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Study shows specific guidelines help auditors overcome 'attraction effect' influences in fair value assumptions

Sudip Bhattacharjee Sudip Bhattacharjee

Auditing a company’s financial statement often requires verifying the value of a company’s investments. Financial Accounting Standards Board (FASB) rules require that such investments are disclosed at “fair value,” calculated by measuring assets and liabilities at estimates of their current value.

If market prices are not available, however, company management estimates fair value by using assumptions that individuals in the marketplace would make.

This is where it can get problematic. Is the auditor verification process of fair value assumptions susceptible to psychological processes? Can inappropriate comparative information — such as the addition of an inferior option into the benchmark set — change auditors’ assessment of the appropriateness of the investment’s value?

Looking for answers, Sudip Bhattacharjee, Pamplin College of Business associate professor of accounting and information systems in the National Capital Region, teamed up with associate professor Kimberly Moreno and assistant professor Nicole Wright, both of Northeastern University, to gather data from more than 125 audit professionals at eight large international public accounting firms. The auditors participating in the research completed a research case study, which the project team analyzed to come up with results.

“We found that auditors are indeed susceptible to what is referred to as ‘attraction effect,’” said Bhattacharjee. “If provided with a set of benchmark companies that includes an attractive option, auditors will evaluate the fair value of the investment higher than auditors who receive a set of benchmark companies with no attractive option.”

More importantly though, according to Bhattacharjee, the study showed that auditors are able to overcome the attraction effect when provided with a straightforward set of specific instructions to help them scrutinize the client’s assumptions. Specific guidelines ensured that adding an inferior option into the benchmark did not make another option in the set more attractive to auditors.

“The results of our study will provide direction for improving the audits of fair value estimates and add to the current PCAOB [Public Company Accounting Oversight Board] debate on the level of guidance that auditors should receive for these difficult-to-audit accounts,” he said.

Bhattacharjee, Moreno, and Wright conducted their research through a competitive grant from the Center for Audit Quality. The grant facilitates the ability of accounting and auditing academic scholars to acquire access to audit firm personnel who participate in their research projects. The review committee of audit partners and senior academics awards this grant based on such factors as ability to address research questions that are important to practice, methodological soundness, and contribution to academic literature.

Posted March 02, 2016