The Effects of Firm Guidance on Auditors' Evaluations of Fair Value Estimates

Abstract

SUMMARY Regulators are concerned that auditors are insufficiently skeptical in evaluating fair value estimates (PCAOB 2020). We employ Nolder and Kadous's (2018) professional skepticism model to examine how firm guidance impacts auditors' skeptical judgments and actions in the fair value context through their cognitive processing of confirming and conflicting 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. JEL Classifications: C91; G18; M42.