This study identifies conditions under which the audit risk model does, and does not, describe audit-planning (investment and pricing) decisions. In an experiment, audit partners and managers examined one of two cases where a material misstatement—error or irregularity—was discovered. The auditors assessed the elements of the audit risk model, assessed business risk and provided recommendations for the audit investment and fee. When the likelihood of an error was high, the audit risk model dominated business risk in the explanation of the audit investment, and the fee did not contain a risk premium. When the likelihood of an irregularity was high, business risk dominated the audit risk model in the explanation of the audit investment, and the fee contained a risk premium. These results suggest that the ability of the audit risk model to describe auditor behavior and the inclination of auditors to charge a risk premium depend upon the nature of the risks present in the audit. In the presence of errors, the audit risk model adequately described audit-planning decisions; in the presence of irregularities it did not.

Based on data collected from 616 experienced financial officers who use U.S. GAAP or IFRS and are domiciled in the U.S., Europe, or Asia, we examine how reporting standards (U.S. GAAP versus IFRS) and domicile (U.S. versus non-U.S.) affect earnings management (real versus accrual). U.S. firms using U.S. GAAP rely more heavily on real methods than non-U.S. firms that use either IFRS or U.S. GAAP and U.S. firms using IFRS. U.S. firms using U.S. GAAP operate in an environment that encourages real over accruals methods; specifically, U.S. GAAP facilitates detection of earnings management, and enforcement is more effective in the U.S. Further, the likelihood and amount of earnings management do not differ across conditions, suggesting that firms using less accruals earnings management tend to fully compensate by increasing real methods. So stronger reporting environments do not necessarily reduce total earnings management, but instead encourage substitution of real for accruals methods.

We provide evidence that analysts' stock-price judgments depend on (1) the method of accounting for a business combination and (2) the number of years that have elapsed since the business combination. Consistent with business-press reports of managers' concerns, analysts' stock-price judgments are lowest when a company applies the purchase method of accounting and ratably amortizes the acquisition premium. The number of years since the business combination affects analysts' price estimates only when the company applies the purchase method and ratably amortizes goodwill—analysts' price estimates are lower when the business-combination transaction is further in the past. However, this joint effect of accounting method and timing is mitigated by the Financial Accounting Standards Board's proposed income-statement format requiring companies to report separate line items for after-tax income before goodwill charges and net-of-tax goodwill charges. When a company uses the purchase method of accounting and writes off the acquisition premium as in-process research and development, analysts' stockprice judgments are not statistically different from their judgments when a company applies pooling-of-interest accounting.