International Financial Reporting Standards and Aggressive Reporting: An Investigation of Proposed Auditor Judgment Guidance

We experimentally investigate auditors’ judgments under accounting standards that differ in their precision. After establishing conditions under which auditors accept managements’ aggressive financial reporting, we examine the effectiveness of alternative judgment frameworks in helping auditors curb this aggressive reporting under less precise International Financial Reporting Standards (IFRS) and more precise U.S. GAAP. One of our frameworks is based on the Securities and Exchange Commission’s (SEC) Advisory Committee on Improvements to Financial Reporting’s (CIFiR) recommendation to use counterfactual reasoning. Another framework based on Construal Level Theory requires auditors to think broadly about a transaction, while our last framework is based on both counterfactual reasoning and Construal Level Theory. We find that auditors’ ability to restrain managers’ opportunistic judgments under less precise IFRS depends on the economic substance of the transaction. We also find that a judgment framework helps auditors curb managements’ aggressive accounting under IFRS. Additionally, the judgment frameworks based on Construal Level Theory are more effective than the framework based on CIFiR’s proposed judgment guidance when the transaction’s economic substance is clear, while the framework based on CIFiR’s proposed guidance is just as effective when the economic substance is unclear. These results inform regulators, standard-setters, and auditors on the effectiveness of different judgment guidance in improving auditors’ judgments under less precise IFRS.