Research Summary 23: Reputation Does Matter

uditors’ judgments about a client’s integrity have a domino effect on their audit decisions—first on risk evaluation, then on the extent of audit evidence collection and ultimately on audit fees. Auditors are leery of clients with whom they have no track record. Our study revealed that when auditors thought a client’s reputation was not squeaky clean, they collected more audit evidence than usual and, in turn, charged more for taking the trouble.

The perception of client integrity also colors whether auditors believe their clients. This is known as source credibility, a reflection of a client’s combined risk—inherent risk and internal control risk. Inherent risk is the probability that an account or transaction contains material misstatements, regardless of the controls in place. Internal controls run the gamut—protecting the effectiveness and efficiency of a company’s operations, the reliability of its financial reporting and its compliance with laws and regulations. Low source credibility increases the probability that a company’s financial statements might not stand up under scrutiny.

We provided 63 Canadian audit partners with information about a potential audit client, including snapshots about the CFO’s integrity. For example, the CFO was either respected or not respected in the local business community. We asked the participants to judge business and combined risk, and to recommend audit extent and fees based on that risk.

Finally, we asked the auditors to judge the CFO’s integrity. The participants associated low integrity with higher levels of inherent and internal control risks. As a result, they made an association among the high risks and an increase in the extent of audit evidence gathered and fees.

The key finding of the study showed that auditors recognized the potential impact of a client’s reputation on risk and collected more data to compensate for less-than-ideal clients.

For the full text of the research paper, see “The Effects of Judgments of New Clients’ Integrity upon Risk Judgments, Audit Evidence and Fees,” Auditing: A Journal of Practice & Theory, September 2001, vol. 20, no. 2.

PHILIP R. BEAULIEU, PhD, is associate professor, Faculty of Management, University of Calgary, Alberta, Canada. His e-mail address is pbeaulie@ucalgary.ca .