Auditors’ Evaluation of Subsequent Events: The Effects of Prior Commitment, Risk Factors, and Type of Accountability

Abstract

Recent international inspection reports indicate that there are deficiencies in the audits of subsequent events. What is less well understood is why these deficiencies occur. As the evaluation of subsequent events generally occurs toward the end of the audit process, this thesis examines whether auditors will commit to an initial view formed during the audit, and are therefore more likely to propose smaller audit adjustments to management in response to subsequent events. This thesis contains two studies. Study 1 examines the effects of prior commitment and risk of material misstatement on auditors’ evaluation of subsequent events. The findings from an experiment involving 87 auditors indicate that auditors propose a significantly smaller audit adjustment on a subsequent event when the event becomes known to them, after they have provided an initial view to management on the fair presentation of the financial statements. However, auditors are expected to be more skeptical when risk factors are present, so that they are more likely to adjust for subsequent events when the risk of material misstatement is high. Study 1 finds that when risk of material misstatement is high, auditors are less influenced by prior commitment. Therefore, they will propose to management a significantly larger amount of audit adjustment. Study 2 builds upon Study 1 by examining how accountability can mitigate auditors’ escalation behavior in evaluating subsequent events. The study specifically examines the effectiveness of two types of accountability—process versus outcome accountability—on auditors’ judgment decision-making. The results from an experiment involving 66 auditors demonstrate that auditors are more skeptical, by proposing a larger audit adjustment on a subsequent event when they are expected to justify their judgment process, than those who are expected to justify their judgment outcome. Study 2 provides evidence that auditors’ tendency to show escalation behavior is mitigated more by process accountability than by outcome accountability. That is, auditors’ proposed adjustments on subsequent events are less influenced by prior commitment to an initial view when the auditors are expected to justify their judgment process, rather than their judgment outcome. This study suggests a benefit of employing process accountability documentation in the audits of subsequent events.