What Happens When Managers Are Informed? Effects of Critical Audit Matter Awareness and Auditor Relationship on Managers’ Accounting Estimates
43 Pages Posted: 8 Jul 2021 Last revised: 6 Aug 2021
Date Written: June 30, 2021
We examine how managers’ accounting estimates are affected by whether they are informed about an impending critical audit matter (CAM) disclosure from a close or distant auditor. A close (distant) auditor is one who has a smaller (greater) social distance from the client in terms of their working relationship. We predict and find that being informed about an impending CAM by a close (distant) auditor leads to more (less) aggressive estimates than if managers are not informed. With a close auditor-client relationship, managers perceive a CAM disclosure as forewarning investors about estimate subjectivity, thus providing a moral license to report more aggressively. With a distant relationship, a CAM disclosure does not provide a moral license but signals greater auditor scrutiny, which leads to less aggressive reporting. Our results inform regulators and standard setters about the effects of CAM on managers’ reporting decisions in the presence of a close auditor-client relationship.
Keywords: impending critical audit matters, auditor-client working relationship, moral licensing, aggressive reporting
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