Evidence from Auditors About Managers’ and Auditors’ Earnings Management Decisions

13772 WordsDec 7, 201156 Pages
THE ACCOUNTING REVIEW Vol. 77 Supplement 2002 pp. 175–202 Evidence from Auditors about Managers’ and Auditors’ Earnings Management Decisions Mark W. Nelson John A. Elliott Cornell University Robin L. Tarpley The George Washington University ABSTRACT: This paper reports analyses of data obtained using a field-based questionnaire in which 253 auditors from one Big 5 firm recalled and described 515 specific experiences they had with clients who they believe were attempting to manage earnings. This approach enables us to analyze separately managers’ decisions about how to attempt earnings management and auditors’ decisions about whether to prevent earnings management by requiring adjustment of the financial statements. Our results…show more content…
Auditors are required by GAAS to understand their clients’ incentives and to search for differences between actual and expected performance that may indicate misstatements, so the auditors who participated in our study were relatively well positioned to identify specific instances of earnings management. Because respondents provided transaction-level data about attempts covering a range of financial accounting transactions, including attempts that are purely judgmental as well as attempts that involve transaction structuring, these data allow us to examine how attempts are affected by the precision of financial accounting standards2 and by other characteristics of attempts. Unlike studies that focus on only postaudit information, we consider separately managers’ decisions about how to attempt earnings management and auditors’ decisions about whether to require adjustments.3 Thus, our study provides evidence about how a key feature of accounting standards (precision of rules) and a key feature of the financial reporting process (activity of external auditors) influence earnings management. Results of descriptive analyses indicate that the earnings management attempts in our sample occurred in numerous accounting areas, including revenue recognition, business combinations, intangibles, fixed assets, investments and leases, but by far the most frequently identified attempts involve reserves. Respondents believe that managers’ attempts were motivated

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