Aggressive Client Reporting: Factors Affecting Auditors' Generation of Financial Reporting Alternatives

Abstract

This paper examines how features of the task environment interact with task knowledge to affect auditors' generation of financial reporting alternatives. We study this issue in a setting in which an audit client proposes an aggressive financial reporting alternative for a complex revenue recognition issue. Companies' aggressiveness in financial reporting is an important contemporary topic (e.g., Levitt 1999; Levitt 2000). For auditors, aggressive financial reporting increases litigation exposure (e.g., Palmrose and Scholz 2001) and attracts regulatory attention (e.g., Public Oversight Board 2000; SEC 1999). By proposing less aggressive financial reporting alternatives, auditors increase the likelihood that clients will report less aggressively, thereby reducing auditors' risks of litigation and regulatory exposure. We study the effects of two common features of auditors' task environment (the level of engagement risk and the availability of previously generated alternatives) on financial reporting alternative generation, investigating whether these effects are contingent on auditors' task knowledge. Our results support interactive effects for both task environment features. Higher engagement risk enhances generation of alternatives only among higher knowledge auditors, while the presence of an inherited alternative inhibits generation of alternatives only among lower knowledge auditors.

Keywords: Auditing; Alternative generation; Task knowledge; Engagement risk; Inherited alternatives; Revenue recognition

JEL Classification: M49, M41, M43