Consistently in Trouble: Negative Consequences of Accounting Inconsistency

• In Event: Challenges/Constraints to Audit Quality

Abstract

We examine how auditors respond to, and are influenced by, accounting inconsistency. Auditors are more likely to include an explanatory paragraph mentioning an accounting policy change in the auditor’s report and issue a preferability letter when firms have inconsistent accounting. More importantly, firms with inconsistencies are more likely to receive a material weakness in internal control over financial reporting. Surprisingly, despite this increased scrutiny by auditors, we also document that firms with inconsistent policies are more likely to misstate their financial statements. When we separate accounting changes into (1) required standard changes, (2) business or transaction changes, and (3) discretionary changes, we find that these results are concentrated in discretionary accounting changes. Our findings imply that auditors do not fully understand the implications of inconsistent accounting on financial reporting quality.

Authors

• Kyle Peterson, University of Oregon

• Roy Schmardebeck, University of Missouri

• T. Jeffrey Wilks, Brigham Young University