The resolution of audit-detected misstatements

Abstract

Purpose

The value of an audit lies in its ability to detect and correct misstatements in financial statements. The purpose of this paper is to investigate the resolution of detected misstatements.

Design/methodology/approach

Using data on a large sample of audit adjustments by a German Big 4 audit firm, this paper reports an analysis of the factors that influence the resolution of detected misstatements at the engagement level and at the level of the individual adjustment.

Findings

The auditor’s book-or-waive decision is influenced by client characteristics and characteristics of the audit adjustments that can be linked to client as well as auditor incentives to oppose (require) the recording of adjustments. Offsetting effects of the detected adjustments on client income play a key role in auditors’ decisions.

Research limitations/implications

The results may not be generalizable to Non-Big 4 audit firms. The sample includes unlisted firms which are subject to mandatory audits in the European Union. Other potential factors may not have been captured in the study.

Practical implications

The findings suggest that standard-setters and audit practice should give more attention to the offsetting effects of audit adjustments on income. The analyses at the two different levels could help practitioners to better structure their book-or-waive decisions.

Originality/value

In contrast to prior studies, the authors analyze the resolution of misstatements at the engagement level and the level of the individual adjustment. This design makes a methodological contribution by expanding the level of analysis of auditors’ book-or-waive decisions to include the engagement level. It further allows examining offsetting effects of different adjustments on client income, as well as the number and the total amount of detected adjustments.

Citation

Ruhnke, K. and Schmidt, M. (2019), "The resolution of audit-detected misstatements", Journal of Applied Accounting Research, Vol. 20 No. 1, pp. 41-62. https://doi.org/10.1108/JAAR-08-2017-0079