The Unintended Consequences of Material Weakness Reporting on Auditors' Acceptance of Aggressive Client Reporting

Regulators are concerned that auditors do not sufficiently identify and report material weaknesses in internal control over financial reporting (ICFR). However, psychological licensing theory suggests reporting material weaknesses could have unintended consequences for acceptance of aggressive clien...

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Bibliographic Details
Published in:The Accounting review 2020-07, Vol.95 (4), p.51-72
Main Authors: Bauer, Tim D., Bucaro, Anthony C., Estep, Cassandra
Format: Article
Language:English
Subjects:
Acceptance
Aggressiveness
Auditors
Auditors opinions
Auditors reports
Audits
Efficacy
Financial reporting
Internal controls
Licenses
Licensing
Strength
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Summary:Regulators are concerned that auditors do not sufficiently identify and report material weaknesses in internal control over financial reporting (ICFR). However, psychological licensing theory suggests reporting material weaknesses could have unintended consequences for acceptance of aggressive client financial reporting. In an experiment, we predict and find auditors accept more aggressive client reporting after they report a material weakness in ICFR than after they report no material weakness. We provide evidence licensing underlies this effect. In a second experiment, we investigate the efficacy of an intervention to reduce the identified licensing effects by prompting an audit quality goal. We find this prompt mitigates the unintended consequence when auditors report a material weakness. While regulators are concerned companies are undeservedly receiving clean ICFR audit opinions, our findings indicate adverse ICFR opinions may lead auditors to give companies undeservedly clean financial statement opinions. We provide a potential remedy to this unintended consequence.
ISSN:0001-4826
1558-7967
DOI:10.2308/accr-52610