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The Effect of Change in the Reporting Threshold and Type of Control Deficiency on Equity Analysts’ Evaluation of the Reliability of Future Financial Statements

36 Pages Posted: 28 Feb 2012  

Stephen Kwaku Asare

University of Florida - Fisher School of Accounting

Arnold Wright

Northeastern University - Accounting Group

Date Written: November 14, 2011

Abstract

We examine the joint effects of the reporting threshold (more than remote versus reasonably possible) and type of control deficiency (entity level versus account specific) described in the adverse report on internal controls on equity analysts’ evaluation of the reliability of a company's future financial statements. We hypothesize that equity analysts interpret a “more than remote” threshold to mean a significantly lower likelihood than a "reasonable possibility” threshold. We also hypothesize that when the reporting threshold is more than remote, equity analysts who evaluate an entity level material weakness will indicate a higher likelihood of future material misstatements than those who evaluate an account specific material weakness. However, when the reporting threshold is reasonably possible, equity analysts will assess the same likelihood of future misstatements for both types of material weakness. The results from an experiment that employed 65 equity analysts support our hypotheses. Taken together, the findings suggest that the change to the “reasonably possible” regime has made the account specific material weakness more consequential in evaluating the reliability of the future financial statements but had no effect on the evaluation of entity level material weaknesses.

Keywords: adverse control reports, reporting thresholds, type of control deficiencies, early warning signal, users’ likelihood assessments

JEL Classification: M40

Suggested Citation

Asare, Stephen Kwaku and Wright, Arnold, The Effect of Change in the Reporting Threshold and Type of Control Deficiency on Equity Analysts’ Evaluation of the Reliability of Future Financial Statements (November 14, 2011). Auditing: A Journal of Practice & Theory, May 2012. Available at SSRN: https://ssrn.com/abstract=2012609

Stephen Kwaku Asare (Contact Author)

University of Florida - Fisher School of Accounting ( email )

Warrington College of Business
PO Box 117166
Gainesville, FL 32611-7166
United States

HOME PAGE: http://warrington.ufl.edu/fsoa/

Arnold Wright

Northeastern University - Accounting Group ( email )

406 Hayden Hall
United States

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