Does Punitive Action Improve the Reasonableness of Accounting Estimates?

• In Event: Auditing Accounting Estimates

Abstract

There is concern from regulators and financial statement users that accounting estimates are biased and that companies take advantage of the subjective nature of estimates to manage earnings. This concern has led to increased regulatory scrutiny of accounting estimates. In this study we examine whether punitive actions taken against a company or an auditor are associated with increased reasonableness, i.e., reduced bias, of accounting estimates. Using a sample of auditors and their bank clients we find that punitive action taken directly against a bank is not associated with improvement in the association between the current period allowance for loan loss estimate and future credit losses; however, punitive action taken against an auditor is associated with an improvement in this association. These results help to disentangle the influence of the auditor from client behavior and provide evidence that the auditor, rather than the client, drives improvements in estimate reasonableness following punitive actions.

Authors

• Sarah Stuber, Michigan State University

• Chris E Hogan, Michigan State University