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Does auditing reduce bias in financial reporting? A review of audit-related adjustment studies
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Recent trends in auditors' liability have led to significant supply-side developments in the auditing industry. As examples, audit firms have resigned from audits of risky enterprises, audit firms have restricted attestation services, and some small audit firms have quit offering auditing services (Holland et al. 1993; Berton 1992). The Public Oversight Board's 1992 annual report(1) expresses concern that, because of the litigation environment, auditors will eventually be unwilling to give the assurances they have traditionally provided to American industry, its investors, and its creditors.
This actual and potential audit supply restriction raises the general question, "What quantitative effects do audits have on financial statements for third-party users?" One measurable consequence of audits is the detection and correction of errors and irregularities identified and documented in the course of the year-end audit. This paper addresses the detection and correction consequence by synthesizing results from prior studies of audit-related adjustments and their effects on published financial statements.
METHOD AND DATA
Financial statements are prepared from business books and records that may contain errors or irregularities. Misstatements may also arise in financial statement preparation.(2) Audits are directed toward detecting material departures from generally accepted accounting principles. Auditors typically collect information on misstatements or "audit differences" in individual items and record them on a summary worksheet for possible financial statement adjustment. Thus, one way to measure the effect of audits is to examine the auditor's adjusting entry worksheet
The "adjusting entry worksheet" approach has been used in a number of recent studies. The approach has the advantage of being based on objective data and it is relatively complete in that it includes audit differences that resulted in financial statement adjustments as well as those that were waived. However, it likely understates the aggregate quantitative effect of auditing due to several factors. First, the approach...