The Costs of Waiving Audit Adjustments

62 Pages Posted: 7 Feb 2018 Last revised: 26 May 2022

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: May 26, 2022

Abstract

We analyze the disposition of auditor-proposed adjustments to financial statements. Our analyses address 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 has consequences for reporting reliability and the audit process. We find waived adjustments are linked to lower financial reporting quality measured by material misstatements, to incentives to meet/beat earnings targets and to the audit process, as measured by higher next-period audit effort and fees and higher next-period proposed adjustments. These effects on the audit process are consistent with auditors responding to the increased risk associated with waived adjustments. In an exploratory analysis we find that controlling for the amount of proposed adjustments, auditor resignations are negatively associated with waived adjustments.

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

JEL Classification: M40, M41, M42, M43, M49

Suggested Citation

Choudhary, Preeti and Merkley, Kenneth J. and Schipper, Katherine, The Costs of Waiving Audit Adjustments (May 26, 2022). 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 )

School of Accountancy
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 ( email )

Box 90120
Durham, NC 27708-0120
United States

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