Auditors’ Cross-Sectional and Temporal Analysis of Account Relations in Identifying Financial Statement Misstatements Available to Purchase

SUMMARY: In order to plan and perform an effective audit, auditing standards and existing research call for auditors to consider relations between accounts (American Institute of Certified Public Accountants [AICPA] 2006; Leitch and Chen 2003; Vandervelde 2006) and how various pieces of evidence fit together to arrive at audit conclusions (Bell et al. 2005). In this study, we illustrate the importance of these broad concepts and their effect on audit effectiveness. Using expectation models and multivariate normal theory, we show that consideration of relations between accounts and the concurrent (joint) analysis of accounts can lead to fewer Type II errors than individual analysis of accounts in isolation. We further show that this reduction of Type II errors is affected by the complexity and uncertainty of both the endogenous business process and exogenous business environment. Even when simply using prior-period account balances in a martingale expectation model for related accounts considered concurrently, we find fewer Type II errors result when simpler and less complex business process and business environment are present. Such a reduction in the number of Type II errors leads to increased audit effectiveness and reduced audit risk. Accordingly, our results suggest that auditors in the planning as well as in the evidence accumulation and evaluation stages should consider related accounts and consider them jointly in their assessment.