Brian Bratten

The Audit of Fair Values and Other Estimates: The Effects of Underlying Environmental, Task, and Auditor-Specific Factors

The rising prominence of fair values and other estimates (FVOEs) to financial reporting increases their significance to the audit. Based on inspections that report numerous deficiencies, the PCAOB is concerned that auditors are not sufficiently prepared for the challenges faced in evaluating fair value measurements. In this paper, we first analyze the possible sources for observed practice deficiencies by evaluating extant archival and experimental research. To organize our discussion, we rely on an established theoretical research framework that examines auditor judgment through an analysis of three critical and interactive factors of the judgment process — the environment, the task, and the person (Bonner 2008). We believe the framework is particularly useful in understanding judgments related to the audits of FVOEs given these areas have unique environmental and task factors such that addressing auditor characteristics alone to improve audit quality is likely to be insufficient. Second, considering the PCAOB-identified practice areas with direct implications for the audits of FVOEs, we develop and present future research lines of inquiry that take into account the important interactions among the three framework factors. We believe empirical evidence within these lines will help identify potential sources of and remedies for observed audit deficiencies.

Earnings Management: Do Firms Play “Follow the Leader”?†

In this study we examine whether the reported performance of one firm affects the discretionary reporting behavior of another firm. We do this by identifying the leader within each industry, defined as the first large announcing firm. We find that the discretionary performance of followers (those firms announcing after the leader) relates positively to the leaders reported performance. Specifically, when the leader misses analysts’ expectations, followers report lower discretionary accruals, have fewer income-decreasing special items, and are less likely to meet analysts’ expectations. In contrast, when leaders report good news, followers report higher discretionary accruals and are more likely to meet expectations (although we do not find evidence of a positive association between leaders’ good news and followers’ income-decreasing special items). Overall, the results are consistent with managers of followers perceiving that earnings news of the leader will affect investors’ and others’ performance expectations for their firms.

Forecasting Tax Expense: New Evidence from Analysts

Using recently available pre-tax earnings forecast data from 2003 to 2012, we infer analysts’ income tax expense and effective tax rate (ETR) forecasts and provide the first large-sample evidence on their dispersion and accuracy. Even though managers provide annual ETR estimates each interim quarter, management’s estimates are not equal in information content and analysts do not merely mimic these estimates, consistent with analysts providing incremental information. Analysts’ forecasts are more disperse and less accurate when management’s interim ETR estimate include discrete items, consistent with more uncertainty and greater difficulty in understanding the tax environment when accounting standards require exceptions to the integral method. Taken together, our results suggest management interim ETR estimates are critical to the market’s understanding of tax expense.