The Effects of Engagement Risk and Experience in Auditor-Client Negotiations

Topics: Audit, Negotiation, Auditor's report Pages: 34 (8674 words) Published: December 16, 2012
The Effects of Engagement Risk and Experience in Auditor-Client Negotiations

Helen L. Brown, PhD, CPA

Department of Accounting and Information Systems

School of Business

University of Wisconsin-Madison

December 2003

The Effects of Engagement Risk and Experience in Auditor-Client Negotiations

Helen L. Brown
University of Wisconsin-Madison

ABSTRACT: This study examines the affect of engagement risk and experience on auditors’ concessionary behavior in auditor-client negotiations. Sixty-six senior audit practitioners (managers and partners) completed an Internet-based, simulated negotiation to resolve a complex revenue recognition issue. Participants assumed the role of auditor and negotiated with a programmed “client” to identify a financial reporting alternative that satisfied both parties. Engagement risk was manipulated between subjects and auditor experience was measured based auditors’ total years of experience. The results indicate that the auditors responded to high engagement risk by making greater concessions to the client (i.e., aggreeing to a revenue recognition method that is more in line with the client’s aggressive reporting preference). However, higher experienced auditors made fewer concessions than low experienced auditors.

Key words: Negotiation, Concessionary Behavior, Audit, Engagement Risk, Experience

The Effects of Engagement Risk and Experience in Auditor-Client Negotiations

Audited financial statements are a joint product of both the auditor and the client (Antle and Nalebuff 1991), and auditors sometimes play an active role in managing the client’s financial reporting choices (Nelson et al. 2002). In the process of financial reporting, circumstances may arise that lead to divergent preferences between clients and auditors on accounting and reporting issues. The resolution of such financial reporting issues can be especially difficult when generally accepted accounting principles (GAAP) are ambiguous (e.g., Johnstone et al. 2002; Nelson and Kinney 1997), since both parties may make different judgments depending on their preferences. As a result, auditors often engage in complex negotiations with their clients to achieve a reporting alternative that adheres to GAAP and reports the substance of the transaction in a representationally faithful manner. Further, these negotiations often have a material effect on the financial statements (Gibbins et al. 2001). Despite the importance of auditor-client negotiation in financial reporting, limited attention has been given to the need for effective negotiations in situations that entail subjective matters (e.g., accounting estimates, imprecise accounting standards, etc.) (Trotman et al. 2002). The purpose of my study is to examine how senior audit practitioners (partners and managers) negotiate with their clients to resolve a complex revenue recognition issue. I examine how certain environmental and psychological factors influence negotiated outcomes. More specifically, this paper provides empirical evidence on how engagement risk and auditor experience affect concessionary behavior in auditor-client negotiations. My study provides an empirical test of some of the auditor-client negotiation theory introduced in Gibbins et al. (2001), extending that study in two main ways. First, their study identifies the significance of negotiation in the audit environment and provides a framework for examining auditor-client negotiation. However, their study does not specifically control for factors generally encountered in an accounting environment (e.g., engagement risk, experience, firm culture, etc.). A logical extension of their study is to examine specific factors that potentially influence auditors to make concessions that ultimately impact the negotiated outcome. Secondly, they note that one limitation of their study is...
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