THE EFFECT OF PARTITION DEPENDENCE ON ASSESSING ACCOUNTING ESTIMATES

SUMMARY: When auditors evaluate accounting estimates by testing management's estimation process, both current and proposed guidance call on auditors to review management's consideration of alternative assumptions and outcomes. Using partition dependence theory, a psychological bias that occurs when decision makers review a set of potential outcomes, we hypothesize that management's presentation of alternative estimate outcomes can bias auditors toward a management-preferred estimate. We demonstrate this result in a case-based experiment using senior auditor participants. We also perform two follow-up experiments, using student participants, to rule out competing rationales for our findings. In a final supplemental experiment, we test partition dependence predictions in a risk assessment setting and find results consistent with partition dependence. Our results have audit quality implications and, therefore, should be of interest to both regulators and audit firms. JEL Classifications: M40; M41; M42.