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    Investors’ Response to Revelations of Prior Uncorrected M...
    research summary posted April 1, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.03 Impact of New Accounting Pronouncements, 09.0 Auditor Judgment, 09.01 Audit Scope and Materiality Judgments, 11.0 Audit Quality and Quality Control, 12.0 Accountants’ Reports and Reporting, 12.05 Changes in Reporting Formats 
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    Title:
    Investors’ Response to Revelations of Prior Uncorrected Misstatements
    Practical Implications:

    The results of this study are important in realizing the investor’s perception of audit quality as it relates to SAB No. 108 disclosures. Investors respond negatively to the quantification of prior period misstatement disclosures. The investor also distinguishes between misstatements that are waived by previous auditors and misstatements waived in the current year. Investors react negatively to misstatements that are disclosed in the current year. The investors also react to the importance of the client as it relates to the misstatements that are waived. Investors understand and react to the correlation between client importance, waived misstatements, and client retention. The results are important to understand that investors react to disclosures made under SAB No. 108.

    Citation:

    Omer, T. C., M. K. Shelley, and A. M. Thompson. 2012. Investors' Response to Revelations of Prior Uncorrected Misstatements. AUDITING: A Journal of Practice & Theory 31 (4):167-192.

    Keywords:
    materiality decisions; Staff Accounting Bulletin No. 108; client importance; audit quality; misstatements.
    Purpose of the Study:

    Staff Accounting Bulletin (SAB) No. 108 requires the disclosure of prior-period waived misstatements as well as the use of multiple methods of quantifying misstatements. The rollover method quantifies misstatement on a current year income statement effect, while the iron curtain method quantifies misstatement based on the balance sheet effect. The two methods can differ in terms of the resulting misstatement amounts. The authors of this study examine:

    • Investor responses to the new disclosures under SAB No. 108. Previously waived misstatements that were deemed immaterial by one quantifying method, but then deemed material by the other must now be disclosed.
    • Investor responses to misstatements waived by a predecessor auditor compared to misstatements waived by a current year auditor.
    • Investor perceptions of audit quality based on the new disclosures.
    • Whether client importance is a factor in relation to SAB No. 108 disclosures. 
    Design/Method/ Approach:

    The authors identified 420 firms that disclosed misstatements under SAB No. 108 using EDGAR and Morningstar Document Research. Of these firms, a sample of 272 firms were chosen to complete market return tests on the data. Multivariate regression analysis was employed on firm disclosures from filings made after November 15, 2006. 

    Findings:
    • The authors find that investors respond negatively to SAB No. 108 disclosures. The findings provide evidence that the information affects how the investor views the financial statement information and biases perceptions of audit quality.
    • The authors find that cumulative abnormal returns exist in relation to misstatements initially waived by current auditors. The findings suggest that investors react negatively to waived misstatements by auditors in the current year. Investors distinguish these misstatements from those of waived misstatements by predecessor auditors.
    • The authors find a negative trend of cumulative abnormal returns associated with the investor’s perception of client importance. The findings suggest that investors react according to the perception that misstatements are waived for important clients in order to retain their business. 
    Category:
    Accountants' Reporting, Audit Quality & Quality Control, Auditor Judgment, Standard Setting
    Sub-category:
    Audit Scope & Materiality Judgements, Changes in Reporting Formats, Changes in Reporting Formats, Impact of New Accounting Pronouncements