Client Identification, Professional Identification, and Social Bond with Work Associates: How They Influence Auditors’ Fair Value Materiality Judgments

Given the worldwide adoption of International Financial Reporting Standards (IFRS), auditors are increasingly required to assess their clients’ fair value measurements and provide assurance that the fair values are free from material misstatements. However, fair value measurements are subjective and require extensive professional judgments. Evidence shows that fair value audit is one of the most significant challenges for auditors and is implicated in audit failures, substantial corporate collapses, and global financial crises. Indeed, there are increasing calls from standard setters, regulators, and researchers for more research into factors that influence auditors’ evaluation of clients’ fair value measurement. Responding to these calls, this thesis examines relevant situational and individual factors that influence auditors’ fair value materiality judgments. This thesis invokes theoretical models in the auditing literature, such as those of Hurtt et al. (2013) and Nolder and Kadous (2018), which highlight the importance of both situational and individual factors in understanding auditors’ judgments and decision making. The situational factor examined in this thesis is outcome imprecision, which refers to the degree of variability of possible misstatements and is manipulated at two levels by providing auditors with either a precise or imprecise range of possible misstatements on fair value. The individual factors are auditors’ client identification, professional identification, and social bond with work associates, and these are measured by using well-established, reliable, and valid scales in management and business. Specifically, this thesis provides empirical evidence on the joint effect of these three factors on auditors’ fair value materiality judgments in two situations, namely when the possible misstatement is precise and when it is imprecise. China was chosen as the national context for this thesis because of China’s significant economic and social influence in global business, and importantly there are concerns about the audit quality of Chinese companies. In addition, fair value measurements are an important and challenging issue for auditors, audit firms, regulators, and researchers in the Chinese context. Given the emerging nature of such research, providing causal evidence is particularly important in extending existing studies. Therefore, a between-subject experiment was conducted among Chinese professional auditors. The findings support the hypotheses that when the possible misstatement is imprecise, auditors are more likely to consider the misstatement to be material and to request an audit adjustment regardless of whether: their client identification is high or low; their professional identification is high or low; and their social bond with work associates is high or low. The findings also support the hypotheses that when the possible misstatement is precise, auditors with high (low) professional identification are more (less) likely to consider that the misstatement is material and request an audit adjustment; and that auditors with high (low) social bonds with work associates are more (less) likely to consider that the misstatement is material and request an audit adjustment. However, the findings show that when the possible misstatement is precise, auditors with high (low) client identification do not significantly differ in their judgments on fair value materiality. This thesis contributes to the auditing literature by demonstrating the importance of taking into account both situational and individual factors when examining auditors’ judgments. It contributes to the global convergence of accounting and auditing practice, and the findings will benefit global standard setters, national regulators, audit firms, and organizations in enhancing the audit quality of fair value measurements.