The professional literature (e.g., COSO 1992, POB 1993), recent auditing standards (e.g., SAS Nos. 78 and 82), and prior research (e.g., Beasley 1996; Beasley et al. 1999; Dechow et al. 1996) highlight the importance of corporate governance and management control philosophy in ensuring the integrity of the financial-reporting process. We examine the link between these two macro-level factors and both preplanning (e.g., client acceptance, business risk judgments) and planning judgments (e.g., extent and timing of testing). Ninety-six auditors evaluated a hypothetical client with corporate governance and management control philosophy characteristics that were either strong or weak. More experienced auditors performed preplanning (client acceptance) judgments, while the remaining auditors performed planning judgments related to the extent and timing of substantive testing. As predicted, management control philosophy and the governance structure did affect the preplanning and planning judgments, with a stronger effect observed for management control philosophy. While the results for judgments related to the extent of testing were consistent with professional guidance, auditors lacked consensus in judging the effect on the timing of tests. The results provide insight into the effect of two important elements of the control environment on preplanning and planning judgments and could prove useful in the development of work papers and risk assessment models.

Prior research on justification has typically focused on the differences in judgments between auditors required, or not required, to justify their decisions. However, justification memos can be prepared using different approaches. In this study we examine the impact of using three justification memos: supporting, balanced, and component. Using a comprehensive control environment case based on an actual client that experienced fraud, we find that the justification memo used can affect the judgments of auditors preparing the memos as well as the judgments of auditors who review their work. Specifically, the results indicate that auditors using an unrestricted component memo, who were required to write memos for components of their task by providing important positive and negative evidence, thought that the firm's control environment was more likely to prevent fraud as compared with the supporting and balanced memo groups. Additional analyses suggest that the reason for this result is that an unrestricted component memo focuses auditors’ attention on a larger percentage of positive control environment characteristics when a firm's underlying evidence set is mostly positive. This may be problematic because firms can have more positive than negative control environment characteristics, even when fraud is present.

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This instructional case provides you an opportunity to perform realistic audit tasks using evidence obtained from an actual company. Through the use of engaging materials, the case helps you to develop an understanding of the control environment concepts presented in SAS No. 78 (AICPA 1995), Consideration of Internal Control in a Financial Statement Audit, and fraud risk assessment presented in SAS No. 99 (AICPA 2002), Consideration of Fraud in a Financial Statement Audit. This case involves making a series of fraud risk assessments based on company background information and a detailed and realistic control environment questionnaire, which provide you a context that makes the often abstract concepts relating to control environment and fraud risk assessment more concrete.

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