The impact of disclosure level and client incentive on auditors’ judgments of related party transactions

Abstract

Purpose The purpose of this study is to present the results of an experiment that examines the effects of client management’s increased disclosure of related party transactions (RPTs) on auditors’ judgments of financial reports that contain RPTs. Design/methodology/approach This study used a 2 × 2 between-subjects experiment to investigate auditors’ judgments in response to questionable RPTs in a Chinese context. Findings The results show that the auditor participants assessed a lower likelihood that the client’s financial statements were intentionally misstated and that they were less likely to request additional evidence when the client management chose to disclose more, as opposed to less, detailed RPT information in their disclosure. Moreover, there was a significant interaction between disclosure level and client incentive to manipulate earnings on the likelihood of the auditor requesting additional evidence. Practical implications This study should be of interest to regulatory agencies that have expressed concerns over auditing practices related to RPTs. Originality/value The findings from this study help to provide a more in-depth understanding of disclosure literature by investigating voluntary RPT disclosure and the moderation role of clients’ incentives to manipulate earnings.