Auditor Independence and Restatement Magnitude

• In Event: Audit and AIS

Abstract

Restatement releases have developed into two basic forms: reissuances (big “R” restatements) and revisions (little “r” restatements). A big R restatement mandates an 8-K filing, while a little r restatement can be publicized in less apparent ways. The Securities and Exchange Commission (SEC) (SEC 2004) mandates firms to reveal restatements in Section 4.02 of an 8-K filing within four business days of discovering errors that should cause investors to not depend on previously disclosed financials. Deciding whether a restatement should cause non-reliance on the previous financial reports entails the evaluation of whether the materiality level of the underlying error is high enough that it would likely influence a reasonable investor’s perspective of the information (SEC 2006; PCAOB 2010). Uncertainty is present when it comes to the 8-K disclosure mandate (Turner and Weirich 2006; Reilly 2006; Huber and Bochner 2012) because materiality is subject to the judgment of both qualitative and quantitative features (FASB 1980; SEC 1999). As a result, auditors may be flexible in some circumstances with regards to having their clients issue big R/little r restatements. The choice as to whether a big R or a little r restatement should be declared is a critical one for a company because the high transparency of a big R restatement revelation results in a greater probability of negative effects on firms, auditors, and executives (e.g., Plumlee and Yohn 2008; Burks 2010). In this paper, I investigate the role that two auditor factors (i.e., auditor-client tenure and client importance at the local office level) play on the probability of a company issuing a little r restatement (relative to a big R restatement). Results show minimal support of a negative association between auditor-client tenure and little r restatement issuance. They also show a negative link between client importance and little r restatement declaration. Overall, this paper shows that auditors maintain their independence when auditing longer-tenured and more important clients. It also shows that one should dig deeper into examining auditor factors before concluding that a big R restatement is major and a little r restatement is not.

Author

• Jadallah Azmi Jadallah, Kent State University - Kent