Doctoral Dissertations

Date of Award

12-1993

Degree Type

Dissertation

Degree Name

Doctor of Philosophy

Major

Business Administration

Major Professor

Harrold P. Roth

Committee Members

Jack Kiger, Dennis Lin, Jim Reeve

Abstract

When companies adopt activity-based costing (ABQ for financial reporting purposes, external auditors must determine the effects of ABC on the audit process. This research examines whether certain factors associated with ABC cause external auditors to adjust their inherent risk assessments (IR) or budgeted audit hours (Hours). Using an empirical model, five ABC adoption factors were tested: product cost accuracy, computational complexity, directional income effects, disclosure requirements, and auditors' system design participation These factors represented aspects of ABC adoption that could influence auditors' decisions concerning inherent risk and budgeted audit hours.

Each auditor participating in this research received two hypothetical case studies that included the five ABC adoption factors. The adoption factors were assigned each case study following a foldover fractional factorial design. In each case study, participating auditors estimated the inherent risk and budgeted audit hours associated with two audit assertions (i.e., valuation and disclosure) for the inventory/cost of sales accounts. As a result, each adoption factor's significance was evaluated in four audit planning decisions: lR:Valuation, IR:Disclosure, Hours:Valuation, and Hours:Disclosure.

Five hypotheses were tested in this study corresponding to the five ABC adoption factors. Two factors proved significant: (1) computational complexity for the IR:Valuation decision, and (2) product cost accuracy for the Hours:Valuation decision. Computational complexity directly affected auditors' inherent risk assessments. As computational complexity increased, auditors increased their inherent risk assessments. Additionally, product cost accuracy demonstrated an inverse relationship with budgeted audit hours. As product cost accuracy increased, auditors reduced their budgeted audit hours.

Product cost accuracy and computational complexity represent two ABC assumptions essential for the improvement of product cost reliability [Noreen, 1991; Roth and Borthick, 1991]. The importance of these factors to auditors presents opportunities for management accountants. First, internal control structure improvements could minimize the possibility of material misstatements occurring due to computational complexity. Second, documenting product cost accuracy improvements could reduce the cost of external audits. Documentation of improvements in both cost pool homogeneity and cost driver/cost pool proportionality could demonstrate whether ABC systems provide more reliable product cost information than traditional volume-based product costing systems.

Additional findings in this research involve the relationship between auditors' inherent risk assessments and budgeted audit hours. Auditors in this study were inconsistent in making their inherent risk decisions. Additionally, changes in inherent risk resulted in insignificant changes in budgeted audit hours. These results suggest that auditors fail to incorporate changes in inherent risk in planning the timing and extent of planned audit hours. If auditors fail to link risk and budgeted audit hours, the potential exists for ineffective and inefficient audits.

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