The Impact of Regulatory Scrutiny on the Resolution of Material Accounting Issues

Posted: 11 Jan 2010 Last revised: 31 Jan 2013

Date Written: March 25, 2010

Abstract

This study investigates the impact of regulatory scrutiny on auditors’ approach to engaging in discussions with managers over the appropriate treatment for material transactions and the financial reporting consequences of these discussions. This research is motivated by concerns that regulatory scrutiny can result in reduced auditor willingness to engage in discussions before client management has developed a documented position. These consequences are relevant as ongoing auditor-client interaction can benefit the financial reporting process by increasing information flows, identifying important issues, enabling mutual understanding and developing auditors’ client business knowledge. This study contributes with an experiment that examines whether the arguments and recommendations that auditors prepare in response to managers’ aggressive accounting preferences are influenced by the degree of regulatory scrutiny and the degree to which managers are committed to their preferences before discussing material transactions with the auditors. Consistent with predictions, the results indicate that the impact of regulatory scrutiny on auditors’ interaction approach is contingent on managers’ commitment to their preferences. Specifically, regulatory scrutiny can both discourage and stimulate auditors’ willingness to respond to managers’ accounting preferences: auditors actively dispute preferences proposed by less committed managers but auditors are reluctant to respond to preferences proposed by committed managers, suggesting that auditors limit information sharing in anticipation of a dispute. The results also provide evidence that regulatory scrutiny not only influences auditors’ interaction approach but also their financial reporting expectations.

Keywords: auditor-client interaction; manager commitment; regulatory scrutiny

JEL Classification: M41

Suggested Citation

Pomeroy, Bradley, The Impact of Regulatory Scrutiny on the Resolution of Material Accounting Issues (March 25, 2010). CAAA Annual Conference 2010. Available at SSRN: https://ssrn.com/abstract=1534349 or http://dx.doi.org/10.2139/ssrn.1534349

Bradley Pomeroy (Contact Author)

University of Waterloo ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1
Canada

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