his study investigated practicing auditors’ perceptions of the likelihood of facing sanctions as a result of an aggressive auditor reporting decision. Participants were given an audit case in which an auditor succumbed to client pressure to issue an unqualified opinion on a set of financial statements, even after having had serious reservations about the adequacy of the allowance for doubtful accounts. Most survey respondents were employed by small CPA firms, and the audit case dealt with a small, nonpublic audit client.
Respondents estimated the likelihood of three potential sanctions against the auditor: (1) adverse litigation, (2) disciplinary actions by professional bodies and (3) poor peer review results. They also rated the articles of the auditor’s action and judged the likelihood that the “average auditor” would commit a similar infraction.
To examine how the severity or magnitude of the situation affected the auditors’ decisions, participants received one of two versions of the case. In the “low magnitude” version, the potential misstatement was relatively small (8% of income), and the audited financial statements were being distributed to two banks with which the client had established relationships. In the “high magnitude” version, the potential misstatement was 40% of income, and the financial statements were used to establish the final price of the audited company in a pending sale.
The results showed that litigation and peer review risk were considered significant deterrents, but the risk of professional disciplinary action was not. In addition, the situation’s magnitude had a significant effect on respondents’ judgments of the ethical acceptability of aggressive reporting, as well as the estimated likelihood of sanctions occurring. However, the results raised concerns regarding auditors’ willingness to acquiesce in aggressive financial reporting decisions. For example, participants estimated a 51% chance that the average auditor would issue an unqualified opinion on a set of financial statements that contained an apparent misstatement equal to 40% of net earnings. These findings reinforced the SEC’s recent concerns about auditors’ willingness to allow aggressive financial reporting and suggested the need for enhanced scrutiny by auditors and the implementation of more effective corporate governance mechanisms.
For the full text of the research paper, see Auditing: A Journal of Practice & Theory, vol. 18, Supplement, 1999.
William E. Shafer, CPA, PhD, is professor of accounting at California State University, Los Angeles, California. Roselyn E. Morris, CPA, PhD, is associate professor of accounting at Southwest Texas State University, San Marcos, Texas. Her e-mail address is firstname.lastname@example.org . Alice A. Ketchand, CPA, PhD, is associate professor of accounting at Sam Houston State University, Huntsville, Texas.