A Model of Auditing Under Bright-Line Accounting Standards

This paper models the demand by auditors for bright-line financial reporting standards, and compares auditors' preferences for bright-line standards with managers' and regulators' preferences. Bright-line standards are unambiguous, requiring no judgment in their application. Standards that are not "bright-line" are soft reporting standards. The model allows auditors to vary in their financial reporting expertise. All auditors have a basic role to verify the accuracy of the financial statements. "Expert" auditors also fill an interpretation role. Under soft standards, expert auditors use their financial reporting expertise to help generate a report that investors can understand. Results show that auditors of different levels of expertise can differ in their preferences over financial reporting standards, and that these preferences depend on whether auditor expertise is observable to investors. If expertise is observable, expert auditors prefer soft standards, and auditors without such expertise prefer bright-line standards. If investors cannot observe auditor expertise, all auditors prefer bright-line standards, and the average level of auditor expertise increases under bright-line standards. The paper also models auditors' preferences for the amount of detail required in the financial statements. We formally distinguish this attribute of financial reporting standards from our measure of bright-line standards, and we compare auditors' preferences for bright-line standards with their preferences along this second attribute