The Costs of Waiving Audit Adjustments
70 Pages Posted: 7 Feb 2018 Last revised: 22 Jul 2020
Date Written: July 21, 2020
We analyze the disposition of auditor-proposed adjustments to financial statements. Our analysis addresses concerns, expressed by regulators and others, that auditors and their clients fixate on quantitative thresholds and overlook qualitative factors in assessing the materiality of discovered misstatements. Using a large sample of PCAOB-inspected audits, we examine the frequency with which management records vs. waives auditor-proposed adjustments and whether waiving proposed adjustments detracts from financial reporting reliability. We find that waived adjustments are linked both to lower financial reporting quality measured by material misstatements and to incentives to meet/beat analyst forecasts; the latter finding suggests disposition decisions can be an earnings-management mechanism. We also find that current-period and next-period audit effort and fees are higher when management waives proposed adjustments. Our evidence points to both costly consequences and possible earnings management benefits of waiving seemingly immaterial audit adjustments.
Keywords: Financial reporting reliability, audit adjustments, restatements, waive versus record, earnings management
JEL Classification: M40, M41, M42, M43, M49
Suggested Citation: Suggested Citation