The Resolution of Audit-Detected Misstatements

Abstract

The value of an audit lies in its ability to detect and correct misstatements in financial statements. Our study investigates the resolution of detected misstatements. Using data on a large recent sample of audit adjustments by a German Big 4 audit firm, we test a broad array of variables related to auditor incentives and client incentives and opportunities, both of which are likely to determine an auditor’s decision to waive audit adjustments. In contrast to prior studies, we analyze adjustments at the engagement level. This design reflects that an auditor judges all adjustments interdependently and allows us to examine not only the offsetting effects of different adjustments on client income but also the effect of the number and total amount of detected adjustments. Our findings suggest that the offsetting effects of the detected adjustments on client income play a key role in auditors’ decisions. Furthermore, the decision is influenced by control risk and clients’ incentives and opportunities.