WORKING PAPER

Auditor Independence: An Examination Independence Risk Factors and Mitigating Factors on Auditor Judgment

Barbara M. Vinciguerra
Penn State Great Valley
School of Graduate Professional Studies

Auditor Independence: An Examination Independence Risk Factors and Mitigating Factors on Auditor Judgment

Abstract

Professional standards require auditors to be independent in the performance of attestation services. Critics of the accounting profession have expressed concern that pressure to maintain and develop business opportunities may erode an auditor’s objectivity and independence when making audit judgments. The profession contends that aspects of the auditing environment such as peer review, consultation review, and auditor professionalism serve to mitigate this risk.

This study examines the impact of financial dependence, consultation review requirement, and moral development on a judgment based audit decision. Fifty-four experienced auditors were asked to assess the appropriateness of an audit client’s proposed change in accounting estimate for warranties. Two levels of financial dependence (Large client with potential for additional consulting revenues / Small client) and two levels of consultation review requirement (Required / Not required) were manipulated in the case materials. Moral development was measured using the Defining Issues Test (DIT) p-score.

Results of the tests indicate that the presence of a consultation review requirement reduced the auditors’ assessments of the appropriateness of the accounting treatment; in addition, higher scores on the DIT were associated with lower assessments of the appropriateness of the accounting treatment. Financial dependence did not influence the assessment of the appropriateness of the accounting treatment. Implications for practice are discussed.
Introduction

Professional standards require auditors to be independent in the performance of attestation services (AICPA Code of Conduct, ET 101.01). In general, independence helps to ensure that auditors are objective when evaluating audit evidence and are free from conflicts of interest in the performance of professional duties. The SEC and some private sector groups have expressed concern over the ability of auditors to maintain their independence in light of the increasing scope of non-audit services provided by audit firms and the highly competitive business environment in which audit firms operate (Schuetze, 1994; Wallman, 1996; Sutton, 1997; Diacont, 1996; Walker, 1998). Recently, the SEC has issued revised independence rules, which include consideration of “independence in fact,” a mental state related to the absence of bias; and “independence in appearance,” the notion that an auditor is not independent if a reasonable investor, with knowledge of all relevant facts and circumstances, would conclude that the auditor is not capable of exercising objective and impartial judgment. These new standards limit the non-audit services that auditors can provide for their audit clients, require disclosure of non-audit fees, and specify financial, employment, and business relationships that constitute an impairment of independence (SEC, 2001) Bazerman et al. (1997) assert that it is impossible for auditors to maintain independence due to information processing limitations referred to as the self-serving bias. Research on the self –serving bias indicates that when people are called on to make impartial judgments, those judgments are likely to be subconsciously biased in favor of the judge’s self interest. Bazerman et al. (1997) contends that individuals are unable to interpret information in an impartial manner because perceptions of a situation depend on one’s role in the situation. They contend that aspects of the auditing environment exacerbate the self-serving bias. Competition for clients and internal organizational pressures that emphasize client retention and development in performance assessment are likely to cause auditors to focus attention on immediate profits, heightening the consequences of auditor-client conflict and potentially resulting in judgment bias. The desire to avoid client conflict may result in the acceptance of an aggressive audit judgment that unduly favors client interests. Conversely, audit risk, risk of litigation, and risk of loss of reputation may result in a judgment bias that favors conservative reporting. Johnstone et al., (2001), present a framework for examining factors affecting independence risk and discuss how these risk factors interact with situational factors to affect audit quality. According to their framework, there must be some actual or perceived incentive for independence risk to exist including direct incentives (direct investments, contingent fees, financial dependence, potential employment) or indirect incentives (interpersonal relationships, auditing work of self or firm). According the framework, a judgment-based decision[1] is necessary for independence risk to affect audit quality. A judgment-based decision contains some uncertainty regarding the appropriate decision or valuation judgment, thus allowing for the possibility that these environmental incentives will bias the auditor’s judgment. Johnstone et al. (2001), further contend that the presence of independence risk factors and judgment-based decisions do not necessarily result in reduced audit quality due to the presence of mitigating factors in the environment. These mitigating factors include a variety of factors such as regulatory oversight, firm policy on consultation review, concurring partner review, organizational culture, and individual auditor characteristics may mitigate the effects of potential biases. The purpose of this paper is to examine the effect of independence risk factors and mitigating factors on auditor judgment. Specifically, this study will examine the effect of an independence risk factor (financial dependence) and two mitigating factors (consultation review requirement and individual moral development) on a judgment-based accounting decision. Little prior research has focussed on the effect of the presence of firm-level quality control factors in this context[2]. This study will focus on the consultation review requirement as a firm-level factor that may mitigate independence risk. The consultation review was recommended by the Panel on Audit Effectiveness (POB, 1994) as a means of improving auditor independence when determining the appropriateness of a company’s accounting choices, particularly in the face of client pressure (POB, 1994; Glazer and Fabian, 1997; AICPA, 1997). The consultation review is viewed as a means of preventing auditors from resolving issues in ways that unduly favor client interests over professional standards. This study addresses following research questions: Will financial dependence on a client, as measured by the importance of the client in engagement hours and profitability, affect an auditor’s judgment regarding the appropriateness of an aggressive accounting treatment? Will the presence of a consultation review requirement, a firm-level quality control, result in less biased judgments? Does an auditor’s level of moral development influence an auditor’s judgment regarding the appropriateness of an aggressive accounting treatment? In order to address the research questions, 54 practicing auditors (mean of 9.67 years of experience) were presented with a case scenario that required the subjects to make a judgment regarding the adequacy of an estimate for warranties. The case materials noted that management recently changed its method for estimating the liability for warranties. All of the subjects received information that both supported and refuted the appropriateness of this change in estimate. Financial dependence (large client / small client) and review by the firm’s accounting consultation unit (required / not required) were manipulated in the case materials.

LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT As discussed earlier, the Johnstone et al. (2001) framework suggests that direct and indirect incentives to compromise independence may result in reduced audit quality when an auditor is faced with an accounting judgment that includes uncertainty regarding the appropriate decision or valuation judgment. They suggest that difficult accounting issues give rise to independence concerns because it raises the possibility that an auditor may acquiesce to management’s preferred accounting treatment. The framework further describes factors that may mitigate independence-related risks. Prior research has developed the notion that various organizational, environmental, and cognitive factors may influence an auditor’s judgment when faced with pressure to adopt an aggressive accounting method, implying that incentives in the audit environment may cause an auditor to compromise his or her independence. This prior research has examined how auditor judgment is influenced by a variety of factors thought to increase and decrease judgment bias.
Effect of conflicting incentives on auditor judgment under client pressure Prior research indicates that third parties perceive auditors to be more susceptible to client pressure where specific technical guidance is lacking (Lindsay, 1990; Knapp, 1985; Trompeter, 1994) and when competition is high, audit fees are high, and MAS services are provided (Lindsay 1990, Gul 1991); however, McKinley, Pany, and Reckers (1985) did not support the notion that the provision of MAS services influences the perception of audit independence[3]. Other studies, using auditors as subjects, have examined factors thought to influence auditor decision making when faced with client pressure to accept an aggressive accounting treatment. Farmer et al. (1987) found that the threat of loss of a client increased the auditor’s likelihood of accepting an aggressive accounting treatment. Where perceived risk of litigation was high, auditors were significantly less likely to accept the aggressive reporting treatment. Moreno and Bhattacharjee (2003) found that judgments of auditors at lower rank (staff and seniors) were influenced by the potential for additional business opportunities while judgments of auditors at higher rank (managers and partners) were not influenced by these additional opportunities. Lord (1992) examined the effect of accountability pressure on decision behavior of auditors. He examined the effect of four contextual variables (client financial condition, auditor competitive environment, provision of non-attest services, and revenue contribution for the firm) and accountability pressure (anonymous response / not anonymous response) on an auditor’s willingness to accept a client’s aggressive accounting treatment. Results indicated that subjects in the accountable treatment were less likely to report aggressively than those in the anonymous treatment group. In addition, Lord found significant higher order interaction effects between accountability pressure and the contextual factors that modified the influencing effect of these variables. Hackenbrack and Nelson (1996) examined the effect of engagement risk level (high/low) and accounting standard on an auditor’s determination as to whether or not an amount can be reasonably estimated. The accounting issue, and thus the accounting standard relevant to determining the appropriate reporting method, was manipulated between subjects. This was done in order to vary whether or not judging that an amount can be reasonably estimated will justify an aggressive or conservative accounting method. Hackenbrack and Nelson (1996) found that auditors tend to make reporting decisions favored by incentives and apply vague language in standards to justify their decisions. Auditors in the high engagement risk group favored conservative reporting and justified their decision based on a conservative interpretation of the accounting standard; auditors in the moderate engagement risk group favored aggressive reporting and used an aggressive interpretation of the standard to justify the decision. Matsumura and Tucker (1995) developed the proposition that economic incentives will bias an engagement partner toward the client’s viewpoint; however, the possibility of a veto penalty (the reputational cost or salary implications of making the wrong decision) will induce more conservative reporting by the engagement partner. Tucker and Matsumura (1997) tested these propositions using student subjects[4]. They found that second partner review reduced, but did not eliminate, reporting bias where first partners had an economic incentive for bias. The presence of financial dependence, an economic threat to independence is purported to result in a bias favoring the client’s preferred accounting treatment. The presence of a consultation review requirement is a mitigating factor that is purported to reduce the bias. The nature of the audit judgment in this study is such that the accounting treatment falls within a “gray area” of the application of GAAP[5]; therefore, the subjects must use their judgment in determining whether or not the treatment is appropriate. This room for judgment leaves open the possibility that an auditor’s judgment may be biased by his or her self-interest. The prior research noted above, although somewhat mixed, seems to support the notion that financial dependence will induce reporting bias. This leads to the expectation that high financial dependence will result in a higher assessment of the appropriateness of the accounting treatment. The research on accountability, second partner review, and engagement risk suggest that auditors are more likely to make conservative judgments when faced with incentives to do so. The results of these studies, in conjunction with the Kirk panel’s suggestion that the use of consultation review will improve auditor independence, leads to the expectation that the presence of a consultation review requirement will result in a more conservative judgment. Accordingly, the following hypotheses are proposed: H1: Financial dependence will be positively related to the assessment of the appropriateness of the client’s proposed accounting treatment. H2: Consultation review requirement will be negatively related to the assessment of the appropriateness of the client’s proposed accounting treatment.

Effect of cognitive factors on auditor judgment under client pressure Ponemon and Gabhart (1993, p. 25-35) characterize the auditor as the man in the middle, who has a professional responsibility serve the public interest and an economic need to serve his own self-interest. Ponemon and Gabhart characterize the ethical domain in auditing as a balance between “instigating forces,” which are factors that may induce ethical conflict and lead to unethical behavior, and “mitigating forces,” which are factors that encourage behavior that is consistent with professional guidelines[6]. These aspects of the audit professional’s job, professional duty to remain independent coupled with economic needs, may influence his or her ability to remain mentally objective, resulting in a source of ethical conflict. Prior research has used the concept of moral development in explaining the ethical judgment behavior of auditors. Kohlberg (1958) proposed a model of moral judgment based on a series of developmental stages. According to Kohlberg’s theory, moral judgment is developed through a series of six stages. These six stages are classified into three broad categories of moral development. The pre-conventional level (Stage 1 and 2) implies an ethic in which the individual places self-interest well above the common interests of society. The conventional level (Stages 3 and 4) is characterized by an ethic in which an individual is concerned with living up to what is expected by people and fulfilling agreed to duties and obligations. At this level of development, adherence to normative rules is sought in the resolution of a dilemma. The post-conventional level (Stages 5 and 6) is characterized by an ethic where the individual follows self-chosen ethical principles. A post-conventional individual would seek an ethical principle over a normative rule in the resolution of a dilemma. The stage of development is determined based on the responses to a series of moral dilemmas compiled into an instrument called the Defining Issues Test (DIT). The DIT, developed by Rest, is a self administered questionnaire that presents subjects with six hypothetical moral dilemmas and a set of standardized responses that relate to the six stages of moral development (Ponemon and Gabhart, 1993). Ethical development has been measured using the Defining Issues Test in a variety of accounting studies. Using a complex decision-making model, Windsor and Ashkanasy (1995) examined the effects of cognitive and economic variables on auditor decision making in a client pressure situation. In an extension of Ponemon and Gabhart (1990), Windsor and Ashkanasy (1995) posited that moral reasoning development and belief in a just world influence resistance to management pressure. Using a within-subjects design, the authors examined the interaction of client economic power (client financial condition, size of fees, and threat of switching audit firms), moral development, and belief in a just world on an auditor’s materiality judgment. They found a main effect for size of fees and client financial condition, and a higher order interaction between client financial condition, belief in a just world, and moral reasoning. Other studies concerned with auditors’ auditor judgment under client pressure have examined the effects of auditor characteristics in the absence of economic self-interest threats to independence. Tsui and Gul (1996) found that moral development moderates the relationship between locus of control and the auditor’s acquiescence to client management. Sweeney and Roberts (1997) examined the influence of moral development on independence judgments. They examined the effect of sanctions (likelihood of discovery), moral development, and firm size on auditor judgment in an independence dilemma (acquiescence to conceal an irregularity). Sweeney and Roberts (1997) found that moral development affected auditor’s sensitivity to ethical issues and independence judgments; auditors with high levels of moral development were less likely to rely purely on technical standards when making independence judgments. These findings lead to the expectation that auditors with higher levels of moral development will assess the client’s aggressive treatment as less appropriate than auditors at lower levels of moral development will assess the treatment. H3: Moral development will be negatively related to the assessment of the appropriateness of the proposed accounting treatment.

Method

Experimental Design The study utilizes a 2x2 between subjects experimental design, where two levels of financial dependence (High/Low) and two level of consultation review requirement (required / not required) are manipulated in a case study. Subjects were randomly assigned to one of the experimental groups. An additional independent variable, moral development, was measured in the case materials.

Description of Research Instrument and Task The audit task in this study involves a judgment regarding the adequacy of an accounting estimate for the estimated liability under warranties. In the basic case materials, subjects are given a description of the company, a discussion of the accounting issue, and descriptions of the applicable accounting standards and authoritative literature. Subjects are also provided with audit evidence, including a monthly summary of sales and past history of warranty claims. Subjects are informed that management reduced the amount of warranty reserves required, claiming that improvements in quality control systems would reduce future claims. This reduction in the warranty reserve results in a material change in estimate. There is little history supporting the claim. Additional information included in the case suggests that claims have declined significantly in the first few quarters after the process change; however, there is also information to suggest that the new reserve may be too low. The case states that the company is narrowly in compliance with its debt covenants; requiring the company to accrue additional charges to its estimated liability under warranties would result in a covenant violation. Given the existing loan covenants, and given that there is a limited amount of reliable claims history, the accounting treatment that management is proposing is aggressive. Subjects are informed that a track record of warranty claims after similar quality improvement initiatives at other companies was not useful because of the uniqueness of the product, discussions with client personnel did not yield any additional insight, and management was very forthright; therefore, no additional information is available beyond the case materials. In addition, subjects are informed that the audit report is due in less than one week leaving no time to gather additional history. The case materials state that the change in estimate is material to the financial statements. Based on the information in the case, subjects are asked to assess the appropriateness of the accounting treatment.
Subjects
A total of one hundred twenty-six questionnaires were distributed to partners, managers, and supervising seniors at five international public accounting firms in the Philadelphia and New York areas. The case materials were distributed to auditor subjects via a contact at the subject’s firm. Competed cases were returned directly to the author to ensure confidentiality. Fifty-four usable responses were received for a response rate of 43 percent. Subjects’ total years of public accounting experience ranged from 3 to 38 years. Mean total years of experience equaled 9.67 years. Fourteen subjects reported their rank as senior associate (26%), thirty-six subjects reported their rank as manager (67%), and four subjects reported their rank as partner (7%). The audit task requires that the auditor place himself or herself in the position of making a decision for the audit team, thus requiring experienced auditors who are capable of this level of responsibility. Tan and Libby’s (1997) findings regarding the acquisition of tacit managerial knowledge[7] suggest that this type of knowledge is learned from experience. Tan and Libby (1997) found that tacit managerial knowledge related to the relative importance of competing goals, efficiency in task performance, management of staff, and management of career, is learned within 4.4 years on the job, i.e., by the time one is an experienced senior. This suggests that subjects at the supervising senior level and above would possess the type of knowledge needed for the task described above, and are appropriate subjects for this study.

Variables and Measurement
Independent Variables The independent variable, financial dependence is dichotomously defined as high or low in a manipulation in the case materials. At the high level, audit fees are high, the fees are significant to particular engagement office, and to the individual auditor’s client base. In addition, the client is a potential source of referrals for additional consulting work. At the low level, audit fees from the client are low relative to the firm and the auditor’s client base. The statement regarding future consulting work is not included in the materials. Consultation review requirement is dichotomously defined as required or not required through a manipulation in the case materials. A statement in the case materials indicates whether or not the audit firm requires a consultation review in this particular situation. Moral development is measured using Defining Issues Test (DIT) p-score, obtained from the subjects’ responses to the short (three story) version of the Defining Issues Test, as used by Windsor and Ashkanasy (1995).
Dependent Variable The dependent variable used in testing the hypotheses in the study is the auditor’s judgment regarding the appropriateness of the accounting treatment in the circumstances. The judgment concerning whether the treatment is appropriate in the circumstances is measured as the subject’s response to the statement, “The client’s proposed treatment is the most appropriate in the circumstances.” Subjects’ responses are measured using a eleven-point scale where "0" indicates "Strongly Disagree “ and "10" indicates "Strongly Agree."
RESULTS
Preliminary Analyses Several items were included in the case materials in order to test various assumptions made by the author. The case was designed to present a situation that auditors viewed as realistic, that presented the subjects with a client position that was aggressive, and required a subjective accounting judgment in a gray area in the application of GAAP. Subjects were asked to evaluate whether the case situation describes a situation that auditors could encounter in practice and whether the client’s proposed accounting treatment reflects the treatment that client management is likely to prefer in practice, on a scale where “0” represents “Strongly Disagree,” “5” represents “Neither Agree nor Disagree,” and “10” represents “Strongly Agree.” The situation realism and client position realism items have means of 9.06 and 7.43 respectively, indicating that subjects viewed the situation and client position as realistic. Subjects were asked to describe the client’s proposed accounting treatment on scale where “0” represents “Very Aggressive” and “5” represents “Neither conservative nor aggressive,” and “10” represents “Very conservative.” This item had a mean of 1.94 indicating that subjects agreed with the author’s assertion that the client’s proposed treatment was aggressive. Two items were included in order to assess whether subjects were sensitive to the ethical content of the case. The case was intended to present a gray area in the application of GAAP, but not to evoke a fraudulent financial reporting hypothesis. Subjects were asked to assess whether the proposed accounting treatment was an attempt by client management to manage earnings. This was measured using a scale where “0” represents “Strongly Disagree,” “5” represents “Neither Agree nor Disagree,” and “10” represents “Strongly Agree.” This item resulted in a mean score of 6.57 suggesting that subjects perceived the client’s position as somewhat neutral, but leaning towards earnings management, indicating that subjects did note that there was an ethical issue. Subjects were also asked to evaluate the client’s position regarding the warranty accrual on a scale ranging from “0” which represents a “legitimate adjustment in the ordinary course of business,” to “10” which represents “fraudulent financial reporting.” The mean score on this item was 5.25 indicating that, on average; subjects were neutral with respect to whether the nature of the accounting treatment was fraudulent financial reporting. Finally, in order to assess whether the case represented a judgment call in the application of GAAP, subjects were asked to assess whether the client’s position is allowable under GAAP and whether it was appropriate in the circumstances. These item was measured on a scale where “0” represents “Strongly Disagree,” “5” represents “Neither Agree nor Disagree,” and “10” represents “Strongly Agree.” The mean score for allowability was 5.06 indicating that subjects were neutral with respect to allowability, and 2.06 with respect to appropriateness in the circumstance. Taken together, these items reflect a client position that subjects view as being allowable under GAAP, but not necessarily the most appropriate in the circumstances. The results of these analyses are included in Table 1.

Insert Table 1
Hypothesis Testing The hypotheses were tested using regression analysis[8]. The results of the tests of H1 through H3 and the descriptive statistics by cell are included in Table 2.

Insert Table 2

The regression results indicate that the relationship between financial dependence and assessment of appropriateness of the accounting treatment is not significant; therefore, Hypothesis 1 is not supported. Contrary to expectations, financial dependence, in this case, size and importance of the audit client, did not influence the auditor’s assessment of the appropriateness of the accounting treatment. There is a significant negative relationship between consultation review requirement and assessment of the appropriateness of the accounting treatment; therefore Hypothesis 2 is supported. This indicates that consultation review requirement reduces the assessment of the appropriateness of the accounting treatment, resulting in a more conservative judgment by the auditors. The regression results indicate a significant negative relationship between p-score (p=. 027) and the dependent variable, indicating that auditors at higher levels of moral development viewed the accounting treatment as less appropriate than auditors at lower levels of moral development. Thus, Hypothesis 3 is supported. The author also tested for the possibility that there were interactions among the variables. Analyses of the two way and three way interactions among the variables indicated that there were no significant higher-level interactions.

Summary and Implications This study investigates the ways in which independence risk factors and mitigating factors influence auditor’s judgment when faced with a judgment based decision. The audit task in this study involved a judgment regarding the appropriateness of a change in accounting estimate for warranties. Assessing the appropriateness of an estimate is a judgment based decision since the estimate has a range of possible outcomes, and it requires that the accounting professional to consider whether the treatment represents the economic substance of the transaction, not to merely follow a rule driven application of GAAP. The results of this study indicate that the presence of a consultation review requirement and higher levels of moral development result in more conservative judgments by experienced auditors. Contrary to expectations, financial dependence on a client did not influence the auditors’ judgments. These results have several implications. First, the finding that financial dependence did not result in biased reporting in this experienced group of auditors seems to support the finding in Moreno and Bhattacharjee (2003), which found that higher ranked auditors were less influenced by additional business opportunities than lower ranked auditors. The subjects in the current study were all experienced auditors who would be capable of making a final decision for the audit team. While much of the professional literature implies that the higher level of auditor would be more susceptible to bias relating to financial dependence, due to the increasing levels of responsibility for developing and maintaining business (Walker 1998), the author found no support for this contention. Other factors, such as an implicit concern over the possibility of litigation risk (not measured in this study) or the nature of the experimental manipulations may have influenced this finding and warrant future research. Consultation review requirement reduced the assessment of the appropriateness of the accounting treatment, indicating that the review resulted in more conservative judgments by auditors. This finding provides some support for the Kirk panel’s assertion that the consultation review may serve as a means to improve auditor independence. In addition, these results can provide the profession with some insight into situations that may require consultation. The AICPA Best Practices for Accounting Consultation (1997) provides guidelines for situations that require consultations and those situations where firm policy should encourage consultation. The situation portrayed in the case, a material change in estimate, is an area for which best practices suggest that the firm should encourage (but not require) consultation. The results indicate that even in this relatively common type of accounting judgment, the consultation review requirement may have an impact on judgment. This case materials for the auditors in the Consultation review required group noted that the judgment would be subject to review by the Accounting Consultation Unit of the hypothetical firm, and required the subjects to complete a Consultation Request Form that was based on best practices. Further research is needed to determine whether there are specific aspects of the consultation review that induced more conservative reporting. Finally, the finding that higher DIT p-scores lead to lower assessments in the appropriateness of this aggressive accounting treatment suggest that the ethical environment may have an influence on audit quality. Higher scores on the DIT are indicative of subjects’ post-conventional reasoning. According to Ponemon and Gabhart (1993) post-conventional individuals, those at the highest levels of moral reasoning, are more likely to make decisions that are based on underlying principles rather than strict interpretations of rules. Recognizing and addressing the notion that differences in the moral reasoning may result in different audit judgments underscores the importance of ethics training for accountants and the importance of a tone at the top that emphasizes high ethical standards.

Table 1
Descriptive Statistics

|Questionnaire Item |Mean |Std. Dev. |
|Situation realism |9.06 |1.15 |
|= strongly disagree; (10) = strongly agree | | |
|Client position realism |7.43 |2.33 |
|= strongly disagree; (10) = strongly agree | | |
|Describe the client’s proposed accounting treatment |1.94 |1.62 |
|very aggressive; (10) very conservative | | |
|Client position is an attempt at earnings management |6.57 |2.48 |
|= strongly disagree; (10) = strongly agree | | |
|Use the scale below to describe your view of the client’s proposed accounting treatment |5.25 |1.72 |
|legitimate adjustment in the ordinary course of business; | | |
|(10) fraudulent financial reporting | | |
|The proposed accounting treatment is allowable under GAAP |5.06 |3.09 |
|strongly disagree; (10) strongly agree | | |
|The proposed accounting treatment represents the most appropriate accounting treatment in the |2.06 |1.78 |
|circumstances. | | |
|(0) strongly disagree; (10) strongly agree | | |
|DIT p-score |35.01 |15.25 |

Table 2
Appropriateness of the Accounting Treatment

Panel A Means, (standard deviations), and n by Group

| |Consultation Review |Consultation Review |
| |Required |Not Required |
|High Financial Dependence |1.44 |3.15 |
| |(1.31) |(2.23) |
| |n=16 |n=13 |
|Low Financial Dependence |1.00 |2.29 |
| |(1.20) |(1.61) |
| |n=8 |n=17 |

Panel B
Regression Results for H1 – H3
| |Unstandardized Coefficients |Standardized | | |
| | |Coefficients | | |
| |B |Std. Error |Beta |T |Sig. |
|Constant |1.888 |.291 | |6.491 |.000 |
|Financial dependence1 |.294 |.203 |.187 |1.449 |.154 |
|Consultation Review2 |-.671 |.202 |-.426 |-3.325 |.002 |
|P-score |-.0149 |.007 |-.288 |-2.283 |.027 |

Adjusted R2 = .221
1 where High = 1 and Low = 0
2 where Required = 1 and Not required = 0
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[1] A judgment-based decision includes difficult accounting issues that require significant estimates or alternative measurement criteria, audit conflict decisions regarding the nature of audit evidence, and materiality decisions.
[2] Matsumura and Tucker (1995) examined second partner review.
[3] Pany and Reckers (1987) argue that the within-subjects design of much of the previous research in this area may have driven the results obtained.
[4] The use of student subjects in this task may not be appropriate since students do not possess the required knowledge, skills, or experience for an audit judgment related task. (Walters-York and Curatola, 1998)
[5] The profession recognizes that there can be a range of acceptable alternatives when applying professional judgment. Professional standards requires that accounting professionals consider the application of GAAP in their decision making and use the concept of conservatism in applying judgment when there is a choice among alternatives.
[6] Instigating factors include factors such as size of client fees, competition, job security, and status/career attainment dependent on client retention. Mitigating forces include professional standards, quality control structures in the firm and the profession, peer review, regulation, and professional integrity.
[7] Tacit managerial knowledge is defined as knowledge of traits and behaviors relating to managing self, others and career that are necessary for success in public accounting.
[8] Data diagnostics indicated possible violations of the assumptions of normality and constant variance. A square root transformation of the dependent variable resulted in significant improvements in the distribution of the data. Examination of diagnostics on the transformed data indicated that the assumptions were not violated, thus parametric tests, based on the transformed data, were used to test the hypotheses.