This experimental study analyzes whether reporting an accounting estimate as a key audit matter (KAM) can influence auditor judgment about the accounting estimate and the corresponding action. We find that skeptical action in the form of proposed adjustment amounts is significantly lower when the accounting estimate is reported as a KAM. Thus, the disclosure of a KAM can serve as a moral license to waive an adjustment. Taking into account that the KAM disclosure does not affect auditors' skeptical judgments in the form of a reasonableness assessment of the accounting estimate, our results indicate the existence of a judgment–action gap. Furthermore, implicit client pressure does not enlarge the moral licensing effect of the KAM disclosure. We also find evidence that audit effort is not affected by reporting a KAM. Overall, our study contributes to the current debate about the audit reporting model by showing that reporting a KAM might have unintended “real effects” on auditors' actions.
SUMMARY:
This paper analyzes whether audit adjustments vary systematically with inherent and control risk factors. The analysis is based on proprietary data from a large recent sample of audit adjustments detected in the financial statement audits conducted by a Big 4 audit firm in Germany. We extend the scope of prior studies by incorporating client-specific planning materiality in our design, enabling us to analyze the relative magnitude of adjustments. Our findings show that audit adjustments vary systematically, as proposed by the audit risk model. Specifically, the integrity and competence of the client's management, economic position, entity-level control strength, and internal control system are associated with the number and relative magnitude of audit adjustments. The results also suggest that inherent and control risk factors are particularly strongly associated with income-affecting adjustments.
JEL Classifications: M40, M41, M42.
Purpose
The value of an audit lies in its ability to detect and correct misstatements in financial statements. The purpose of this paper is to investigate the resolution of detected misstatements.
Design/methodology/approach
Using data on a large sample of audit adjustments by a German Big 4 audit firm, this paper reports an analysis of the factors that influence the resolution of detected misstatements at the engagement level and at the level of the individual adjustment.
Findings
The auditor’s book-or-waive decision is influenced by client characteristics and characteristics of the audit adjustments that can be linked to client as well as auditor incentives to oppose (require) the recording of adjustments. Offsetting effects of the detected adjustments on client income play a key role in auditors’ decisions.
Research limitations/implications
The results may not be generalizable to Non-Big 4 audit firms. The sample includes unlisted firms which are subject to mandatory audits in the European Union. Other potential factors may not have been captured in the study.
Practical implications
The findings suggest that standard-setters and audit practice should give more attention to the offsetting effects of audit adjustments on income. The analyses at the two different levels could help practitioners to better structure their book-or-waive decisions.
Originality/value
In contrast to prior studies, the authors analyze the resolution of misstatements at the engagement level and the level of the individual adjustment. This design makes a methodological contribution by expanding the level of analysis of auditors’ book-or-waive decisions to include the engagement level. It further allows examining offsetting effects of different adjustments on client income, as well as the number and the total amount of detected adjustments.
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