The Effects of Audit Guidance on Auditors’ Evaluations of Fair Value Estimates

Abstract

Fair value estimates (FVEs) are common in financial reporting and regulators are concerned that auditors are insufficiently skeptical in their FVEs evaluations. Using Nolder and Kadous’s (2018) professional skepticism model, we examine the process by which firm guidance impacts auditors’ skeptical judgments and actions through their cognitive processing of evidence. We find that rewording firm guidance to include either a directional goal instructing them to oppose management’s assertions or a bi-directional goal instructing them to support and oppose management’s assertions lead auditors to gather more conflicting evidence than a directional goal instructing them to support management’s assertions. However, gathering more conflicting evidence does not yield more skeptical actions unless auditors are instructed to support and oppose management’s assertions. This is supported by theory suggesting that attending to both confirming and conflicting information forces individuals to reconcile the inconsistent information, enhancing the likelihood that it will be incorporated in their judgments.