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Prior research has shown that knowledge is an important determinant of audit
task performance (Libby and Luft 1993). Implicit in this finding is the notion
that knowledge is an integral component to sustaining a competitive advantage
for an audit firm in delivering its professional services. Many audit firms have
recognized the strategic importance of knowledge in recent years and have
emphasized the management of knowledge as a means to improve profitability. For
example, KPMG has identified knowledge management as "a core and necessary
firm-wide process to support and enable KPMG's strategy of growth and
productivity enhancement" (Alavi 1997, 9).
Audit firms have always
managed their knowledge through the systematic assignment of staff. However, two
recent developments have heightened audit firms' interest in knowledge
management. First, advances in information technology have dramatically improved
the capacity of audit firms to codify and disseminate firm knowledge throughout
the organization. Second, since the number of different types of services
offered by audit firms has increased (e.g., assurance services), there is
substantial interest in understanding the extent to which different types of
firm knowledge can be transferred across various tasks, industries, and
functions.
The purpose of this study is to provide evidence related to
the management of audit task knowledge. Specifically, I explore whether a
specific type of task knowledge develops differently for in-charge auditors
working in different industry specializations. Since auditors at the in-charge
level are often asked to choose an industry specialization, understanding
whether certain industries provide the opportunity for differential knowledge
development is important (Libby and Frederick 1990), especially if such
knowledge can be transferred to aid performance in tasks completed across
industries. Specifically, this study explores whether the task knowledge under
investigation, loan credit review, can be transferred across both industry and
task contexts to aid performance in the going concern judgment.
The task
knowledge related to loan credit review was selected for investigation because
this knowledge may be useful in making other audit judgments that require a
financial viability evaluation (e.g., the going concern judgment) and because
the opportunity to develop this knowledge differs depending on an auditor's
industry specialization. Specifically, auditors with a financial service
industry background have numerous opportunities to evaluate the financial
viability of debtors in a bank's loan portfolio while completing loan credit
reviews. In contrast, auditors in other industries, like manufacturing, have
limited opportunities to evaluate financial viability of a firm. Differential
opportunities are expected to lead to variations in the development of this
knowledge.
The results of an experiment administered to 60 in-charge
auditors provide evidence that financial service auditors possess more and
better-clustered loan credit review knowledge than do manufacturing auditors.
This result demonstrates that auditors at the same rank develop task knowledge
differently, depending on their industry specialization.
The results
also provide evidence that loan credit review task knowledge can be transferred
across task and industry contexts to aid performance in the going concern
judgment. This result is important because it suggests that certain types of
task knowledge may be transferable to other tasks and industries. This is the
first study in the audit literature to provide empirical evidence on this issue.
THEORY AND HYPOTHESES
Knowledge Transfer
Knowledge
transfer refers to the situation in which knowledge developed for one task will
assist an individual's judgment performance in another task. In the early
psychology literature, Thorndyke and Woodworth (1901) proposed a theory of
identical elements to explain the transfer of knowledge across contexts. They
believed that training in one activity would transfer to another only if the
activities shared common elements. Singley and Anderson (1989) contend that
these common elements are comparable to the production rules of a skilled task.
To the extent that production rules or elements overlap, transfer of knowledge
between tasks can occur.
Larkin (1989) used an expert system to identify
the specific types of knowledge that may transfer across domains. Among her
findings, she identified two additional conditions that must be met in order for
knowledge transfer to occur. First, an individual must understand the base
domain well, and second, the transferable knowledge must be organized in such a
way that an individual can apply that knowledge to a target domain. The latter
condition implies that the transferable knowledge is not intermingled with other
knowledge from the base domain in a manner that would prevent that knowledge
from being applied to a target domain.
To date no research has
investigated the nature of auditor knowledge that transfers across various
domains (Bedard and Chi 1993). Despite the lack of research on this issue,
Marchant (1989) investigated the use of analogical reasoning by both expert and
novice auditors. To solve a problem using analogy, an individual is first
reminded of a similar problem whose solution is known. The individual will then
"map" the solution of the known problem to the current problem (Gick and Holyoak
1983). Marchant's (1989) results indicate that both expert and novice auditors
rely on analogy to generate a potential hypothesis in an unfamiliar situation.
These findings demonstrate that analogical reasoning is a cognitive mechanism
that is used by an individual to transfer knowledge across various contexts.
However, Marchant's (1989) research did not provide evidence about the specific
types of knowledge that are transferable, nor did the research provide evidence
about the different types of domains where knowledge transfer might occur.
Rather, the research focused on whether analogical reasoning was indeed a
cognitive mechanism used by auditors. The current study is therefore an
important addition to this line of audit research (see Davis and Solomon 1989;
Bedard and Chi 1993).
Condition #1--The Common Element
The first
condition of knowledge transfer is that a common element must exist (Singley and
Anderson 1985, 1989). To address this condition, a summary task analysis
(Gibbins and Jamal 1993) of both the loan credit review and the going concern
judgment are provided in this section.
When completing a loan credit
review judgment, Generally Accepted Auditing Standards (GAAS) suggest that an
auditor consider six primary factors (AICPA 1984). The first factor reflects the
importance of the context in which the loan credit review is being performed.
For each client, an auditor is required to gain an understanding of how certain
aspects of the institution's lending environment (e.g., control environment,
lending policies) might impact his/her collectibility assessment. The five
remaining factors reflect the exacting specifications of the loan balance under
review. For each loan balance, the auditor should consider information related
to a borrower's (1) payment history; (2) financial condition; (3) past and
expected future cash flows; (4) pledged collateral; and (5) guarantors (AICPA
1984).
The cognitive computational model of the loan credit review
judgment reported by Wright and Willingham (1997) describes the knowledge that
is used by an auditor to complete this task. The knowledge is organized around
the completion of the five task subgoals, which correspond to the five factors
for an individual loan balance described previously. To complete the loan credit
review judgment, conclusions must be reached on each of these subgoals. Panel A
of Figure 1 illustrates the loan credit review judgment process and how the
knowledge about each subgoal underlies each phase of the loan credit review
judgment process.
When completing a going concern judgment, GAAS
requires that auditors assess an entity's ability to meet existing obligations,
as they become due in the upcoming year (AICPA 1998). Although there is no
definitive algorithm that an auditor can rely upon to complete the going concern
judgment, SAS No. 59 provides a general approach. Ellingson et al. (1989)
outline the approach, illustrated in Panel B of Figure 1.
[FIGURE 1
OMITTED]
The evaluation of whether "substantial doubt" exists regarding
an entity's going concern status is of particular interest in the present
context because several of the subgoals that are likely to be addressed in the
loan credit review judgment are also likely to be addressed in the going concern
judgment. Specifically, of the six subgoals identified in Panel A of Figure 1,
the three that underlie the evaluation of a borrower's ability to repay a loan
on an unsecured basis are also likely to be addressed in the going concern
judgment. (1) Therefore, the knowledge about these subgoals provides the basis
to describe the common element that exist between the loan credit review and the
going concern judgment. As discussed below, the audit literature provides
empirical evidence that these three subgoals are addressed in both the loan
credit review and the going concern judgment:
Financial Condition: An
auditor's evaluation of a firm's financial condition is based, in part, on an
evaluation of a firm's liquidity, which is typically completed in both the loan
credit review (Wright and Willingham 1997) and the going concern judgment (Biggs
et al. 1993; AICPA 1998). Expected Future Cash Flow: An auditor's evaluation of
a firm's expected future cash flow is based, in part, on an evaluation of a
firm's previous cash flow from operations, which is typically completed in both
the loan credit review (Wright and Willingham 1997) and the going concern
judgment (Biggs et al. 1993; AICPA 1998). Payment History: The evaluation of
payment history for principal and interest payments is typically completed in
both the loan credit review (Wright and Willingham 1997) and the going concern
judgment (Mutchler 1984; AICPA 1998).
The preceding discussion provides
a basis to advance the notion that common elements exist between the going
concern and the loan credit review judgment, thereby satisfying the first
condition of knowledge transfer.
Condition #2--The Content of Knowledge
The second condition of knowledge transfer is that an individual must
understand the base task domain well (Larkin 1989). According to Larkin, this
condition is met if the knowledge about the base task is maintained in memory so
that the knowledge can be transferred to the target task. While Larkin (1989)
does not provide specific details, it is likely that auditors possessing more
knowledge about the base task domain will be better candidates to transfer such
knowledge. The remainder of this section therefore explores differences in the
opportunity to acquire this base task knowledge that exist across
auditors.
The audit literature has shown that auditors acquire much of
their knowledge about a task through practice and feedback (Bonner and Walker
1994; Salterio 1994). Importantly, the amount of practice and the quality of
feedback received are likely to differ across audit tasks and industry domains
(Bonner and Pennington 1991). Given these differences, the audit literature has
called for a better understanding of differential learning opportunities,
because these differences are likely to lead to differential knowledge
development across auditors (Libby...
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