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    Real Earnings Management: A Threat to Auditor Comfort?
    research summary posted January 12, 2017 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.04 Management Integrity, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.06 Earnings Management – Detection and Response 
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    Title:
    Real Earnings Management: A Threat to Auditor Comfort?
    Practical Implications:

    Given that REM often causes significant auditor discomfort, the authors’ paper provides broader REM and auditor comfort-related questions pertaining to the effects of management’s focus on short-term results, the extent to which REM is a problem that can or needs to be fixed, and the possibility that REM is a gateway to more serious forms of accounting manipulation. 

    Citation:

    Commerford, B. P., D. R. Hermanson, R. W. Houston, and M. F. Peters. 2016. Real Earnings Management: A Threat to Auditor Comfort? Auditing: A Journal of Practice and Theory 35 (4): 39 – 56. 

    Keywords:
    real earnings management, auditor, comfort, rationality, emotions, and body senses
    Purpose of the Study:

    The authors address two overarching questions that have not received very much attention to date. First, “To what extent does real earnings management (REM) affect auditor comfort?” Second, “What strategies do auditors rely on in trying to reach a state of comfort when the client engages in REM?” Auditing standards that relate to REM are vague and limited and, despite evidence showing that REM is becoming increasingly common, little research considers auditors’ perceptions of REM and how they respond to it. The authors wish to fill this void by writing this paper. 

    Design/Method/ Approach:

    The authors conduct in-depth interviews with experienced auditors to examine how auditors respond to an emerging issue in the post-SOX period, the increasing use of real earnings management to achieve financial reporting objectives. 

    Findings:
    • The authors find that auditors are aware of REM and often identify it through formalized audit protocols, including analytical procedures, discussions with management, ad/or their knowledge of the business.
    • The authors find that formal audit procedures play a role in identifying sources of discomfort but also find references to body senses and the use of emotive language related to feelings of discomfort.
    • The authors find that most of the interviewees have concerns about REM, largely because they believe it indicates management’s desire to meet short-term targets, implying poor management tone, which could signal other, less acceptable earnings management methods. 
    Category:
    Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management – Detection and Response, Management Integrity