Misstatements in Financial Statements: The Relationship between Inherent and Control Risk Factors and Audit Adjustments

Abstract

SUMMARY:This paper analyzes whether audit adjustments vary systematically with inherent and control risk factors. The analysis is based on proprietary data from a large recent sample of audit adjustments detected in the financial statement audits conducted by a Big 4 audit firm in Germany. We extend the scope of prior studies by incorporating client-specific planning materiality in our design, enabling us to analyze the relative magnitude of adjustments. Our findings show that audit adjustments vary systematically, as proposed by the audit risk model. Specifically, the integrity and competence of the client's management, economic position, entity-level control strength, and internal control system are associated with the number and relative magnitude of audit adjustments. The results also suggest that inherent and control risk factors are particularly strongly associated with income-affecting adjustments.JEL Classifications: M40, M41, M42.