AAA Spark Meeting of Regions

How Do Auditors Respond to Real Earnings Management? The Effects of Timing and Consequence on Auditor Decision Making

• In Event: Earnings Management and Professional Judgement

Abstract

While real earnings management (REM) is increasingly being used by managers to manipulate earnings, it is still unclear how auditors respond to management’s REM behavior. In this study, we investigate whether the timing and the consequence of the transaction influence auditors’ decisions with regard to REM. Based on the results of an online experiment with 159 CPA participants, we find that auditors use the timing of the transaction as a signal of management’s intent to identify REM. Specifically, a transaction that occurred at the end of a reporting period is more likely to be viewed as REM than a transaction that did not occur at the end of a reporting period. While the timing of the transaction helps auditors identify REM, how auditors respond to REM also depends on their evaluation of the transaction. We find that auditors are more likely to respond when the transaction occurred at the end of a reporting period and is likely to result in more negative consequences to the firm’s future operations. Additional analyses suggest that the timing and the consequence of the transaction lead to different auditor responses via altered trust and risk perceptions.

Authors

• Bob Cochran, Longwood University

• Fengchun Tang, Virginia Commonwealth University

• Ling Yang, New Jersey City University