Published Paper: The Costs of Waiving Audit Adjustments
Paper Authors: Preeti Choudhary, Kenneth Merkley and Katherine Schipper
Publication: Journal of Accounting Research
Abstract: We analyze the disposition of auditor-proposed adjustments to financial statements. Our analyses address concerns, expressed by regulators and others, that auditors and their clients fixate on quantitative thresholds and overlook qualitative factors in assessing the materiality of discovered misstatements. Using a large sample of Public Company Accounting Oversight Board (PCAOB)-inspected audits, we examine the frequency with which management records versus waives auditor-proposed adjustments and whether waiving-proposed adjustments ha consequences for reporting reliability and the audit process. We find waived adjustments are linked to lower financial reporting quality measured by material misstatements, to incentives to meet/beat earnings targets, and to the audit process, as measured by higher next-period audit effort and fees and higher next-period proposed adjustments. These effects on the audit process are consistent with auditors responding to the increased risk associated with waived adjustments. In an exploratory analysis, we find that controlling for the amount of proposed adjustments, auditor resignations are negatively associated with waived adjustments.
The economic research fellows and staff economists generate high-quality working papers that inform the oversight activities of the PCAOB and are disseminated to stimulate discussion and critical comment to the benefit of the public. Working papers are preliminary materials that have not been approved by the Board and reflect only the views of the author(s).
The research topics of economic research fellows, including a description of any nonpublic data sets required for research, are presented to the Board for approval and research papers are reviewed to confirm that the topic of the paper is consistent with the researcher's proposal. That review does not, however, encompass an evaluation of the conclusions reached by researchers.