LABORATORY STUDY OF THE EFFECTS OF AUDITOR'S BUSINESS RISK ON AUDIT SCOPE

This study addressed the following research question: Does the auditor's business risk affect audit scope? There is disagreement in the auditing literature on whether or not business risk affects audit scope. The purpose of this study was to determine the extent, if any, that business risk from factors related to auditor litigation affects audit scope. It was hypothesized that audit scope would increase when auditing clients with increased auditor's business risk.; A laboratory study was performed with 32 audit managers from two Big Eight firms as subjects. The following business risk factors were manipulated: industry, ownership, and financial condition. Industry was manipulated as litigious and nonlitigious. Ownership was manipulated as public and private. Financial condition was manipulated as weak and strong. Audit scope was operationalized by total budgeted hours, materiality, sample sizes (including confirmations), and selected audit procedures.; Each subject was given four cases which required audit scope decisions in planning the year-end substantive tests of accounts receivable. A between subjects design was used for industry, and a repeated measures design was used for ownership and financial condition. ANOVAs were performed to test developed hypotheses. Error expectation was measured and included as a covariate in additional analyses using covariance analysis.; Budgeted audit hours, which is an overall measure of audit scope, had significant effects from ownership and financial condition. Budgeted audit hours were significantly greater for a public company and a client with a weak financial condition. When firm and error expectation were included in the analysis, ownership and firm had significant effects, while financial condition did not. A four-way interaction among firm x industry x ownership x financial condition also resulted. Materiality was not significantly affected. The analysis of materiality was surprising in that materiality judgments changed in the opposite direction than was expected with changes in industry and financial condition. There were no significant effects on number of confirmations or on selected audit procedures. There were significant effects from ownership and financial condition on sample sizes to test the cutoff of sales. The CPA firm had a significant effect on budgeted audit hours, materiality, and number of confirmations. Error expectation was significantly affected with manipulations of financial condition; i.e., the managers expected significantly more errors if the financial condition was weak.