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Misstatement Direction, Litigation Risk, and Planned Audit Investment

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  • Orie Barron
  • Jamie Pratt
  • James D. Stice

Abstract

This study reports the results of an experiment showing that auditor assessments of litigation risk and planned audit investments are higher when potential errors overstate financial performance than when those errors understate performance. This result is much stronger in the presence of high levels of litigation risk in the client’s industry. These results suggest that in industries where litigation risk is high audited financial statements may contain more unintentional material understatement errors than overstatement errors. Thus, litigation risk—through its effect on auditors—may encourage financial statements that understate firm performance

Suggested Citation

  • Orie Barron & Jamie Pratt & James D. Stice, 2001. "Misstatement Direction, Litigation Risk, and Planned Audit Investment," Journal of Accounting Research, Wiley Blackwell, vol. 39(3), pages 449-462, December.
    • Handle: RePEc:bla:joares:v:39:y:2001:i:3:p:449-462
    DOI: 10.1111/1475-679X.00022
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    Cited by:

    1. Chen, Vincent Y.S. & Keung, Edmund C. & Lin, I-Min, 2019. "Disclosure of fair value measurement in goodwill impairment test and audit fees," Journal of Contemporary Accounting and Economics, Elsevier, vol. 15(3).
    2. Frank D. Hodge & Roger D. Martin & Jamie H. Pratt, 2006. "Audit Qualifications of Income†Decreasing Accounting Choices," Contemporary Accounting Research, John Wiley & Sons, vol. 23(2), pages 369-394, June.
    3. Dechow, Patricia & Ge, Weili & Schrand, Catherine, 2010. "Understanding earnings quality: A review of the proxies, their determinants and their consequences," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 344-401, December.
    4. Norman, Carolyn Strand & Rose, Anna M. & Rose, Jacob M., 2010. "Internal audit reporting lines, fraud risk decomposition, and assessments of fraud risk," Accounting, Organizations and Society, Elsevier, vol. 35(5), pages 546-557, July.
    5. Rowe, Stephen P., 2019. "Auditors’ comfort with uncertain estimates: More evidence is not always better," Accounting, Organizations and Society, Elsevier, vol. 76(C), pages 1-11.
    6. Habib, Ahsan & Jiang, Haiyan & Bhuiyan, Md. Borhan Uddin & Islam, Ainul, 2014. "Litigation risk, financial reporting and auditing: A survey of the literature," Research in Accounting Regulation, Elsevier, vol. 26(2), pages 145-163.
    7. Santanu Mitra & Mahmud Hossain & Donald Deis, 2007. "The empirical relationship between ownership characteristics and audit fees," Review of Quantitative Finance and Accounting, Springer, vol. 28(3), pages 257-285, April.
    8. Jeremy B. Griffin, 2014. "The Effects of Uncertainty and Disclosure on Auditors' Fair Value Materiality Decisions," Journal of Accounting Research, Wiley Blackwell, vol. 52(5), pages 1165-1193, December.
    9. Norman, Carolyn Strand & Rose, Jacob M. & Suh, Ik Seon, 2011. "The effects of disclosure type and audit committee expertise on Chief Audit Executives' tolerance for financial misstatements," Accounting, Organizations and Society, Elsevier, vol. 36(2), pages 102-108, February.

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