Auditors consideration of material income-increasing versus material income-decreasing items during the audit process.

Abstract

We examine how auditors' consideration of material items is affected by each item's directional impact on income. Prior research indicates that auditors face greater litigation risk for non-detection of fraudulent income-increasing items compared to income-decreasing items. Therefore, we expect that auditors will spend greater cognitive effort evaluating material income-increasing (as opposed to income-decreasing) items, resulting in superior memories for such items. However, in an effort to direct auditors' attention to both increasing and decreasing material items, we manipulate whether or not auditors were asked to form expectations about the future effects of material items. Our results indicate that auditors' memories for income-increasing items are significantly greater than that for income-decreasing items when auditors are not asked to form expectations about the future effects of the items. However, this difference is not observed when auditors are asked to form expectations about future effects of each item. Furthermore, our results indicate that auditors are less likely to refer back to the work papers to verify the accuracy of income-decreasing items compared to income-increasing items. This suggests that auditors are not inclined to compensate for their poor memory of income-decreasing items by referring to working papers. However, it also suggests that auditors compensate for the greater risk associated with income-increasing items by requiring greater verification of such items.