Financial audits are nothing short of legendary as a result of corporate scandals in recent years—think Enron—that at once made the stuff of balance sheets as compelling as a good suspense novel. One consequence of these corporate crises is that considerable pressure has been placed on auditors to improve the overall audit process to ensure they are uncovering material misstatements. In short, the auditor’s report, an important tool in informing investors, the government and others that a company’s financial statements have been prepared in accordance with Generally Accepted Accounting Principles, has come under intense scrutiny.

The auditor’s reporting model has long inspired interest, featuring prominently in academic research through the years. From the early 20^th century when an auditor’s  report might have totaled a mere two sentences, to a more standardized report including components like a scope and an opinion paragraph, and on to more recent changes following the passage of the Sarbanes-Oxley Act, the evolution of the auditor’s report has been a source of editorials and analyses.

Concerns over the auditor’s reporting model have prompted the Public Company Accounting Oversight Board in the last few years to hold two Standing Advisory Group (SAG) meetings to explore issues surrounding the model. That project came to involve researchers with a penchant for exploring the auditor’s judgment and decision-making process—namely Shawn M. Davis, a visiting assistant professor at Emory University’s Goizueta Business School, and her coauthors, Bryan K Church, a professor at the Georgia Institute of Technology and Susan A. McCracken, an associate professor at McMaster University.

Motivated by the questions raised at the SAG meetings, Church, Davis and McCracken collaborated on “The Auditor’s Reporting Model: A Literature Overview and Research Synthesis,” published this March in Accounting Horizons. “The auditor’s report is the primary communication of the work performed that the public sees,” notes Davis. “We decided to take an in-depth look at what is out there.”

Their analysis studies the existing literature regarding the auditor’s reporting model, from its historical development to relevant research that focuses on the auditor’s reporting decision and the content of the auditor’s report. “This is a historical walk of the auditor’s report looking at what the research has shown us about the auditor’s reporting model in terms of every step from the time auditors evaluate the company’s financial assertions and gather evidence, to examining that evidence to coming up with a final decision (the opinion) and then providing the information to the public,” explains Davis. “We wanted to see what researchers have found concerning the relevance of the auditor’s information.”

Throughout the article, which the authors say provides a state-of-the-art basis for understand the auditor’s reporting model, they identify areas needing change and further study. The research tackles the two overarching themes inherent in the SAG discussion questions: the inputs, or determinants of the reporter’s decision, and the outputs, or the information that is conveyed to the users—the content. 

Two key findings emerge from the authors’ analysis of the audit process. Review of the literature suggests that the audit process is complex and can be influenced by factors that are controllable, such as the sequence of evidence collection, as well as uncontrollable. “Matters such as the auditor-client relationship, litigation risk, negative press coverage and the way in which auditors receive audit evidence can impact the overall reporting decision,” explains Davis. “That gets into the complexity of the process; it’s not just a stand-alone process for the auditors themselves, but there are a lot of external factors that play a part in the way in which the information is processed and in the ultimate decision.”

The nature of accounting standards—principles- versus rules-based—can also influence the audit process. “If it’s rules-based, then auditors have something to follow. This leads to less aggressive financial reporting and not much wiggle room for the auditor,” says Davis. “However, principles-based standards may be better because you’re improving the quality of the audit by allowing that expertise or judgment to come into play to help determine the true underlying picture of the company.” Either way, these standards influence how auditors go about reaching a decision, and they are currently under debate.

The authors conclude that the auditor’s report, the actual information that is reported, has symbolic value but little else. “Right now the auditors report is a report card of pass or fail and that’s the level of information that is being provided,” notes Davis. “Our research is showing that there’s truly a lack of communicative value coming through via the auditor’s report.”

Future studies, they suggest, should investigate the usefulness of additional disclosures in the report. “The key here is to make the auditor’s report become more transparent regarding the audit process,” explains Davis. “We’re talking about more disclosures, more details about the auditor’s process. For example, what are the findings that the auditors are coming up with? Companies have these immaterial and material misstatements that the auditors detect, but why not also disclose some of those findings?” What’s more, adds Davis, people need to be educated about the level of assurance that the auditor’s report provides. “A lot of people who read financial statements and look at the auditor’s report might not know that it does not provide absolute assurance that they have uncovered all the material misstatements. People will read the report and find that a pass report is good news, but that is not a 100% guarantee.”

The authors believe their “historical walk” through the auditor’s report literature will motivate their colleagues to get more involved in addressing issues of concern. “That is the end result,” says Davis. “We want our research to serve as an eye opener and stimulate further research in this area—to ultimately have a more effective auditor’s reporting model.” Meanwhile, their own ongoing quest to explore the auditor’s judgment and decision-making process continues. Adds Davis: “Using laboratory markets and archrival data, we are working on a few projects to address issues from this research. A lot of our future research will focus on the market reaction to the auditor’s processes as well as the auditor’s information set.”