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

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.