The effect of ambiguity on loss contingency reporting judgements.

Abstract This paper reports the results of an experiment that examines the influence of uncertainty about the probability that a future loss will occur ("ambiguity") on auditors and financial statement users' judgments about appropriate reference to contingent losses in audit reports. Application of Einhorn and Hogarth's (1985) ambiguity model suggests that, with respect to losses of tow (high) probability, both auditors and users will act as if an ambiguous probability of loss is higher (lower) than a precise probability of the same magnitude, thus demonstrating a conservative (unconservative) reaction to ambiguity. In addition, since auditors may jeopardize client relations when they unnecessarily make audit report reference to contingent losses, auditors may react less conservatively to ambiguity than do users. The results of the experiment support these predictions.