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.

Citation

Yang, L., Ruan, L. and Tang, F. (2020), "The impact of disclosure level and client incentive on auditors’ judgments of related party transactions", International Journal of Accounting & Information Management, Vol. 28 No. 4, pp. 717-737. https://doi.org/10.1108/IJAIM-02-2020-0016