AUDIT

Restatement and Audit Opinion

Restatement and Audit Opinion

Introduction

Most nonprofit organizations are required to have an annual audit. The audit is usually performed by a certified public accountant (CPA). The audit tests the financial information of the organization and determines if the financial statements are prepared in accordance with GAAP. Once this determination is made, the CPA issues an opinion about the financial statements. The opinion letter can be found in a complete set of annual audited financial statements, placed before the financial statements. Additional information about audits and opinion letters is provided later in the chapter.

Auditors' restatement, materiality judgments, and decisions are important to audit quality, auditors, and clients. This statement can use the judgmental in nature of materiality to make aggressive financial reporting choices. Audit quality is comprised of auditors' ability to find misstatements in clients' financial statements and to require correction of the misstatements when faced with pressure from clients to avoid correcting the misstatements (DeAngelo 1981).

Indeed, authoritative literature requires auditors to evaluate misstatements, materiality and to require correction of material misstatements prior to issuing an unqualified audit report (AICPA 2006b). However, public company observers in the 1990s expressed concerns that auditors and their clients were inappropriately using the judgmental aspects of misstatement materiality evaluations to avoid correcting misstatements that were important to financial statement users and to manage clients' reported earnings (Levitt 1998). Subsequent academic literature provides evidence to support the claim that auditors and clients use materiality judgments to achieve clients' preferred outcomes (Libby and Kinney 2000; Nelson et al. 2002; Keune and Johnstone 2010).

However, regulation in the form of the Sarbanes-Oxley Act of 2002 has changed the judgment environment in which auditors make misstatement materiality judgments and decisions. SOX shifted the responsibility of misstatement materiality judgments and decisions from auditors to client management. It also shifted the power to hire and fire auditors from client management to the audit committee, which effectively reduced the financial advantage that client management can use to pressure auditors to agree with clients' preferences not to correct misstatements. These changes are simply examples of the SOX related changes that were intended to improve audit and financial reporting quality. Despite the pervasiveness of these changes, academic literature has not extensively examined auditors' misstatement materiality judgments and processes in this new regulatory environment.

This paper experimentally examines the effects of post-Sarbanes-Oxley Act changes on auditors' misstatement materiality judgments and decisions. First I examine the effects that auditors' communication of preliminary views and clients' documentation rationale have on auditors' decisions to correct misstatements. In addition to placing more responsibility on clients for the fair presentation of the financial statements, SOX requires clients and auditors to evaluate the effectiveness of clients' internal control over financial reporting. Auditors and their clients have implemented these mandates by reducing or eliminating the communication of preliminary views regarding the appropriateness of judgmental financial reporting issues such as materiality (SEC 2005a. 2005b). Additionally, many clients often document the rationale behind conclusions on these issues and provide this documentation to ...