Improving Auditors' Consideration of Evidence Contradicting Management's Estimate Assumptions

Abstract

Auditors have difficulty evaluating the assumptions underlying management's estimates. One source of these problems is that auditors appear to dismiss evidence contradicting management's assumptions because their initial preference to support management's accounting biases their preliminary conclusions and, thus, their interpretation of evidence. We experimentally examine whether auditors with a balanced focus (i.e., a focus on documenting evidence that supports and contradicts their preliminary conclusion) are less likely to dismiss evidence that contradicts management's assumptions than auditors with a supporting focus (i.e., a focus on documenting evidence that supports their preliminary conclusion). We expect and find that, compared with auditors with a supporting focus, auditors with a balanced focus create documentation that is less dismissive of evidence contradicting management's estimate. Importantly, a balanced focus changes auditors' cognition and affects how auditors interpret contradicting evidence rather than merely increasing their documentation of this evidence. The effects of reduced dismissiveness persist to improve auditors' evaluations of a biased estimate and subsequent actions, improving audit quality in an important and difficult area.

Using Audit Programs to Improve Auditor Evidence Collection

“…Auditors also have incentives to be efficient and avoid conflicts with client management; this can make them hesitant to follow-up on evidence contradicting management's assertions (Coram, Ng, and Woodliff 2004;Bennett and Hatfield 2012;Brazel, Jackson, Schaefer and Stewart 2016). Indeed, auditors sometimes engage in motivated reasoning, where they underweight information contradicting management's assertions (Hackenbrack and Nelson 1996;Kadous, Kennedy, and Peecher 2003;Austin, Hammersley, and Ricci 2020). Alternatively, auditors may underweight contradicting evidence if they do not recognize the importance of it.…”

“…Auditors evaluated the reasonableness of the client's revenue projections, a key input to a fair value estimate used in the client's goodwill impairment test. We heavily adapted our task from prior research (e.g., Griffith et al 2015b;Austin et al 2020;Kadous and Zhou 2019). As illustrated in Figure 1, the case began with background information about an electronicsmanufacturer client and the client's step one goodwill impairment test.…”

“…We used this procedure to elicit issues that auditors wanted to discuss with their manager because prior research has shown that auditors overwhelmingly want to talk with their manager before reaching a final conclusion (i.e., auditors overwhelmingly choose the second or third option; c.f. Griffith et al 2015b;Austin et al 2020).…”

“…Thus, we examine auditors' judgments of the reasonableness of the revenue projections and the fair value. These judgments are clean measures of auditors' level of comfort with the estimates but, unlike target issues, do not capture auditors' critical thinking (e.g., what auditors are concerned about and what they would do) (Austin et al 2020). Table 3 provides descriptive statistics for auditors' judgments (Panel A), ANOVAs for each of the two judgments (Panels B and C, respectively), and planned contrasts for each of the two judgments (Panels D and E, respectively).…”

“…Thus, the judgments and decisions they made after evidence collection were based on their memory of the evidence they chose to examine. This is one of many differences between our instrument and those used in prior studies (e.g.,Griffith et al 2015b;Austin et al 2020;Kadous and Zhou 2019).Downloaded from http://meridian.allenpress.com/doi/pdf/10.2308/tar-2018-0120 by guest on 03 October 2020…”