The Last Chance to Improve Financial Reporting Reliability: Evidence from Recorded and Waived Audit Adjustments

58 Pages Posted: 7 Feb 2018 Last revised: 8 Nov 2018

See all articles by Preeti Choudhary

Preeti Choudhary

University of Arizona, Eller College of Management

Kenneth J. Merkley

Indiana University - Kelley School of Business - Department of Accounting

Katherine Schipper

Duke University - Fuqua School of Business

Date Written: November 7, 2018

Abstract

We provide evidence on auditors’ proposed audit adjustments and management’s disposition of those adjustments using a large sample of audits of SEC registrants by eight large accounting firms and inspected by the PCAOB between 2005-2014. We find that proposed audit adjustments are pervasive, 81% of sample audit engagements receive at least one proposed adjustment, and that managers appear to frequently disagree with auditors about the disposition of these adjustments, at least one adjustment is waived in 72% of sample engagements. We find that firms with earnings management incentives and those with poor quality financial reporting systems are more likely to benefit from financial statement audits because these factors are associated with more proposed and recorded audit adjustments relative to waived adjustments. Finally, we provide evidence consistent with the disposition of audit adjustments having consequences for financial reporting reliability. We find that the decision to waive audit adjustments is associated with a higher likelihood that financial statements are subsequently restated, while recorded audit adjustments either have no effect or improve financial statement reliability.

Keywords: Financial reporting reliability, audit adjustments, restatements, waive versus record, earnings management

JEL Classification: M40, M41, M42

Suggested Citation

Choudhary, Preeti and Merkley, Kenneth J. and Schipper, Katherine, The Last Chance to Improve Financial Reporting Reliability: Evidence from Recorded and Waived Audit Adjustments (November 7, 2018). Available at SSRN: https://ssrn.com/abstract=3112957 or http://dx.doi.org/10.2139/ssrn.3112957

Preeti Choudhary (Contact Author)

University of Arizona, Eller College of Management ( email )

Department of History
Tucson, AZ 85721
United States

Kenneth J. Merkley

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

Katherine Schipper

Duke University - Fuqua School of Business

Box 90120
Durham, NC 27708-0120
United States

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