Accounting Changes and Misstatement Risk
65 Pages Posted: 29 Jan 2021 Last revised: 17 Mar 2022
Date Written: March 15, 2022
We examine how various types of accounting changes affect financial misstatement risk and the ways auditors mitigate that risk. We find greater misstatement risk for both idiosyncratic and industry-wide accounting changes and that auditors play an important role in mitigating some of these risks in some situations but not others. Higher quality auditors appear to mitigate the misstatement risk from industry-wide changes, but not idiosyncratic ones. Misstatement risk is also mitigated when auditors communicate accounting changes through explanatory paragraphs and preferability letters and when they identify material weaknesses. We also find evidence that revenue- and non-revenue-related accounting changes are associated with revenue-related and non-revenue-related misstatements, respectively. Our evidence suggests that accounting changes are associated with a heightened risk of misstating the financial statements and auditors do not fully mitigate these risks in their audits.
Keywords: accounting changes, accounting consistency, misstatements, auditors
JEL Classification: M41
Suggested Citation: Suggested Citation