DOES AUDITING REDUCE BIAS IN FINANCIAL-REPORTING - A REVIEW OF AUDIT-RELATED ADJUSTMENT STUDIES

Do year-end audit adjustments reduce bias in management's assertions about earnings and assets, and if so, by how much? These and related questions are addressed by an analysis of nine data sets of audit-related adjustments from more than 1,500 audits across 15 audit years. Included are clients of all of the Big Six CPA firms and a broad cross section of industries. Summary statistics are tabulated by direction of effect on earnings, by selected accounts, and by magnitude. Overall, audit-related adjustments show an overwhelmingly negative effect on preaudit net earnings and net assets. The average aggregate adjustment reduces earnings and assets by two to eight times the minimum amount that would materially misstate the financial statements. Thus, the year-end audit is seen as directly reducing positive bias in preaudit net earnings and net assets as well as improving the precision of measurement. This implies that, other things equal, if auditing had not been applied, then the financial reports of these firms would have tended to show materially inflated earnings and assets.