Management Bias in Multiple Accounting Estimates to Meet or Beat Analyst Expectations and the Effect of PCAOB Auditing Standard No. 14

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Abstract

PCAOB Auditing Standard No. 14 (AS14, PCAOB 2010a) instructs auditors to evaluate whether management accounting estimates exhibit bias and whether that bias, aggregated across multiple accounting estimates, allows management to attain a preferred result. We examine whether bias aggregated from multiple client estimates (i.e., reserve and/or allowance accounts) is associated with the likelihood of meeting or just beating analyst expectations. We then examine whether AS 14, which focuses auditor’s attention on this issue, affects this association. Using a sample of manufacturing firms that disclose multiple accounting estimates, we find a positive and significant association between aggregated income-increasing bias across multiple estimates and the likelihood of meeting or just beating analyst earnings forecasts. This association is only manifest when firms meet or just beat the analyst earnings forecast by one cent and not when firms miss the analyst consensus or when they beat the analyst consensus by more than one cent. Additionally, we find that the likelihood of using aggregated income-increasing bias across multiple estimates to meet or beat the analyst earnings consensus has declined since the issuance of AS 14.

Authors

• Timothy Andrew Seidel, Utah State University

• Chad Allan Simon, Utah State University

• Nathaniel Martin Stephens, Utah State University