Auditor Responses to Estimation Uncertainty in Financial Statements

• In Event: Audit Quality and Pricing

Abstract

Estimation uncertainty surrounding accounting estimates poses unique challenges for auditors. Moreover, auditors face heightened expectations from investors and regulators to improve the quality of accounting estimates and communicate their risks. Given these challenges and expectations, we examine auditor responses to estimation uncertainty. We find that auditors who face increased estimation uncertainty communicate this increased risk through topic-specific explanatory audit-opinion language. This association is more pronounced when investor information needs are higher and less pronounced when litigation risk is higher. In recent years, auditors convey these estimation risks through critical audit matter (CAM) disclosures. Addressing their own risks, auditors charge higher risk premiums and expend greater effort in response to estimation uncertainty. This study finds that auditors respond predictably to estimation uncertainty by including risk disclosures in audit opinions and creating risk protection mechanisms.

Authors

• Zhuoli Axelton, University of Wisconsin Green Bay

• Jeffrey Gramlich, Washington State University

• Brandon Szerwo, University at Buffalo (SUNY)