
strategy.
One of the most basic findings in memory research is that repetition
of an item eases its subsequent retrieval and results in frequency learning
(see, e.g., Crowder [1976]). Libby's [1985] results suggest that frequency
knowledge is associated with experienced auditors' hypothesis generation
behavior. Studies of medical diagnosticians suggest that accurate consid-
eration of disease prevalence is a major distinction between seasoned and
unseasoned clinicians' diagnoses (Christensen-Szalanski et al. [1983] and
Benbassat and Bachar-Bassan [1984]). Accurate knowledge of frequency
may be an important factor which allows the more experienced auditor
to outperform the inexperienced one (cf. Whitlow [1984]).
From the perspective of knowledge of financial statement errors,
university accounting and auditing courses appear to be aimed at popu-
lating the knowledge structure but not imparting an understanding of
error frequencies. In fact, the attention given to historic cases of fraud
such as Equity Funding may leave the student with highly unrealistic
perceptions. The more practically oriented training provided by CPA
firms and the errors actually encountered in practice should work to
correct any such misperceptions over time. Further, Butt's [1988] find-
ings in a laboratory setting suggest that, in an idealized environment,
this type of more direct experience results in the most effective frequency
learning. Our next hypothesis predicts that experience in the field pro-
duces similar results.
H2: As experience increases, perceptions of the frequency of occurrence
of financial statement errors become more accurate.
As suggested above, repetition also strengthens an error in memory
which eases subsequent retrieval of that error. This implies the relation
in Hypothesis 3.
H3: As experience increases, errors that occur more frequently will be
generated as explanations for audit findings.
3.3 STRUCTURE CHANGES AND GENERATION SEQUENCE

The third change suggested is that, in the memories of more experi-
enced individuals, there are more linkages or dimensions of classification
between different elements in the structure (Chi and Koeske [1983]).
These added linkages could allow more experienced individuals to access
their much larger knowledge stores efficiently.
Often, auditors inherit an initial explanation for an audit finding from
the work papers or from others, including client personnel and coworkers.
This starting point should affect the other alternatives considered, be-
cause accessing a particular error in memory decreases the processing
necessary to activate another error closely linked to it in the knowledge
store (see Libby [1985]).4 As a result, differences in the organization of
financial statement error knowledge should cause differences in the
sequence of alternatives generated in response to a prompt. These re-
sponses to the prompt are used here to test for proposed differences in
the dimensions of classification.
It is suggested that experienced auditors have a well-defined transac-
tion cycle dimension in their knowledge structures, and inexperienced
auditors do not. As a result, we would expect that, when prompted with
an error from a particular transaction cycle, experienced auditors will
generate more financial statement errors from that same transaction
cycle, and inexperienced auditors will not.
However, category members differ in typicality or goodness of example
(Rosch [1978]). Mervis and Rosch [1981, p. 97] indicate that the effect
of a prompt will be mediated by its typicality. Atypical exemplars more
strongly facilitate retrieval of other category members than do typical
category members.5 Existence of a well-defined transaction cycle dimen-
sion only in the experienced auditors' knowledge structures combined
with the typicality effect suggests Hypothesis 4.
H4: Experienced auditors: Subjects who are prompted with an atypical
financial statement error will generate more subsequent errors from the
same transaction cycle as the prompt, but prompting subjects with a
typical member will have no such effect.
Inexperienced auditors: Neither atypical nor typical prompts will
affect the transaction cycle membership of subjects' responses.
Since Hypothesis 4 predicts that prompts will not affect the cycle
membership of students' responses, it is important to ensure that this
finding does not result simply from the students' failure to attend to the
prompts. This possibility is examined in additional analysis which is
presented following the hypothesis tests.
The four hypotheses were tested in a hypothesis generation experiment
(cf. Gettys and Fisher [1979]). Auditors with three different levels of
experience generated potential financial statement error explanations for
changes in a financial ratio profile. The task was performed after receiv-
ing no prompt or a typical or atypical sales and receivables cycle error
prompt. Responses were classified into a predetermined scheme, and
comparisons were made among both the subject experience level groups
and the experimental treatment groups to test the hypotheses. The next
section describes the method in detail.
4 Activated errors also have an inhibiting effect on retrieval of other errors since they
are likely to be re-retrieved. Overall, following common findings in the literature, we expect
presentation of only one category exemplar to result in net facilitation.
5 Since more typical exemplars are more strongly related to the category, they tend to
be re-retrieved more often than atypical exemplars, which interferes to some degree with
the retrieval of other category members. This could explain Libby's [1985] finding of no
effect of typical prompts.
4. Method
4.1 SUBJECTS
Participants in the experiment included 61 new audit managers with
a median of five years of audit experience, 65 audit staff members with
a median of one year of audit experience, and 70 senior auditing students
with a median of no audit experience. All but five of the managers had
five years of experience, all but three of the staff had one year of
experience, and all but three of the students had no experience. None of
the experience distributions overlapped. Our initial expectation was that
the knowledge changes hypothesized above should follow a continuous
process over the years when the auditor is primarily involved in technical
tasks, including the years prior to promotion to the management group.
These three particular experience levels were selected to allow a deter-
mination of whether the most significant changes resulted from having
some versus no experience or from more extensive experience (cf. Ashton
and Kramer [1980]), and in recognition of the decreasing marginal effects
of experience commonly found in the literature (the well-known learning
curve).
The audit managers and staff members were employed by various
offices of a single Big Eight CPA firm, and they completed the task
during class while attending in-house educational programs. The inex-
perienced subjects included 50 students from the University of Colorado
and 20 from the University of Michigan.6 They completed the task in an
introductory auditing class during the last three weeks of the term. The
managers and staff had completed an average of 4.5 and 4.2 years of
education beyond high school, respectively. The students had completed
an average of 24 hours of accounting.
4.2 PROCEDURE
The experimental task was a modified version of Libby's [1985] hy-
pothesis generation task.7 Subjects were told that this experiment was
part of a study examining how auditors investigate unexpected financial
statement relationships discovered in analytical review and that they
would be presented with a simplified ratio analysis problem. They were
asked to assume the role of an audit supervisor on a new manufacturing
client during the preliminary analytical review stage of audit planning.
They were then presented with three pages of background information
6
There was no detectable difference in behavior across schools.
7 The principal changes made were to eliminate detailed discussion of the accounting
system, to present the prompt before the financial ratio profile and again on the answer
sheet (in the two prompted conditions), and to increase the number of errors in the
frequency rating task to 12.
on the company and the prior year's income statement and balance sheet.
The experimental task itself (presented in Appendix A for the typical
prompt condition) displayed three financial ratios computed from the
prior year's audited statements and the current year's unaudited state-
ments. They were told that the differences in the ratios could be due to
normal year-to-year variation and/or a single material error in the
unaudited statements or multiple occurrences of the same error. Subjects
were not asked to judge whether the ratio changes were unexpected or
whether any unexpected fluctuations should be investigated. Their task
was to list material financial statement errors which might have led to
the change in ratios (see Appendix A).
Subjects were randomly assigned to a control condition which received
no prompt and two treatment groups which received either the typical
or atypical sales and receivables cycle prompt. Prompts were selected
based on Barsalou's [1985] and Nosofsky's [1988] conclusion that per-
ceived frequency of occurrence is a major determinant of typicality. The
typical prompt (next period's credit sales recorded in the current period)
was the highest frequency sales and receivables error reported by Coakley
and Loebbecke [1985]. The atypical prompt (sales to valid customers
recorded more than once) was not included in Coakley and Loebbecke's
listing and was the lowest in perceived frequency of the five sales and
receipts cycle errors examined in Libby [1985]. Subjects in the control
condition were asked to list, in the order in which they came to mind, up
to seven financial statement errors which might have led to the ratio
changes. Subjects in the typical prompt and atypical prompt conditions
were first told that "For example: The change in the ratios might have
resulted from (prompt)" and were then asked to generate up to six
additional potential error explanations. This difference in the maximum
list length, in conjunction with the critical item method (described in the
next section), adjusts for the fact that subjects in the treatment groups
do not have the opportunity to generate the error that served as their
prompt (see Libby [1985, pp. 660-61]).
After completing the task, all subjects answered a debriefing question-
naire in two parts. The first asked about age, educational background,
and auditing experience. The second required that they rate 12 financial
statement errors (see Appendix B) by their relative frequency of occur-
rence by assigning the number "100" to the most frequently occurring
error and rating each remaining error proportionately based on its
frequency relative to the initially selected item.
5. Results
One of the authors (who had four years of auditing experience) and a
doctoral student (who had one and one-half years of auditing experience)
classified the error explanations generated by the experimental subjects
both by cycle and audit objective violated.8 If either the cycle or objective
violated could not be determined, the response was classified as uninter-
pretable. The ratings were made directly from the subjects' response
pages. The doctoral student rater was unaware of this study's hypotheses
and the experience level of the subjects who provided the responses. The
experimental treatment was indicated to the raters by the existence of
the prompts.
The responses were also classified by whether they were members of a
list of six high-frequency errors.9 The listing of frequently occurring
errors was constructed based on Coakley and Loebbecke's [1985] study
of expected error frequencies, the only one to report frequency data for
specific financial statement errors. It also examined medium-sized man-
ufacturing firms (the context for our experiment). The six errors Coakley
and Loebbecke [1985] listed expected to produce material error in the
aggregate in more than 10% of medium-sized manufacturing audits were
included. All of the six errors occurred in the balance sheet accounts
found by Hylas and Ashton [1982] and others to contain errors most
frequently. This listing was used in our test of Hypothesis 3.
The raters disagreed 7.08% and 8.23% of the time on cycle and audit
objective classifications, respectively. The majority of these disagree-
ments occurred when one coder classified the response as interpretable
and the other classified it as uninterpretable. Disagreements were re-
solved by a second doctoral student.
5.1 NUMBER OF EXPLANATIONS
The first hypothesis proposes that more experienced subjects will
generate more plausible and fewer implausible explanations than the less
experienced subjects. To test this hypothesis, the numbers of plausible
and implausible explanations generated by the subjects were compared
across experience levels. Explanations were classified as implausible if
they met one of the following conditions: (1) the cycle or audit objective
violated could not be determined (was uninterpretable); (2) the error
8 The transaction cycle categories were revenue and receipts, inventories, purchasing
and disbursements, payroll, indebtedness, investments, and cash. The audit objective
violation categories were timing, valuation, classification within financial statements,
classification between financial statements, recording of transactions, recording of year-
end accruals and adjustments.
'The error list and frequencies from Coakley and Loebbecke [1985] were:
Error Frequency
1. Wrong period credited for sale 14.9%
2. Uncollectable accounts not written off 12.3%
3. Liability incurred but not recorded 17.0%
4. Purchases recorded in wrong period 16.1%
5. Failure to include items that should be accrued 16.2%
6. Obsolete items maintained in inventory 15.3%
TABLE 1
Hypotheses Generated By Experience Level: Means and (Standard Deviations)
ExperienceLevel
HypothesesGenerated
Students Staff Managers
Number of Plausible Hy-
potheses 3.0 (1.8) 4.1 (1.6) 5.0 (1.5)
Number of Implausible Hy-
potheses 2.2 (1.6) 1.5 (1.4) 0.9 (1.3)
Number of High-Frequency
Hypotheses 0.8 (0.7) 1.6 (0.8) 2.1 (1.2)
Proportion of High-Frequency
Hypotheses .20 (.18) .37 (.20) .39 (.20)
would cause a change in direction of one or more ratios in the direction

opposite of that presented in the case; (3) it was not a financial statement
error; or (4) it was a duplicate. Table 1 reports the number of plausible
and implausible explanations generated by the subject groups. The more
experienced subjects generated more plausible and fewer implausible
explanations than did the less experienced subjects (F(2,193) = 22.15, p
= .000 and F(2,193) = 13.04, p = .000, respectively).10 All differences in
the mean number of plausible hypotheses were significant" in the pre-
dicted direction, supporting Hypothesis 1 (p = .004 between the managers
and staff and p = .000 between the staff and students). This finding
suggests that more experienced auditors have more of the knowledge
necessary to perform the task.
The differences between the number of implausible hypotheses gen-
erated by the managers and staff and the staff and students were also
significant in the expected direction (p = .010 andp = .014, respectively).
The staff auditors generated more of each category of implausible re-
sponses than did the managers.'2 The implausible responses generated
by the students were predominantly nonerrors and uninterpretable. This
finding indicates that the overall difficulty in performing the task in-
creased significantly for the less experienced subjects. Only the responses
of those subjects who provided two or more plausible responses (as
defined above) are included in the remaining analyses.13
10 Tests of normality and homogeneity of variance were performed. Where appropriate,

data were transformed to achieve closer correspondence. Since cell sample sizes do not
differ greatly, violations of these assumptions have little effect on the relation between the
reported and actual levels of significance (Neter, Wasserman, and Kutner [1985]). In all
tests where violations persisted, results were highly significant (p = .000). The analysis
was completed using the comparative regression models approach described in Neter et al.
[1985].
" All multiple comparison tests between experience levels were conducted using Bonfer-
roni adjusted t-tests (Neter et al. [1985]). Since all of the hypotheses are directional, one-
tailed p values are presented.
5.2 ERROR PREVALENCE EFFECTS

The second hypothesis suggests that more experienced auditors have
more accurate perceptions of the relative frequency of occurrence of
financial statement errors. The accuracy of each subject's perceptions
was assessed by computing the correlation between his or her error
frequency ratings for 11 of the 12 errors in the debriefing questionnaire
with archival frequency data, which was gathered from the audit differ-
ence work papers of a sample of 82 manufacturing clients provided by
the experienced subjects' firm.'4 Willingham and Wright [1985] describe
the client sample in detail.'5
Since the subjects' frequency ratings indicate their perceptions of
relative frequencies, differences in mean or variance between the subjects'
responses and the archival data are not interpretable. Therefore, we used
the Pearson product-moment correlation to measure the accuracy of
perceptions. The mean correlation coefficients presented in table 2 were
compared across experience levels in an ANOVA. Experience had a
significant effect on accuracy (F(2,156) = 21.96,p = .000), which supports
Hypothesis 2. The perceptions of the managers were more accurate than
12 The mean number of each type of implausible response by experience level was:
Manager Staff Student

1. Uninterpretable .49 .85 1.53
2. Wrong direction .18 .29 .16
3. Not an error .10 .18 .31
4. Duplicate .10 .22 .16
13 The major reason for this requirement was that much of the analysis involves the
proportion of subject responses belonging to a certain group. For those subjects providing
zero plausible responses, these measures are undefined. For those subjects providing one
plausible response, the distributions of proportions are highly nonnormal. This screen
eliminates 3 managers, 6 staff, and 17 students. Even after this screen, all differences
between the number of plausible and implausible hypotheses generated across experience
levels are still significant except for the difference in implausible responses between the
staff and students (p = .1936).
14 In Libby [1985], an independent group of managers who had not performed the
hypothesis generation task also answered the frequency questions. Analysis of their re-
sponses and those of the subjects who had performed the hypothesis generation task
revealed no difference in results.
15 The archival data were gathered by counting the frequency of occurrence in the client
sample of each of the 12 errors listed in Appendix B using a 10% of overall materiality
threshold. The error frequencies were 27, 8, 25, 2, 54, 0, 0, 3, 1, 10, 6, 0. Error seven was
not included in this analysis because errors of this type were excluded from the available
archival data. Errors in the audit difference work papers not described in enough detail to
permit their classification according to this list were omitted from the count. We have no
reason to believe that any bias results from these omissions. More important, to invalidate
our results, any possible bias would have to differentially affect the accuracy of the three
experience level subject groups in the predicted direction. Thus, we expect any measurement
error to result only in a reduction of the power of our test. Four staff and five students did
not complete the frequency judgment task and are omitted from this analysis.
TABLE 2
Correlations Between Frequency Judgments and Archival Frequencies by Experience Level:
Means and (Standard Deviations)
Experience Level
Correlation Measure
Pearson Product-Moment Cor-
relation .26 (.25) .48 (.27) .58 (.23)
Spearman Rank-Order Corre-
lation .29 (.25) .52 (.24) .60 (.22)
those of the staff (p = .050), who in turn were more accurate than were
the students (p = .000). Analyzing rank-order correlations (also pre-
sented in table 2) produced similar results (managers versus staff, p =
.080, and staff versus students, p = .000).
Hypothesis 3 predicts that more experienced auditors will generate
more-frequently-occurring errors as explanations for audit findings. This
hypothesis was examined by comparing, across experience levels, the
number of errors generated which were among the six high-frequency
errors (see n. 9). As predicted, more experienced subjects generated more
of the frequently-occurring errors (F(2,165) = 24.75, p = .000). The
differences between the managers and staff (p = .009) and the staff and
students (p = .000) were significant. However, this result could occur
just because the more experienced subjects generated a larger number of
plausible hypotheses. To test this possibility, we compared the propor-
tions of the subjects' responses from the high-frequency group across
experience levels.16 Since the variance of a proportion is a function of its
mean, these proportions were analyzed after applying the arcsin-square-
root transformation (see Press [1972]). Again, overall, the more experi-
enced subjects generated a greater proportion of their responses from the
more-frequently-occurring group (F(2,165) = 16.13, p = .000). The
staff generated a higher proportion than did the students (p = .000).
However, there was no significant difference between the managers and
staff (p = .728). These findings support Hypothesis 3 and suggest that a
key knowledge-related advantage is the ability to generate more likely
explanations for audit findings.
5.3 STRUCTURE CHANGES AND GENERATION SEQUENCE
Hypothesis 4 suggests that differences between the experienced and
inexperienced auditors' knowledge structures will affect the additional
hypotheses they generate in reaction to a prompt. It proposes that only
experienced auditors have a well-defined transaction cycle dimension in
16
This adjustment slightly underestimates the propensity of those who generate a larger
number of explanations to generate more prevalent explanations and thus biases the results
against finding a significant effect.
their knowledge structures, and as a result, only the experienced auditors

will generate more explanations from the same transaction cycle as the
prompt. This results from the fact that less processing is necessary, on
average, to generate a closely related error than an unrelated one.
However, this effect will be mediated by the typicality of the prompt.
The facilitative effect of prompting with a less typical category member
will be much stronger than that of a more typical prompt. As a result,
Hypothesis 4 proposes that (1) neither prompt will affect the cycle
membership of additional errors generated by the inexperienced subjects
and (2) the atypical prompt will have a greater effect than the typical
prompt on the cycle membership of additional errors generated by the
experienced subjects. Since only the experienced subject groups should
be affected by the treatment variable (the prompts), we expect an
interaction between the effect of the three treatments (control, typical
prompt, and atypical prompt) and the subject's experience level on the
proportion of responses generated from the same cycle as the prompt.
Subjects in the control groups have the opportunity to generate all
errors which are members of the sales and receivables cycle, but the
treatment groups do not have the opportunity to generate the prompts.
As a result, Hypothesis 4 cannot be tested by simply comparing the
number of responses generated from the same cycle as the prompt (the
sales and receivables cycle). To adjust for this, only those responses
which never served as prompts (the critical responses) were counted in
the analysis because members of the control and treatment groups have
the same opportunity to generate these items (see, e.g., Roediger, Stellon,
and Tulving [1977] and Libby [1985]). Using the critical item method,
up to one response (the other prompt) is eliminated from the count for
the treatment groups and up to two responses (both prompts) for the
control group. This difference was compensated for, in part, by allowing
the control subjects to generate one more response than the treatment
groups and by converting the category response frequencies to propor-
tions. As in the test of Hypothesis 3, converting to proportions also
eliminates the effects of the larger number of errors generated by the
more experienced subjects.
Each of the subject's critical responses was classified as belonging or
not belonging to the same cycle as the prompt (the sales and receivables
cycle). A two-way ANOVA (treatment x experience level) was performed
on the proportions after application of the arcsin-square-root transfor-
mation. The means and standard deviations of the proportions are
presented in table 3. The experience level main effect was significant at
p = .004 (F(2,159) = 5.70) and the treatment X experience level inter-
action at p = .064 (F(4,159) = 2.27). As predicted by Hypothesis 4, the
treatment variable affected the managers and staff (p = .090 and p =
.076, respectively) but not the inexperienced student subjects (p = .328).
Also, as predicted, the effect of the typical prompt on the experienced
subjects was not significant (p > .1), while the effect of the atypical
TABLE 3
Effect of Typical and Atypical Prompts on Generation of Sales and Receivables Cycle Errors
by Experience Level: Mean Proportions and (Standard Deviations)
ExperienceLevel
PromptCondition
No Prompt .22 (.18) .24 (.23) .17 (.14)
Typical Prompt .17 (.18) .30 (.18) .24 (.17)
Atypical Prompt .16 (.29) .39 (.24) .35 (.27)
prompt was significant (p < .025 for the managers and staff using
Dunnett's one-tailed t comparing two treatment groups with a control
group). These results confirm Hypothesis 4 and support the typicality
explanation for Libby's [1985] nonsignificant results. The significant
interaction found in this analysis resulted from the failure of the prompts
to affect the transaction cycle membership of the students' responses.
This result has two possible explanations. We suggest above that it is
caused by differences in the structure of the students' knowledge bases.
However, the interaction could also have resulted from the students'
failure to attend to the prompts. Eliminating this possibility required
evidence that the novices reacted to the prompts. The following tests
provide this evidence.
5.4 MANIPULATION CHECK
We can eliminate the possibility that students did not attend to the
prompts by examining our earlier suggestion that experienced auditors
also categorize errors on a basis closely associated with audit objective
and that inexperienced auditors categorize errors based on surface fea-
tures. Since there is significant overlap between a structure based on the
audit objectives violated and key words or surface features such as
"recorded" and "cutoff," we expect both experienced and inexperienced
auditors to generate subsequent errors from the same audit objective
category as a prompt. This study did not employ an experimental design
sufficiently complex to determine directly whether different structures
actually caused the similar behavior. Because of the overlap between
surface features and the audit objective which an error violates, all groups
of subjects should generate more errors which violate the same audit
objective as the prompt.17 The effect should be evident in a main effect
of treatment when comparing the proportion of responses from the same
audit objective as the prompt between each of the treatment groups and
the control group. Since we expected significant overlap in the way
17 While notions of typicality should also mediate the facilitative effects suggested here,
they were not directly addressed by our experimental design since only one prompt was
chosen from each audit objective category.
subjects from all experience levels categorize errors, no interaction with

experience level is expected.
All subjects' critical responses were classified as violating the timing
objective, the recording of transaction objective, or other. Since the two
prompts violate different audit objectives, they were compared to the
control group separately. For each of the treatment groups, the trans-
formed proportions of critical responses violating the same objective as
the prompt were compared in 2 X 3 (treatment X experience level)
ANOVAs. The treatment effect was significant in the expected direction
in the analyses of both the cutoff prompt (p = .006) and the recording
prompt (p = .013). Overall, less experienced auditors generated a greater
proportion of recording errors (p = .030). There was no interaction
between treatment and experience level, which indicates that experience
did not create a difference in the effect of the prompts on the audit
objective category from which the explanations were generated. However,
they do ensure that the results of the test of Hypothesis 4 were not
caused by the students failing to attend to the prompt.
6. Discussion
6.1 OVERVIEW
The approach taken in this paper differs in two ways from most prior
studies of the effects of experience on audit decisions (see Frederick and
Libby [1986]). First, we examined a less structured task, where knowledge
differences are likely to be of greatest consequence. Second, by specifying
the nature of expected knowledge differences in advance, and the mech-
anisms through which they will affect judgment, we were able to test
directional predictions of differences in certain aspects of judgment
behavior (knowledge-stimulus interactions). The results of this study
suggest experience-related knowledge changes including (1) increases in
the number of plausible errors accessible in memory, (2) more accurate
knowledge of frequency of occurrence resulting in greater generation of
more likely explanations, and (3) development of the transaction cycle
dimension of the knowledge structure.
Each of the results suggests a potential benefit of employing more
experienced personnel to explain audit findings. More experienced au-
ditors generated a larger number of plausible error to explain audit
findings. More complete consideration of possible explanations may be
one advantage of employing more experienced auditors. Prior research
indicates two reasons this is a particularly important advantage. First,
the primary cause of diagnostic failure in medical diagnosis studies is not
the misinterpretation of subsequent tests but the failure ever to consider
the actual explanation for presenting symptoms in one's set of initial
hypotheses (Elstein et al. [1978]). The higher number of plausible solu-
tions generated by the experienced auditors decreases the probability
that they will miss the actual cause of an audit finding because the error
is not available in or accessible from memory. Second, findings in the
diagnostic-reasoning literature suggest that accurate evaluation of the
likelihood of a hypothesis requires consideration of alternative hy-
potheses (Einhorn and Hogarth [1986]). If more experienced auditors
naturally generate a larger set of alternatives, this may decrease overcon-
fidence in judgment resulting from failure adequately to consider alter-
natives (Heiman [1988]).
More experienced auditors' frequency perceptions were more accurate,
and they generated more likely errors as explanations. All other things
equal, this would allow more experienced auditors to reach an appropriate
conclusion more quickly than their less experienced colleagues. Similar
efficiency gains were suggested both by Chase and Simon's [1973] con-
clusion that chess experts consider better potential moves than novices
and by the conclusions from the medical literature discussed earlier.
The responses to the error prompts used in this study imply that the
experienced auditors organize their knowledge based on the underlying
structure of the accounting system-transaction cycles. Since individual
pieces of audit evidence bear on the possibility of many errors from the
same cycle, knowledge of the cycle organization may allow whole classes
of explanations to be rejected based on the same additional data. More
efficient hypothesis testing would result. This result should be sensitive
to the organization of the CPA firm's audit approach.
The differential effects of the typical and atypical prompts explain the
inconsistent findings in Libby's [1985] results concerning the transaction
cycle dimension. Libby employed only typical prompts; these had little
or no effect on the subsequent generation of explanations. Because
dimensions of objects other than frequency of occurrence also determine
typicality, additional research will be necessary before the impact of
typicality on diagnostic decisions is well understood.
6.2 IMPLICATIONS FOR PRACTICE AND RESEARCH
This study provides initial evidence concerning what we believe to be
an important underlying element of task specific knowledge and its
effects on decision performance. From a more practical perspective, this
research can help identify the task components where experience-related
performance differences are large and the economic payoff from employ-
ing more highly paid, more experienced auditors is the greatest (cf.
Bonner [forthcoming]). Even if these task components have been iden-
tified, it is often not obvious what knowledge elements underlie the
performance differences. Our purpose was not to provide a direct basis
for training or expert system development. However, as has been recog-
nized in other disciplines, understanding what differentiates experienced
from inexperienced auditors' performance and knowledge will aid the
efficient development of such systems. Training or decision aids can
produce the greatest potential gain in situations where differences be-
tween experts' and novices' knowledge and performances are the greatest.
Developing systems which focus on teaching or making available the

knowledge which is unique to the more experienced individuals would
provide the greatest benefit and allow the use of less costly, less experi-
enced personnel in some tasks.
The results of the current study suggest three avenues for future
research. First, we did not specifically examine the role of knowledge of
linkages between the three types of audit evidence (inherent risk factors,
internal control factors, and substantive test results) and financial state-
ment errors in the diagnostic process. Since these linkages provide the
basis for planning an efficient search process, their nature and decision
effects are critical to understanding the audit diagnosis process.
Second, although there were significant performance differences be-
tween staff auditors and managers, the largest and most consistent
differences were between the experienced auditors and students. Uncov-
ering the nature of knowledge elements which differentiate the most
experienced auditors will require further research.
Finally, there are two dimensions to knowledge effects: how perform-
ance and knowledge, on average, change with elements of training and
experience, and why two individuals with the same training and experi-
ence exhibit dramatically different knowledge and performance (cf.
Sternberg [1986]). Examining the effect of the amount and type of audit
experience is a first step in determining the interplay between experience
and individual characteristics which lead to superior learning and true
expertise.
APPENDIX A
Instructions
Presentedbelow are two sets of financial ratios. The ratios in the first column
were computedfrom EAZ Manufacturing'sprioryear auditedstatements. In the
second column are ratios computedfrom the currentyear unauditedstatements.
The differencebetween the two years' ratios could be the result of normalyear-
to-yearvariationand/or an errorin the unauditedstatementswhichhas a material
effect on net income or, if only the balance sheet is affected, is material in
relation to total assets or total liabilities. You have no other reason to expect
majorchangesfromprioryear'sfinancialrelationships.Assumethat any financial
statement erroris causedby a single mistake or multipleoccurrencesof the same
mistake.(There is only one cause.)
For example:The change in the ratios might have resultedfrom next period's
creditsales recordedin the currentperiod.
FINANCIAL RATIOS
Prior Year CurrentYear
Ratio Audited Unaudited
GROSS MARGIN
Gross Profit 26.1% 26.3%
Net Sales
CURRENT RATIO
Current Assets 2.43 2.72
Current Liabilities
QUICK RATIO
Quick Assets 1.04 1.25
Current Liabilities
Your task is to list below up to six (6) other specific errors which may have led to
the change in the financial ratios, in the order in which they come to mind. In
your answers, be specific about the accounts that are affected (both debits and
credits).
Possible Errors
EXAMPLE:
Next period's credit sales recorded in the current period.
1.
2.
3.
4.
5.
6.
Once you have completed your list, please make no corrections, additions, or
deletions.
APPENDIX B
In manufacturing audit engagements where a material error has been encoun-
tered, how often is that error of the following twelve types?
Determine which of the twelve you believe is the most frequent type and write
the number "100" in the column next to it. Then assign values between 1 and 99
to the remaining error types depending on how frequently thay occur compared
to the type assigned "100." For example, if an error type occurs half as often as
the most frequent type, it should be assigned a "50." Remember, only consider
the frequency of material errors.
Type of Material Error Frequency
1. Bad debt expense and allowance not recorded or

underrecorded.
2. Goods returned by customer in current period not
recorded or recorded next period.
3. Current period purchases on account not recorded
or recorded next period.
4. Payments on account recorded but not made or
overrecording of such payments.
5. Accrued expenses and payables not recorded or un-
derrecorded.
6. Purchase returns recorded but goods not returned

or returned next period.
7. Current portion of long-term debt improperly clas-
sified as noncurrent.
8. Marketable securities not written down to lower of
cost or market.
9. Expense payments made but not recorded or un-
derrecording of such payments.
10. Next period's credit sales recorded in the current
period.
11. Expense items improperly classified as inventory.
12. Sales to valid customers are recorded more than
once.
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Accounting Research Center, Booth School of Business, University of Chicago

Experience and the Ability to Explain Audit Findings

Experience and the Ability to

techniques; the organizational structure, operating characteristics, and external factors

which allow more experienced auditors to perform tasks better (see

them to consider clusters of potential errors which have similar evidence

2. Auditing Diagnoses and the Related Memory Structure

knowledge from this network is often modeled as involving spreading of

3. Experience and Knowledge Differences

Plausible is defined here as consistent with the evidence.

could be highly inefficient. Since error occurrence rates differ dramati-

3.3 STRUCTURE CHANGES AND GENERATION SEQUENCE

would cause a change in direction of one or more ratios in the direction

10 Tests of normality and homogeneity of variance were performed. Where appropriate,

5.2 ERROR PREVALENCE EFFECTS

Manager Staff Student

their knowledge structures, and as a result, only the experienced auditors

subjects from all experience levels categorize errors, no interaction with

Developing systems which focus on teaching or making available the

Type of Material Error Frequency

1. Bad debt expense and allowance not recorded or

6. Purchase returns recorded but goods not returned

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