Evidence from Auditors About Managers’ and Auditors’ Earnings Management Decisions

THE ACCOUNTING REVIEW Vol. 77 Supplement 2002 pp. 175–202

Evidence from Auditors about Managers’ and Auditors’ Earnings Management Decisions
Mark W. Nelson John A. Elliott
Cornell University

Robin L. Tarpley
The George Washington University
ABSTRACT: This paper reports analyses of data obtained using a field-based questionnaire in which 253 auditors from one Big 5 firm recalled and described 515 specific experiences they had with clients who they believe were attempting to manage earnings. This approach enables us to analyze separately managers’ decisions about how to attempt earnings management and auditors’ decisions about whether to prevent earnings management by requiring adjustment of the financial statements. Our results indicate that managers are more likely to attempt earnings management, and auditors are less likely to adjust earnings management attempts, which are structured (not structured) with respect to precise (imprecise) standards. We also find that managers are more likely to make attempts that increase current-year income, but auditors are more likely to require that those attempts be adjusted, that managers are more likely to make attempts that decrease current-year income with unstructured transactions and/or when standards are imprecise, and that auditors are more likely to require adjustment of attempts that they identify as material or that are attempted by small clients.

We appreciate comments from Michael Gibbins (the discussant), Katherine Schipper (the editor), and Linda Bamber, Mike Bamber, Rob Bloomfield, Karl Hackenbrack, Frank Hodge, Steve Kachelmeier, Bill Kinney, Lisa Koonce, Susan Krische, Bob Libby, John Lyon, Steve Salterio, two anonymous reviewers, and participants at The Accounting Review’s Conference on Quality of Earnings and the Conference on Behavioral Research in Financial Reporting (both at Emory University), as well as workshop participants at the Australian Graduate School of Management, University of

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