Do Auditors’ Incentives Affect Materiality Assessments of Prior-Period Misstatements?

Posted: 8 Aug 2019 Last revised: 7 Jan 2022

See all articles by Brant E. Christensen

Brant E. Christensen

University of Oklahoma; Norwegian School of Economics (NHH) - Department of Accounting, Auditing and Law

Roy Schmardebeck

The University of Tennessee, Knoxville - Haslam College of Business, Accounting and Information Management

Timothy A. Seidel

Brigham Young University

Date Written: January 4, 2022

Abstract

We examine whether auditors' incentives affect materiality assessments of prior-period misstatements. Interviews with global network firm partners reveal consistency across firms in the process used to assess prior-period misstatements and highlight points in the process where judgments are most susceptible to auditors’ conscious or subconscious biases. In related empirical tests, we find that auditors assess misstatements as less material (i.e., misstatements are disclosed less prominently) when auditors face greater engagement risk (comprised of the risk of litigation and reputation loss) or have greater incentives to please important clients. These effects only occur when auditor incentives to avoid further litigation or client losses within an audit office are most salient and when the quantitative magnitude of the misstatement is in a range subject to greater professional judgment. Thus, we identify boundary conditions on the extent to which auditor incentives affect materiality judgments. Finally, additional tests suggest that neither local engagement partners nor professional practice partners are immune from these incentives. Our study should be informative to audit firms when designing and updating quality control structures.

Keywords: Materiality; Incentives; Litigation and reputation risk; Engagement risk; Misstatement correction disclosure; Escalation of commitment

Suggested Citation

Christensen, Brant E. and Schmardebeck, Roy and Seidel, Timothy A., Do Auditors’ Incentives Affect Materiality Assessments of Prior-Period Misstatements? (January 4, 2022). Accounting, Organizations and Society, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3432547 or http://dx.doi.org/10.2139/ssrn.3432547

Brant E. Christensen

University of Oklahoma ( email )

Norman, OK 73019-4004
United States

Norwegian School of Economics (NHH) - Department of Accounting, Auditing and Law ( email )

Helleveien 30
N-5045 Bergen
Norway

Roy Schmardebeck

The University of Tennessee, Knoxville - Haslam College of Business, Accounting and Information Management ( email )

The Boyd Center for Business and Economic Research
Knoxville, TN 37996
United States

Timothy A. Seidel (Contact Author)

Brigham Young University ( email )

Provo, UT 84602
United States

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