Users' Judgments of Managers and Auditors : The impact of accounting treatment and reconciliation

We examine how supplemental accounting disclosures affect users’ judgments about management credibility and, in turn, their expectations of the auditor. In a lease obligation setting, our experiment separates the effects of understanding the financial impact of accounting treatment (by manipulating the presence of a supplemental reconciliation relative to control conditions) from inferences made based on management’s choice of accounting disclosures (by manipulating the source of the reconciliation). Users who receive a reconciliation (of disclosed lease obligations to capitalization) report lower perceptions of management credibility, higher investment risk, and higher audit expectations when the reconciliation is provided by a source other than management. Results demonstrate the effects of the presence and source of reconciliation on investment risk and management credibility judgments, extending research on the influence of managerial reporting discretion to audit expectations, with implications for research on the expectation gap and on auditor business and litigation risk. These findings suggest boundary conditions in which audit expectations are higher (and, thus, auditors’ business and litigation risk may also be higher) for disclosed information than for recognized information.