Recognition v. disclosure, auditor tolerance for misstatement, and the reliability of stock-compensation and lease information

Robert Libby, Mark Nelson, James Hunton

Research output: Contribution to journalArticleResearchpeer-review

91 Citations (Scopus)

Abstract

We examine whether information in footnotes might lack reliability because auditors permit more misstatement in disclosed, as opposed to recognized, amounts. In both the stock-compensation and lease settings, audit partners require greater correction of misstatements in recognized amounts than in the equivalent disclosed amounts. Debriefing questions indicate that the partners make these decisions knowingly, even though they expect greater client resistance to correcting recognized amounts, because they view recognized amounts as more material. Partners also spend more time on correction decisions for recognized information. While prior literature suggests that amounts are often relegated to footnotes because they are less reliable, our results suggest that the actual choice to disclose versus recognize can also reduce information reliability. These results have implications for the interpretation of prior research on the reliability of recognized and disclosed numbers, for financial-accounting standard setters who may want to consider the reliability effects of their recognition versus disclosure decisions, and for auditing standard setters who may wish to clarify auditors responsibilities for preventing misstatements in disclosed amounts.
Original languageEnglish
Pages (from-to)533 - 560
Number of pages28
JournalJournal of Accounting Research
Volume44
Issue number3
DOIs
Publication statusPublished - 2006
Externally publishedYes

Cite this