The Role of Reporting Incentives and Quantification in Auditors' Evaluations of Earnings Fluctuations

28 Pages Posted: 30 Jul 2001

See all articles by Urton Anderson

Urton Anderson

University of Kentucky - Von Allmen School of Accountancy

Kathryn Kadous

Emory University - Goizueta Business School

Lisa Koonce

University of Texas

Date Written: July 12, 2001

Abstract

Company managers frequently provide explanations in response to auditor inquiries about unexpected earnings fluctuations. Client-inquiry is particularly common when the financial statement account causing the fluctuation is subjective and involves estimates, as the ability to obtain reliable evidence from other sources often is limited in these situations. In this study, we examine two factors that we expect to affect how auditors evaluate client-provided explanations for an important account that requires significant estimation (i.e., revenue): the client manager's incentives to manage earnings and whether the explanation is quantified (i.e., put into numbers). We expected that auditors' evaluations of client-provided explanations would be a joint function of management's incentives and the type of explanation provided to the auditor. Instead, we found that auditors' views of the persuasiveness of client explanations are primarily affected by the manager's incentives to manage earnings. Focus on client manager incentives is consistent with auditors' and regulators' recent and vociferous concerns about earnings management. However, such a focus implies that when the likelihood of earnings management is low, auditors may underestimate the reliability of quantified explanations that demonstrate how the client's explanation fully accounts for the earnings fluctuation.

Keywords: Earnings management; Quantification; Auditing

JEL Classification: M41, M43, M49

Suggested Citation

Anderson, Urton L. and Kadous, Kathryn and Koonce, Lisa L., The Role of Reporting Incentives and Quantification in Auditors' Evaluations of Earnings Fluctuations (July 12, 2001). Available at SSRN: https://ssrn.com/abstract=276570 or http://dx.doi.org/10.2139/ssrn.276570

Urton L. Anderson

University of Kentucky - Von Allmen School of Accountancy ( email )

Lexington, KY 40506
United States
859-218-1788 (Phone)

Kathryn Kadous

Emory University - Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States
404-727-4967 (Phone)

Lisa L. Koonce (Contact Author)

University of Texas ( email )

Dept. of Accounting
McCombs School of Business
Austin, TX 78712
United States
512-471-5576 (Phone)
512-471-3904 (Fax)

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