The Association of Preaudit Engagement Risk with Discretionary Accruals

In an archival study of audits by multiple offices of three international audit firms, we examine whether preaudit engagement risk assessments made by the auditor are associated with estimated postaudit discretionary accruals. We find that preaudit engagement risk is significantly and positively associated with the estimated level of discretionary accruals reported in audited financial statements. As higher levels of discretionary accruals have been shown to be associated with higher risk of post-audit litigation, it appears that rather than taking actions that result in higher-risk clients reporting less aggressive discretionary accruals, auditors instead are accepting a higher postaudit risk for these clients.