An Examination of Factors Affecting the Decision to Waive Audit Adjustments

Abstract

The value of audit services is determined by an auditor's ability to both (1) discover misstatements in the client's accounting system and (2) report those misstatements (DeAngelo [1981a, 1981b]). Audit adjustments reflect the auditor's discovery of a potential breach in the client's accounting system. The decision to waive an audit adjustment is important, since it can potentially lead to misleading financial statements. Waiving an adjustments) may also result in litigation and loss of auditor reputation. Despite its importance, we have very little empirical evidence on the decision to waive an adjustment. The purpose of this study is to initiate an understanding of the importance placed by auditors on a number of factors noted in the literature in determining whether a proposed audit adjustment is waived. The study reported here utilizes archival data gathered from actual audit engagements to examine variables that may explain the decision to waive an audit adjustment. The findings reveal that in addition to materiality, a number of factors appear to be considered, including directional impact on income, the nature of the adjustment (objective versus subjective), and size of the client. Finally, a number of adjustments exceeding materiality were waived, highlighting the need for future research to more fully understand factors affecting this important decision and to ensure that business decisions (e.g., client pressures) do not overly influence the auditor.