The Effects of Rule-Based Versus Principle-Based Accounting Estimates on Auditors’ Going Concern Assessments
58 Pages Posted: 7 Jul 2019
Date Written: July 3, 2019
This study investigates whether auditors use information in accounting estimates when making going concern assessments and whether the usefulness of information in accounting estimates to auditors depends on whether the estimate is prepared following a rule-based standard or a principle-based standard. We use goodwill impairments and increases in the valuation allowance on deferred tax assets, both of which could be indicative of poor financial condition, to operationalize rule-based and principle-based accounting estimates, respectively. Using a sample of U.S. public companies for the period 2005 – 2015, we find that both rule-based and principle-based estimates inform auditor going concern assessments and assessments of the likelihood of failure. Auditors, however, appear to rely more on rule-based estimates when assessing going concern, consistent with auditors placing greater weight on information that is more familiar to audit. The results of a path analysis show that a going concern opinion subsumes more of the information in rule-based estimates when predicting the likelihood of company failure, further supporting this inference. Our research should be of interest to standard setters, auditors, investors, and academics, who continue to evaluate the role of estimates in financial reporting and the usefulness of estimates for decision-making in various contexts.
Keywords: accounting estimates, auditors, rule-based standards, principle-based standards, going concern opinions, company failure
JEL Classification: M40, M41, M42, H25
Suggested Citation: Suggested Citation