The Auditor-Client Contractual Relationship: An Economic Analysis by Linda ElizabethDeAngelo Review by: Wanda A.. LUCAS Project Manager Financial Accounting Standards Board LINDA ELIZA
Trang 1The Auditor-Client Contractual Relationship: An Economic Analysis by Linda Elizabeth
DeAngelo
Review by: Wanda A Wallace
The Accounting Review, Vol 57, No 3 (Jul., 1982), pp 643-644
Published by: American Accounting Association
Stable URL: http://www.jstor.org/stable/246890
Accessed: 08/05/2014 19:02
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at
http://www.jstor.org/page/info/about/policies/terms.jsp
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive We use information technology and tools to increase productivity and facilitate new forms
of scholarship For more information about JSTOR, please contact support@jstor.org.
American Accounting Association is collaborating with JSTOR to digitize, preserve and extend access to The Accounting Review.
http://www.jstor.org
Trang 2Book Reviews 643
Inflation Will Ration The Goods of The Nation
As the title suggests, this book is aimed prin-
cipally at practicing managers As a brief but
far-ranging introduction to the subject designed
to elicit interest and stimulate further thought
and study, it has much to recommend it, not-
withstanding the shortcomings noted above A
simple and straightforward explanation of this
subject is a daunting challenge and will in-
evitably sacrifice some of the finer distinctions to
achieve simplicity The need for such an explana-
tion is great This book might also be useful as
supplemental reading to introduce the problem
of changing prices in an undergraduate course
on managerial accounting, especially one that
emphasizes capital budgeting decisions
TIMOTHY S LUCAS Project Manager Financial Accounting Standards Board
LINDA ELIZABETH DEANGELO, The A uditor-
Client Contractual Relationship: An
Economic Analysis (Ann Arbor, MI: UMI
Research Press, 1981, pp ix, 129, $24.95)
The primary strengths of this work include its
integration of economic literature in the dis-
cussion of conventional wisdom regarding the
nature of audit services and related contractual
arrangements and its formal structuring of
arguments The reader is provided with an easy-
to-read description of how agency theory affects
demand for audits and why the public-good
attributes of an audit do not preclude its analysis
as a private good Interesting points that are
discussed include a rationale for why bond-
holders require covenants, an explanation of
"sorting"-determining the "quality" of com-
panies' securities-and the use of the audit as a
sorting mechanism, the ability of the corporate
structure with its ex ante sharing rule to effec-
tively prevent intra-shareholder free rider
problems, and the use of the brand-name
mechanism as one means of making the audit
process observable
The formal discussion of hypotheses and the
model development concisely summarize such
intuitive concepts as: "The average length of the
auditor-client relationship will increase when,
ceteris paribus, (1) the transactions costs of
changing auditors increase, or (2) learning-by- doing advantages increase" (p 97) The eco- nomic analysis explains the practice of "low- balling" or undercharging for audits in an initial engagement as a response to the CPA's invest- ment in specialized assets in the form of client- specific information which will produce cost savings in future years The specialized assets are claimed to impair independence since the CPA has a vested interest in future audits of the client With this central theme, issues concerning the average length of auditor-client relationships, auditor concentration over time, and the selec- tion of client portfolios when industry, general, and client-specific knowledge on the part of auditors, as well as differential costs of coor- dinating a number of audit clients, are incor- porated in the model The analysis includes a summary of empirical evidence from other researchers' studies which is thought to be relevant to the model's predictions; however, no new evidence is presented, nor are any rigorous analyses of existing data performed that might appropriately control for numerous competing hypotheses
In this reviewer's opinion, the study suffers from a flaw which is common to such economic analyses: the model merely formalizes basic assumptions and computes deterministic com- parative statics predictions of the model, as is apparent in the text from such phrases as "Given the definitions and assumptions of the model" (p 59), "We can see that, by assumption," (p 71), and "This result obtains because of the assumed relationship between" (p 90) Un- fortunately, few new insights are gained, and the assertion that the critical components of the contracting decision have been isolated and that material effects are implied by the analysis is left unsubstantiated
The material provides an interesting frame- work for future research and shares numerous research ideas; however, the reader should be wary of those claims that are, in the opinion of this reviewer, counterintuitive Examples include the following claims: (1) "the client is able to impose material costs on the auditor by termi- nating him" (emphasis added, p 37) or threaten- ing to terminate, and can thereby impair independence-if this were true, the essence of the auditing service would be undermined; (2)
"consumers' assessments of the auditor's incen- tives for false attestation decline as the total number of two period clients of that auditor increases" (p 66), thereby implying that smaller CPA firms are not independent; and (3) "main-
Trang 3644 The Accounting Review, July 1982
training a relationship with an auditor who
possesses "future economic interest" in the
client" (as described in this study) has a "negative
impact on client firm value" (p 3), despite the
conflicting empirical fact that a change of
auditors is considered to be a "red flag" to
auditors in evaluating audit risk and may itself
be the negative information signal
While the economic analysis acknowledges
that the auditor's "specialized assets on all clients
serves as a sort of collateral bond which con-
strains auditor opportunism" (p 96), the relative
importance of the specialized assets as a threat to
independence is, in the opinion of this reviewer,
strongly overstated, to the detriment of the
model The existence of companies with policies
of changing auditors frequently and the common
practice by acquired companies of changing to
the parent company's auditor have implications
regarding the magnitude of the cost savings from
specialized assets and suggest the importance of
embellishing the model to consider additional
dimensions of the auditor-client contractual
relationship
This work is likely to be of interest to those
who are curious as to alternative approaches to
modeling the auditor-client relationship
WANDA A WALLACE
Assistant Professor of Accounting
The University of Rochester
J R EDWARDS, Company Legislation and
Changing Patterns of Disclosure in British
Company Accounts 1900-1940 (London:
The Institute of Chartered Accountants in
England and Wales, 1981, pp ii, 77,
?5.95)
The study of the history of accounting is not
merely an academic exercise of interest to a
relative few specialist accountants Due to the
comparatively brief history of modern account-
ing, it is a study of a subject striving to reach
maturity As such, it is important that present-
day accountants and students of accounting are
fully appreciative of relatively recent develop-
ments and issues At times, this therefore means
studying events, activities, and data of the
immediate past But such examinations ought to
highlight successes and failures in accounting
development which can be emulated or avoided
in the future In a sense, what is being argued is
that the study of "contemporary" history is a
substantial part of the present-day accountant's
learning curve
Edwards' study for The Institute of Chartered Accountants in England and Wales falls easily into the above format It is "contemporary" history (covering a recent period of 1900 to 1940); and it deals with corporate financial reporting (a matter which has and will continue
to occupy the attention of accountants to a considerable extent) Thus, it is important to view Edwards' work as a contribution to the future development of such reporting as well as a review of past practices
The period of research commences with the time at which UK reports effectively became an established part of corporate legal requirements (the Companies Act 1900 introducing a compul- sory audit) and ending with a point of time that marked the beginning of the substantial influence
of the major professional accountancy bodies through recommendation and standardization The basis for the research is an examination of the published financial reports of 12 steel com- panies-thus the study must be regarded as a very limited one, both in terms of time period and subject material (how representative of reporting practices were those of steel com- panies?)
The text includes various commentaries on the substantial reporting requirements of the period -these all being contained in the various Com- panies Acts None of this material is original, although it is helpful to the reader to have it explained as a context to the analysis of specific reporting practices by the steel companies Edwards deals with such matters as the format of financial statements, the detail of the data dis- closed, accounting practices such as deprecia- tion of fixed assets, and secret-reserve account- ing
In doing so, Edwards reveals how little infor- mation was disclosed to stockholders compared with the volumes of data which can appear in present-day reports; the considerable delay that could take place in producing financial state- ments-mainly due to the difficulties of estimating tax; the slowness of reporting on consolidated financial results (the latter were not seen in the UK until the 1930s); the problem of determining whether depreciation was to be treated as an expense or an appropriation; evidence of considerable, and then acceptable, use of secret-reserve accounting; and the pub- lication of reports of directors many years before this practice became legally required
The overall conclusions that come from the study are of substantial lack of disclosure by these companies to their stockholders; of relative consistency in this lack of disclosure; and an