Managing audits to manage earnings: The impact of diversions on an auditor’s detection of earnings management

The Unintended Consequences of Material Weakness Reporting on Auditors' Acceptance of Aggressive Client Reporting

“…In our setting, this would suggest that when auditors first encounter an issue in ICFR (versus not), they will be more likely to identify a financial reporting issue as aggressive. However, a key difference between our setting and that of Luippold et al (2015) could lead to different auditor behavior, consistent with licensing. In Luippold et al (2015), participants identify a potential error in the financial statements, but do not disclose that potential error to the public.…”

“…However, a key difference between our setting and that of Luippold et al (2015) could lead to different auditor behavior, consistent with licensing. In Luippold et al (2015), participants identify a potential error in the financial statements, but do not disclose that potential error to the public. Signaling to potential observers a good deed (e.g., through disclosure) is an important step in licensing theory for individuals to feel a release that licenses them to later act inappropriately (Miller and Effron 2010).…”

“…Signaling to potential observers a good deed (e.g., through disclosure) is an important step in licensing theory for individuals to feel a release that licenses them to later act inappropriately (Miller and Effron 2010). Thus, licensing effects are more likely to be observed in our setting than that of Luippold et al (2015) because auditors who decide to report a material weakness (versus not) can more sufficiently signal a good deed and/or warn financial statement users of the potential for misstatement.…”

“…6 Importantly, psychological licensing theory suggests that licensing can occur regardless of whether two decisions are seen as related or unrelated, provided that the subsequent decision is conceived as part of a sequence of decisions that define one's morals/duty (Klotz and Bolino 2013;Mullen and Monin 2016). 7 A recent study by Luippold, Kida, Piercey, and Smith (2015) suggests auditors may not be affected by licensing when making decisions in unrelated areas. When auditors in their study are diverted by management to an audit area with (versus without) errors, they are more likely to identify an unusual fluctuation in another audit area as earnings management.…”

External Auditors' Judgment and Decision Making: An Audit Process Task Analysis

“…Luippold, Kida, Piercey, and Smith () study management's use of strategic diversion on auditors' abilities to uncover managed earnings. They seed an intentional error to allow management to meet their earnings target and then manipulate whether management diverts the auditors' attention to other accounts with an error or to clean/non‐error accounts.…”