Impact of company level information on auditor conservatism

Abstract

Purpose

Auditors tend to focus more on income-increasing items compared to income-decreasing items because they are trained to be conservative and also because the risk of litigation is significantly higher for failing to detect material income-increasing items compared to material income-decreasing items. Auditors’ consideration of transaction-level items is also affected by their evaluation of company-level information. Therefore, this study aims to examine how the interaction between company-level information and sign of the material items affects auditors’ evaluation of income-increasing and income-decreasing items.

Design/methodology/approach

A three-treatment between-subjects experiment was conducted to investigate the research questions.

Findings

The results indicate that in the absence of company-level information, auditors intuitively associate a higher risk and audit effort to income-increasing items. When the company-level information indicates that management is under pressure to inflate earnings, auditors’ conservatism associated with income-increasing items gets amplified. This leads to an increase in the difference in assessed risk and audit effort between income-increasing and income-decreasing items. However, when the company-level information indicates that management is not under pressure to inflate earnings, there are no significant differences in assessed risk and audit effort between income-increasing and income-decreasing items. These results indicate that auditor conservatism is affected by company-level information.

Originality/value

The findings indicate how an analysis of company-level information (as prescribed by auditing standards) and inherent auditor conservatism could potentially affect audit procedures and have important implications for the audit profession.

Citation

Desai, N. (2016), "Impact of company level information on auditor conservatism", Review of Accounting and Finance, Vol. 15 No. 4, pp. 518-532. https://doi.org/10.1108/RAF-10-2015-0141