Does Reporting Risks of Material Misstatement in the Audit Report Impact Audit Adjustments? Experimental Evidence from U.K. Audit Partners and Senior Managers

48 Pages Posted: 22 Aug 2019 Last revised: 18 Sep 2020

See all articles by Lauren C. Reid

Lauren C. Reid

Wake Forest University - Schools of Business

Mark W. Nelson

Cornell University - Samuel Curtis Johnson Graduate School of Management

Joseph V. Carcello

University of Tennessee

Date Written: September 17, 2020

Abstract

This experimental study examines whether requiring auditors to report risks of material misstatement (and related auditor findings) affects audit adjustments. Experienced audit partners and senior managers in the United Kingdom proposed audit adjustments under three different reporting regimes: (a) an audit report where no risks are disclosed, (b) a report where risks of material misstatement are disclosed, and (c) a report where risks of misstatement are disclosed, augmented with the auditor’s findings with respect to those risks. Our results indicate that disclosing risks of material misstatement without findings has no effect on audit adjustments, but that lower audit adjustments occur when the disclosure also includes findings, and that this result is driven by auditors requiring particularly low adjustments when they indicate a finding that the post-audit account balance is “mildly optimistic” (as opposed to “reasonable”). Results also suggest that this tendency is unintentional. Overall, these findings indicate that auditors unintentionally trade off audit adjustments for disclosures, consistent with increased detailed disclosure providing an opportunity for “moral licensing” that enables auditors to satisfy client demands while also complying with professional standards. From a practice perspective, these results suggest that disclosure of critical or key audit matters as recently required by U.S. and international standard setters may not affect auditor behavior, but that allowing disclosure of additional findings as done voluntarily in some jurisdictions may have the unintended consequence of reducing the size of audit adjustments that auditors require.

Keywords: audit report, risks of material misstatement, audit adjustments, critical audit matters

JEL Classification: M42

Suggested Citation

Reid, Lauren C. and Nelson, Mark W. and Carcello, Joseph V., Does Reporting Risks of Material Misstatement in the Audit Report Impact Audit Adjustments? Experimental Evidence from U.K. Audit Partners and Senior Managers (September 17, 2020). Available at SSRN: https://ssrn.com/abstract=3439508 or http://dx.doi.org/10.2139/ssrn.3439508

Lauren C. Reid (Contact Author)

Wake Forest University - Schools of Business ( email )

P.O. Box 7659
Winston-Salem, NC 27109-7285
United States

Mark W. Nelson

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

448 Sage Hall
Ithaca, NY 14853
United States
607-255-6323 (Phone)
607-254-4590 (Fax)

Joseph V. Carcello

University of Tennessee ( email )

Department of Accounting & Information Management
629 Stokely Management Center
Knoxville, TN 37996-0560
United States
865-974-1757 (Phone)
865-974-4631 (Fax)

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