Evidence from Auditors About Managers' and Auditors' Earnings-Management Decisions

50 Pages Posted: 26 Dec 2001

See all articles by Mark W. Nelson

Mark W. Nelson

Cornell University - Samuel Curtis Johnson Graduate School of Management

John A. Elliott

University of Connecticut - Department of Accounting

Robin L. Tarpley

George Washington University - Department of Accountancy

Date Written: December 20, 2001

Abstract

We report survey evidence about 515 experiences that auditors have had with clients who they identified as attempting to manage earnings. This approach enables us to analyze separately managers' decisions about how to attempt earnings management ("EM") and auditors' decisions about whether or not to waive adjustment of managers' earnings-management attempts ("EMAs"). We provide evidence that the likelihood that managers make EMAs (and auditors waive adjustment of EMAs) that involve transaction structuring varies with the precision of the related accounting standards. Managers tend to make EMAs that increase current-year income, but auditors are less likely to waive EMAs that increase current-year income. Managers are more likely to make EMAs that decrease current-year income with unstructured transactions and/or when standards are imprecise (presumably because the resulting "cookie jar reserves" are easier to harvest in future years if structuring is not necessary or the relevant standards are flexible). Auditors are more likely to waive EMAs that they identify as immaterial or that are attempted by large clients. These variables combine to affect the areas in which EMAs are attempted and waived to become EM in the audited financial statements.

Note: A prior version of this paper was titled "Where Do Companies Attempt Earnings Management, and When Do Auditors Prevent It?"

JEL Classification: M41, M44, M49, G14

Suggested Citation

Nelson, Mark W. and Elliott, John A. and Tarpley, Robin L., Evidence from Auditors About Managers' and Auditors' Earnings-Management Decisions (December 20, 2001). Available at SSRN: https://ssrn.com/abstract=294688 or http://dx.doi.org/10.2139/ssrn.294688

Mark W. Nelson (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

448 Sage Hall
Ithaca, NY 14853
United States
607-255-6323 (Phone)
607-254-4590 (Fax)

John A. Elliott

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States
860-486-5524 (Phone)

Robin L. Tarpley

George Washington University - Department of Accountancy ( email )

School of Business and Public Management
Washington, DC 20052
United States

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