The Resolution of Audit-Detected Misstatements

Abstract

The value of an audit lies in its ability to detect and correct misstatements in financial statements. This study investigates the resolution of detected misstatements. Using data on a large sample of audit adjustments by a German Big 4 audit firm, this paper reports an analysis of the factors that influence the resolution of detected misstatements. In contrast to prior studies, we analyze the resolution of misstatements at the engagement level and the level of the individual adjustment. This design makes a methodological contribution by expanding the level of analysis of auditors’ book-or-waive decisions to include the engagement level. It further allows examining offsetting effects of different adjustments on client income, as well as the number and the total amount of detected adjustments. We find that the auditor’s book-or-waive decision is influenced by client characteristics and characteristics of the audit adjustments that can be linked to client as well as auditor incentives to oppose (require) the recording of adjustments. Offsetting effects of the detected adjustments on client income play a key role in auditors’ decisions. The findings suggest that standard-setters and audit practice should give more attention to the offsetting effects of audit adjustments on income. Our analyses at the two different levels could help practitioners to better structure their book-or-waive decisions.

Keywords: Audit adjustments, Audit differences, Audit risk model, International Standards on Auditing, Materiality, Waived adjustments

JEL Classification: M40, M41, M42