The Costs of Waiving Audit Adjustments

70 Pages Posted: 7 Feb 2018 Last revised: 22 Jul 2020

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: July 21, 2020

Abstract

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

Choudhary, Preeti and Merkley, Kenneth J. and Schipper, Katherine, The Costs of Waiving Audit Adjustments (July 21, 2020). 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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