Auditor Reporting Decisions Involving Accounting Principle Changes: Some Evidence on Materiality Thresholds

Despite concerns that profit-sharing plans might have a detrimental effect on audit quality, there is little empirical evidence on this issue. We examine the effects of the type of profit-sharing plan, level of client importance, and auditor reinforcement sensitivity (joint sensitivity to rewards and punishments) on auditor reporting decisions. By relying on agency theory and reinforcement sensitivity theory, we posit that the joint effects of profit sharing and client importance on auditors' decisions are contingent on reinforcement sensitivity. In an experiment with 450 audit partners and managers, we manipulate type of profit-sharing plan and client importance, and measure extroversion and neuroticism. We find the highest audit quality when profit sharing is based on firm performance, client importance is low, and reinforcement sensitivity is high. Thus, instead of just modifying the type of profit-sharing plans, it is the mix of economic incentives and personality traits that affect audit quality.

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The effect of real activities manipulation on going concern audit opinions for financially distressed companies

Review of Accounting and Finance ◽

10.1108/raf-09-2016-0135 ◽

2018 ◽

Vol 17 (4) ◽

pp. 514-539

Author(s):

Hongkang Xu ◽

Mai Dao ◽

Jia Wu

Keyword(s):

Audit Quality ◽

Positive Association ◽

Content Type ◽

Going Concern ◽

Accruals Management ◽

Reporting Decisions ◽

Going Concern Opinion ◽

Distressed Firms ◽

Real Activities Manipulation ◽

Auditor Reporting

Purpose This study aims to examine the effect of real activities manipulation (RAM) on auditors’ decision of issuing going concern (GC) opinions for distressed companies. Design/methodology/approach This study estimates and examines three types of RAM: reduction of discretionary expenses, sales manipulation and overproduction. It investigates the effect of RAM on auditor reporting conservatism by including the three measures of RAM methods in logistic regressions that explain the issuance of going concern opinions. The authors perform the analysis specifically on distressed firms for 2004-2013 period. Findings This study finds a significant and positive association between RAM and the likelihood of receiving going concern opinion in the financial distressed firm sample, suggesting that client’s abnormal business activity affects the auditor reporting conservatism. Practical implications This study provides evidence that auditors make going concern reporting decisions in consideration of the client’s abnormal operating decisions and management’s opportunism. Originality/value Recent literature argues that auditors have little recourse other than to resign if a client uses RAM to impact earnings or the financial statements, and hence the enhanced audit quality in the post-SOX period is due to the shift from using accruals management to RAM (Cohen et al., 2008; Chi et al., 2011; Kim and Park, 2014). The evidence provided in this study indicates that auditors report more conservatively (rather than simply resign) in response to the aggressive RAM.

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Selecting Experimental and Comparison Samples for Use in Studies of Auditor Reporting Decisions

Journal of Accounting Research ◽

10.2307/2491264 ◽

1987 ◽

Vol 25 (1) ◽

pp. 161 ◽

Cited By ~ 13

Author(s):

Jack E. Wilkerson

Keyword(s):

Reporting Decisions ◽

Auditor Reporting

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State Liability Regimes within the United States and Auditor Reporting

The Accounting Review ◽

10.2308/accr-51426 ◽

2016 ◽

Vol 91 (6) ◽

pp. 1545-1575 ◽

Cited By ~ 20

Author(s):

Divya Anantharaman ◽

Jeffrey A. Pittman ◽

Nader Wans

Keyword(s):

United States ◽

New Jersey ◽

State Level ◽

The United States ◽

Third Party ◽

Litigation Risk ◽

Exogenous Shocks ◽

Reporting Decisions ◽

Auditor Reporting ◽

State Liability

ABSTRACT We examine how state liability regimes within the United States affect auditor reporting decisions. We exploit variation across state-level common law in two aspects of auditor liability: the extent to which auditors can be held liable by third parties for negligence, and rules for apportioning liability across multiple defendants. We find that auditors are more likely to issue a modified going-concern (GC) report to financially distressed clients from high-liability states than to those from low-liability states. We sharpen inferences using a natural experiment that examines the causal effects of two exogenous shocks to auditor third-party liability standards, which dramatically restricted auditors' liability in New Jersey in 1995 and in California in 1992. Results from difference-in-differences tests imply that auditors' propensity to issue a modified opinion for client firms in New Jersey and California decreases significantly after the decline in auditors' litigation exposure, relative to control firms from other jurisdictions. These findings add to our understanding of how litigation risk affects auditor behavior and highlight an important source of variation in litigation risk within the U.S. that has seldom been studied to date.

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Audit Fees, Nonaudit Fees, and Auditor Reporting on Stressed Companies

Auditing A Journal of Practice & Theory ◽

10.2308/aud.2003.22.2.53 ◽

2003 ◽

Vol 22 (2) ◽

pp. 53-69 ◽

Cited By ~ 164

Author(s):

Marshall A. Geiger ◽

Dasaratha V. Rama

Keyword(s):

Audit Committee ◽

Positive Association ◽

Audit Fees ◽

Manufacturing Companies ◽

Significant Positive Association ◽

Going Concern ◽

Reporting Decisions ◽

Nonaudit Services ◽

Audit Opinions ◽

Auditor Reporting

The SEC and legislators have expressed concerns that independence may be negatively impacted if auditors perform significant nonaudit services for their audit clients, and that providing lucrative nonaudit services to clients may make it more likely that auditors will “see things the client's way.” Such concerns are particularly salient in the context of issues that involve significant auditor judgment, as in the case of reporting decisions related to going-concern uncertainties for financially stressed clients. In this study we examine the association between the magnitude of audit and nonaudit fees and auditor report modification decisions for financially stressed manufacturing companies. In our analysis we control for financial stress, company size, reporting lag, default status, audit committee effectiveness, and management plans. The results indicate a significant positive association between the magnitude of audit fees and the likelihood of receiving a going-concern modified audit opinion, but we find no significant association between nonaudit fees and audit opinions. Additional analyses also find no significant relationship between the ratio of nonaudit service fees to audit fees and reporting decisions, and indicate that our results are robust across alternative model, variable, and sample specifications. We also control for the potential endogeneity of audit opinions, audit fees, and nonaudit fees, and find the same positive association of audit fees with opinions, but no association between nonaudit fees and audit opinions. Overall, we find no evidence of a significant adverse effect of nonaudit fees on auditor reporting judgments for our sample of distressed companies.

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Reexamining the influence of large clients on office-level auditor reporting decisions

American Journal of Business ◽

10.1108/ajb-06-2015-0020 ◽

2016 ◽

Vol 31 (1) ◽

pp. 4-16

Author(s):

Lucy Lim

Keyword(s):

Big Five ◽

Logistic Model ◽

Design Methodology ◽

Audit Fees ◽

Content Type ◽

Going Concern ◽

Discretionary Accrual ◽

Reporting Decisions ◽

Auditor Reporting ◽

Office Level

Purpose – This paper revisits the Reynolds and Francis’ (2001) study via the use of a more current dataset, incorporation of improvements into the accrual model and the use of actual fee data vs estimates. Using the improved analyses, the purpose of this paper is to examine whether more conservative auditors’ reports on larger clients are still evident. Design/methodology/approach – The paper follows Reynolds and Francis (2001) in using a regression model with White-adjusted t-statistics for the discretionary accrual model and a logistic model for going concern analysis. The most current discretionary accrual model is used to improve the original model, use actual fee data (not available previously), and add analyses using the two components of total fees (i.e. audit and non-audit fees). Findings – As opposed to Reynolds and Francis (2001), the results show that the Big Five auditors are less conservative with higher-paying clients as they allow their clients to have more discretionary accruals. While Reynolds and Francis (2001) found that auditors are more likely to report going concern opinions for higher-paying clients, the results in this paper does not show any difference in the propensity of auditors to issue going concern opinions. Originality/value – This study replicates Reynolds and Francis (2001) using more recent US data, applying the most recent discretionary accrual model, using the actual fee data, and adding analyses using total fees decomposition.

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Recent Changes in the Association between Bankruptcies and Prior Audit Opinions

Auditing A Journal of Practice & Theory ◽

10.2308/aud.2005.24.1.21 ◽

2005 ◽

Vol 24 (1) ◽

pp. 21-35 ◽

Cited By ~ 120

Author(s):

Marshall A. Geiger ◽

K. Raghunandan ◽

Dasaratha V. Rama

Keyword(s):

Paradigm Shift ◽

Recovery Period ◽

Client Characteristics ◽

Going Concern ◽

High Profile ◽

Sarbanes Oxley ◽

Reporting Decisions ◽

Audit Opinions ◽

Auditor Reporting ◽

The U.S

The intense legislative and media scrutiny after a series of high-profile corporate failures, coupled with the paradigm shift in the regulation of the auditing profession brought forth by the Sarbanes-Oxley Act, suggests that auditors' decisions would be more conservative in the period after December 2001. Based on analyses of 226 financially stressed companies that entered bankruptcy during the period from 2000 to 2003, we find that auditors are more likely to issue going-concern modified audit opinions in the period after December 2001. Since the post-December 2001 period coincides with recovery from a recession in the U.S., we also examine prior audit opinions for 93 companies entering bankruptcy in 1991 and 1992. We find that auditors were also more likely to issue prior going-concern modified audit opinions in 2002–03 than in the earlier recession recovery period. Following the technique used in Francis and Krishnan (2002), we document that the increase in going-concern modification rates for bankrupt companies after December 2001 is due to changes in auditor reporting decisions and not solely due to differences in client characteristics between the time periods studied.

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