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.