Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

Posts

  • Jennifer M Mueller-Phillips
    Are All Industry Specialist Auditors the Same?
    research summary posted October 13, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 11.0 Audit Quality and Quality Control 
    Title:
    Are All Industry Specialist Auditors the Same?
    Practical Implications:

    The results have implications on two fronts. First, the findings indicate that auditors pursue different production and pricing strategies in different segments of the market, suggesting that the Big 4 audit firms respond to the competitive pressures in each submarket. Second, the evidence raises questions about the construct validity of market share-based measures of industry specialization, which have been used extensively in the literature. The evidence suggests that auditors who obtain a large market share by auditing a large proportion of the industry sector may actually do so by producing lower quality, lower cost audits. As such, these auditors are not acting as true specialists in the sense of using specialized training and knowledge to raise the quality of the audit performed.

    Citation:

    Cahan, S. F., D. C. Jeter, and V. Naiker. 2011. Are All Industry Specialist Auditors the Same? Auditing: A Journal of Practice & Theory 30 (4): 191-222.

    Keywords:
    audit fees, audit quality, auditor market share, industry specialization, market segmentation, product differentiation
    Purpose of the Study:

    Auditor industry specialization continues to attract considerable attention in the literature. This may reflect the importance that clients place on industry specialization, e.g., 80 percent of companies viewed industry expertise or specialization as being an important factor in choosing an auditor. Most commonly, archival studies identify industry specialist auditors using a market share-based measure where a significant share, or an industry leading share, of the industry’s audit fees is used to designate specialists. However, a market share-based measure is problematic because market share depends jointly on the proportion of clients audited and the average size of those clients. For example, it is possible to attain a large industry market share by auditing a few relatively large clients in an industry or many relatively small ones. The question the authors examine is as follows: Are industry specialists who obtain a high market share in disparate ways similar in terms of product (audit) quality and price (audit fees)?

    Design/Method/ Approach:

    The authors begin with all client-years from 2003 through 2007 with requisite data available from Compustat and Audit Analytics. For the audit fee sample, the data requirement to compute the control variables results in a final sample of 9,565 client-year observations. For the discretionary accruals model, the additional data requirements needed to estimate discretionary accruals and the control variables for Equation (3) result in a final sample of 9,396 client-year observations. Sixty-one industries are represented by observations in both the audit fee and discretionary accruals samples. 

    Findings:

    The authors find evidence of higher (lower) audit quality when the auditor attains a high market share by auditing a lower (higher) proportion of clients in the industry. Combined, the findings suggest that industry specialists who gain market share by auditing a small proportion of clients in an industry pursue a product differentiation strategy, offering a higher quality, but more costly, audit. On the other hand, those specialists who gain market share by auditing a large proportion of clients follow a cost minimization strategy, competing on price and sacrificing quality. The authors do not find any evidence that the Big 4 operates as a tight oligopoly either in the overall audit market or within industry markets, whether defined at the national or local level. In summary, the results suggest that not all industry specialists are the same.

    Category:
    Audit Quality & Quality Control, Audit Team Composition, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • Jennifer M Mueller-Phillips
    How Much Does IFRS Cost? IFRS Adoption and Audit Fees.
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 15.0 International Matters, 15.02 IFRS Changes – Impacts 
    Title:
    How Much Does IFRS Cost? IFRS Adoption and Audit Fees.
    Practical Implications:

    The authors document and quantify audit fees as a significant cost associated with mandatory adoption of IFRS. The empirical results concerning small firms also inform discussions on the appropriateness of mandated IFRS regulations for small to mid-sized entities. Given the emphasis of auditing in the proposed roadmap for U.S. convergence to IFRS, the results will be of particular importance to U.S. firms, auditors, and regulators. On a broader level, the authors document variation in the costs of IFRS adoption that provides insight into the significant variation in the net benefit observed in previous studies. For instance, the authors find evidence that certain IFRS requirements have higher compliance costs than others, which explains the significant heterogeneity in compliance costs during the adoption of IFRS. 

    Citation:

    De George, E. T., C. B. Ferguson, and N. A. Spear. 2013. How Much Does IFRS Cost? IFRS Adoption and Audit Fees. Accounting Review 88 (2): 429-462.

    Keywords:
    audit fees, IFRS, IFRS costs, international harmonization
    Purpose of the Study:

    Regulators and standard setters claim that International Financial Reporting Standards (IFRS) enhance the comparability and quality of financial reporting. However, the true returns to IFRS adoption should be evaluated by trading off the costs of transition and any recurring costs of reporting against the recurring benefits of comparability and increased reporting quality. Given the impending decision and renewed debate surrounding whether the Securities and Exchange Commission (SEC) should mandate the use of IFRS in the U.S. market, understanding the costs of IFRS implementation is of timely importance.

    This study quantifies the directly observable and significant cost of IFRS compliance by examining the fees incurred by firms for the statutory audit of their financial statements. The focus on audit costs is motivated by the fact that the pervasive nature of IFRS adoption is likely to have a profound impact on a firm’s financial reporting costs. Firms currently subject to IFRS have already raised concerns over increasing preparation and certification costs.

    Design/Method/ Approach:

    The sample of 907 firms consists of companies publicly traded on the Australian Stock Exchange (ASX) that adopted IFRS from January 1, 2005, and have sufficient available data from 2002 to 2006. Preceding audit fee data in the pre-IFRS period, auditor information, and IFRS transition information is hand-collected from publicly available annual reports. The authors collect data on the number of local and foreign subsidiaries directly from publicly available reports and other financial information from Aspect Huntley’s Fin Analysis database.

    Findings:
    • The authors estimate a 23 percent increase in the average level of audit fees in the year of IFRS adoption.
    • They find an abnormal increase of 8 percent in the year of IFRS adoption, beyond normal yearly increases in fees.
    • The authors find a positive and significant relation between fee increases and IFRS-exposure.
    • The results are consistent with IFRS transition costs being a function of firm-specific exposure to IFRS and a fixed economy-wide switching cost.
    • IFRS compliance is onerous for small firms.
    • The estimated percentage increase in audit fees associated with IFRS adoption is approximately 1.6 times greater for small firms.
    • Small firms exhibit a significant fixed-cost component to their fee increase in the year of IFRS adoption. This increase is in addition to their incremental fee increase explained by their IFRS adjustments.
    • In contrast, the audit fee increases incurred by large firms are primarily explained by the magnitude of their IFRS adjustments, with no discernible fixed-cost component.
    • A survey of professional auditors at a Big 4 accounting firm shows that auditors believe that certain aspects of the new IFRS reporting requirements require greater auditor effort and expertise to ensure adequate compliance.
    Category:
    Engagement Management, International Matters
    Sub-category:
    Audit Fees & Fee Negotiations, IFRS Changes – Impacts
  • Jennifer M Mueller-Phillips
    Client-Auditor Supply Chain Relationships, Audit Quality,...
    research summary posted March 2, 2015 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Client-Auditor Supply Chain Relationships, Audit Quality, and Audit Pricing
    Practical Implications:

    The results of this study provide empirical evidence of an association between supply chain knowledge and improved audit quality, as well as audit efficiency when this knowledge exists at a local level.  Audit firms often attempt to differentiate themselves by a certain level service and audit quality that can be provided based on specialized knowledge, such as industry experience.  Supply chain knowledge can add a new dimension to auditor knowledge and specialization.  By identifying an association between supply chain knowledge and audit quality and fees, this study demonstrates to audit firms an additional value-adding, quality-differentiating audit service. 

    For more information on this study, please contact Karla Johnstone.

    Citation:

    Johnstone, K. M., C. Li, and S. Luo. 2014. Client-Auditor Supply Chain Relationships, Audit Quality, and Audit Pricing. Auditing: A Journal of Practice and Theory 33 (4): 119-166

    Keywords:
    audit pricing; audit quality; supply chain relationships; industry expertise
    Purpose of the Study:

    This study examines the implications of auditor supply chain knowledge on audit quality and audit fee pricing.  The auditor may develop supply chain knowledge when performing the audit of both the supplier and its major customer.  This supply chain knowledge is a specialized understanding of the accounting and auditing issues in the revenue cycle that relates to both the supplier and its major customer.  This study examines the following potential impacts on an audit engagement as a result of supply chain knowledge:

    • As revenue recognition is often a significant audit area, as well as one of the highest areas subject to restatement, an auditor’s level of understanding of the revenue cycle is hypothesized to improve audit quality. 
    • An improved understanding of an audit client’s revenue cycle could also lead to audit efficiencies.  These efficiencies are hypothesized to be reflected in lower audit fees for auditors with supply chain knowledge. 
    • Supply chain knowledge can be developed and transferred at the local office and audit firm level.  The study hypothesizes that this knowledge transfer is stronger when the same office performs the audit of the both the supplier and customer rather than when both the supplier and customer are audited by difference offices in the same firm.  
    Design/Method/ Approach:

    The supply chain relationships for the years 2003 through 2010 were collected using the Compustat customer segment file , which identifies the names of major customers disclosed in the footnotes of the supplier’s 10-K.  Auditor supply chain knowledge was measured as the ratio of the number of supplier and major customer companies employing the same auditor divided by the total number of the supplier companies for the same auditor in the year.  This ratio was measured at both the city-office level and national level.

    Audit quality was measured using three common proxies: absolute discretionary accruals, existence of a restatement, and the propensity to meet or beat analyst’s earnings forecasts.

    Findings:
    • Auditor’s supply chain knowledge at the city level is associated with higher audit quality and lower audit fees for supplier companies compared to companies employing auditors with supply chain knowledge at the national level only, or auditors without supply chain knowledge.
    • This association is present only for suppliers that are highly dependent on their major customer.
    • The association is stronger among a subsample of companies for which the revenue cycle accounts are particularly important (those with high level of accounts receivable balances). 

    The results suggest that knowledge redundancy exists when a supplier and its major customer are audited by audit teams out of the same city level office.  They further suggest that this knowledge redundancy contributes to audit efficiencies, thus reducing audit fees where the city level supply chain knowledge exists.

    Category:
    Audit Quality & Quality Control, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Who’s Really in Charge? Audit Committee versus CFO Power a...
    research summary posted March 1, 2015 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    Who’s Really in Charge? Audit Committee versus CFO Power and Audit Fees
    Practical Implications:

    The results demonstrate the importance of, and tension between, CFO and audit committee power in audit fee negotiations. Our findings suggest CFOs often continue to exert significant influence over audit fees even though contractual responsibility for compensating external auditors resides with the audit committee. These results highlight the importance for auditors to identify the more powerful party when negotiating audit fees with their clients.

    In addition, this study has significant implications for investors who believe current regulations separate management from audit fee negotiations. These regulations may give investors a false sense of security if they assume the audit committee always limits managerial influence during audit fee negotiations.

    For more information on this study, please contact Elaine Mauldin.

    Citation:

    Beck, M. J. and E. Mauldin, 2014. Who’s really in charge? Audit committee versus CFO power and audit fees. The Accounting Review 89 (6): 2057-2085.

    Keywords:
    audit fees, audit committee, CFO, recession
    Purpose of the Study:

    Sarbanes-Oxley (SOX) intended to restore and improve investor confidence in financial reporting by charging audit committees with direct responsibility for determining external audit fees. However, some auditors report that management continues to control the external auditor relationship, even though the audit committee, by law, has contractual responsibility. Thus, current regulations may give investors a false sense of security if they assume the audit committee always limits managerial influence during audit fee negotiations.

    We compare chief financial officer (CFO) and audit committee influence on audit fees to provide insight into the effectiveness of mandating contractual responsibility for audit fees to the audit committee. We examine changes in fees during the recent financial crisis and economic recession as this time period creates a natural experiment that allows us to better isolate and identify the influence of audit committee and CFOs on audit fees. We expect CFOs with greater power, relative to the audit committee, will negotiate fee reductions during the recession because cutting audit fees directly improves net income and reduced audit fees could result in less audit effort and allow management more earnings management opportunities. On the other hand, we expect audit committees with greater power, relative to the CFO, will not negotiate fee reductions during the recession because they more likely support the auditor’s and shareholders’ desire for higher fees to combat higher audit risks

    Design/Method/ Approach:

    We utilize a sample of firms from 2006-2009 and utilize OLS regressions to examine the effects that audit committee and CFO power have on audit fees during the recession. We utilize tenure of the audit committee and CFO to proxy for power as longer tenure increases firm-specific expert knowledge necessary for effective bargaining and the ability to develop networks of key stakeholders, enabling individuals to form coalitions in support of their bargaining position.

    Findings:
    • We find that during the recession audit fees declined by 4 percent on average 
    • We find smaller fee reductions when audit committee power is greater than CFO power and larger fee reductions when CFO power is greater than CFO power
    • We find when the audit committee is sufficiently more powerful than the CFO, audit fee reductions during the recession disappeared
    Category:
    Corporate Matters, Engagement Management
    Sub-category:
    Audit Committee Effectiveness, Audit Fee Decisions
  • Jennifer M Mueller-Phillips
    Effect of Client Reputation on Audit Fees at the Office...
    research summary posted February 20, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
    Title:
    Effect of Client Reputation on Audit Fees at the Office Level: An Examination of S&P 500 Index Membership
    Practical Implications:

    The results of this study are important for audit firms to consider when they choose their clients.  The evidence indicates that auditors can benefit from client’s reputation by using it for advertising audit quality. Promotion of audit quality via the presence of reputed clients in the portfolio enables the auditors to negotiate favorable audit pricing from their other clients.    

    For more information on this study, please contact Dr. Sharad Asthana.

    Citation:

    Asthana, S. C., and R. Kalelkar. 2014. Effect of Client Reputation on Audit Fees at the Office Level: An Examination of S&P 500 Index Membership. AUDITING: A Journal of Practice & Theory 33(1): 1-27.

    Keywords:
    Auditor reputation; client reputation; S&P 500 index; audit fees; rent extraction; cost recovery
    Purpose of the Study:

    The impact of a decline in the reputation of the auditor or a client on other clients of the auditor is well documented. However, the effect of an unexpected increase in a client’s reputation on the auditing environment has never been examined. The authors try to fill the gap in extant research by examining the outcome of the addition of a client to the prestigious S&P 500 Index on the audit office and other clients of this office.

    The authors posit that the inclusion of a client in the S&P 500 index will have two outcomes. First, inclusion of a client in the S&P 500 index will increase the client’s visibility and monitoring by external agencies, thus improving its reporting quality. As a result of the improved reporting quality, the audit office will be willing to grant audit fee discounts to this client.

    Second, inclusion of a client in the S&P 500 index will have an impact on the audit fees of other clients in the audit office portfolio. An audit office’s association with an S&P 500 client is expected to have a positive impact on the office’s perceived audit quality. Once the perception of the auditor’s reputation in the local audit market is improved, other clients will be willing to pay higher remunerations for the audit services. Thus, the audit office is likely to increase their audit fees for non- S&P 500 clients to extract rent for its enhanced reputation.

    The authors motivate their expectations based on the marketing literature that suggest that branding and service differentiation could lead to increased market power and higher prices when firms are successful in differentiating their services or developing brand value. 

    Design/Method/ Approach:

    The research evidence is collected in the post-Sarbanes-Oxley period from 2003 to 2012.  The authors use clients of Big 4 audit offices that did not change auditors in the sample period. The authors divide clients into two groups: 1) S&P 500 clients if the clients are in the S&P 500 index during the sample period, and 2) non-S&P 500 clients if the clients were never in the S&P 500 index during the sample period.  

    Findings:
    • The authors find that the audit fees are discounted for S&P 500 clients (reputed clients) when it enters the index. The audit fee for this client increases following its exit from the index. The change in the audit fees correspond with the change in reporting quality of the firm. 
    • The authors find increases in the audit fees of non-S&P clients of the audit office following the increase in the S&P 500 clients in the auditors’ portfolio. Additional test reveals that increase in the audit fees is not supported by improvement in the reporting quality of other non S&P clients.
    Category:
    Client Acceptance and Continuance, Engagement Management
    Sub-category:
    Audit Fee Decisions, Audit Fees & Fee Negotiations
  • Jennifer M Mueller-Phillips
    City-Level Auditor Industry Specialization, Economies of...
    research summary posted February 17, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
    Title:
    City-Level Auditor Industry Specialization, Economies of Scale, and Audit Pricing
    Practical Implications:

    The consolidation of audit firms from the Big 6 to the Big 5 in 1998, and then to the Big 4 in 2002, has raised concerns about the lack of competition in the large-client market (GAO 2003). However, while it is possible that the consolidation has reduced competition and increased prices, it could also have created efficiencies leading to reduced prices. This study shows that there is some merit in the "efficiency" argument that larger firms pass on an economies-of-scale discount to their clients. The finding provides some support for the GAO’s (2008) observation that there is little evidence of Big N oligopolistic pricing.

    For more information on this study, please contact Jagan Krishnan.

    Citation:

    Fung, Simon Y.K., Ferdinand A. Gul, and Jagan Krishnan. 2012. City-Level Auditor Industry Specialization, Economies of Scale, and Audit Pricing. The Accounting Review 87 (4): 1281-1307.

    Keywords:
    industry specialization; scale economies; audit pricing; client bargaining power
    Purpose of the Study:

    Increasing auditor size leads to two outcomes, which include industry specialization due to the expertise developed from expanding within industries, and economies of scale arising from spreading audit investment costs over a large client base. Academic research has examined the effects of industry specialization and, to a much lesser extent, the effects of scale economies, on audit pricing. The authors find that while the national operations of the Big N auditors are evenly divided, their scale of operations are significantly different at the city level. The purpose of this study is to examine whether (and in what settings) the benefits of scale economies at the city level are passed on to clients, particularly in light of concerns that the Big N audit firms dominate the audit market. Evidence on the effects of scale economies on the fees charged to audit clients is therefore of interest to regulators, auditors, and market participants.

    Design/Method/ Approach:

    The authors extract information of Big N auditors as well as their publicly listed audit clients in the U.S. for the period 2000–2007. Observations with missing information, those in the financial sector (which is regulated very differently), and foreign firms are excluded from the sample. The test sample includes 17,207 client-year observations across 54 two-digit SIC industries. Multivariate regressions are used to conduct statistical inferences.

    Findings:
    • There are significant variations in the city-industry scale in the U.S. Big N audit market.
    • Industry specialist auditors at the city-level earn significant premiums (14.8 percent, or $226,000, on average) compared to non-specialist auditors; but audit fees decrease by 1.7 percent (or $25,900) for a one-decile increase in city-industry scale.
    • The effects of industry specialization and economies of scale on audit pricing are highly interactive. The negative effect of city-industry scale on audit fees applies only to industry specialist auditors, and the audit fee premium for industry specialization is smaller for auditors with a larger city-industry scale.
    • The industry specialization premiums are higher after SOX, although scale discounts are slightly smaller. However, the aforementioned interactive effects hold in both periods.
    • Client bargaining power exerts a moderating effect on both the specialization premium and the scale discount. Both specialist and non-specialist auditors pass on some scale discounts to clients with a high degree of bargaining power. However, only specialist auditors pass on scale discounts to clients with a relatively low degree of bargaining power. 
    Category:
    Client Acceptance and Continuance, Engagement Management
    Sub-category:
    Audit Fee Decisions, Audit Fees & Fee Negotiations
  • Jennifer M Mueller-Phillips
    Reconciling Archival and Experimental Research: Does...
    research summary posted February 16, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
    Title:
    Reconciling Archival and Experimental Research: Does Internal Audit Contribution Affect the External Audit Fee?
    Practical Implications:

     The results of this study are useful to managers, boards of directors, and audit committees to benchmark their own organizations and determine areas in which they may be able to realize cost savings.  Standard setters for external auditors could consider these results in terms of whether external auditors are appropriately relying on specified characteristics of the IAF when making their reliance decisions.  Client companies and their auditors might both find it worthwhile to examine whether external auditors could make better use of financial work performed by internal auditors on which the external auditors might later rely.  Finally researchers may wish to consider the results of this study when examining the external auditor’s reliance decision or when performing other audit fee analyses, especially considering whether proxies used in this study would be appropriate control variables or experimental variables of interest with respect to the contribution of internal auditing.

    For more information on this study, please contact David A. Wood.

    Citation:

    Prawitt, D. F., N. Y. Sharp, and D. A. Wood. 2011. Reconciling archival and experimental research:  Does internal audit contribution affect the external audit fee. Behavioral Research in Accounting 23 (2): 187-206

    Keywords:
    Internal audit function, internal audit costs, internal audit quality, external audit fee, SAS No. 65, AS 5
    Purpose of the Study:

    Experimental and survey research consistently have found evidence of a negative relation between measures of internal audit contribution and external audit fees. By contrast, past archival research typically has documented either no relation or a positive relation.  While it has provided important insights, prior archival research examining the relation between internal auditing and external audit fees has been limited by the unavailability of detailed data about internal audit functions (IAF).  With newly available archival data, this paper examines the internal audit contribution/external audit fee relation using direct measures of the amount of time internal auditors work directly assisting external auditors, and the amount of time internal auditors spend performing tasks upon which the external auditor is likely to rely.

    Understanding the association between the contribution of internal auditing and external audit fees is important because this is an economically important relationship.  External auditing standards allow the external auditor to either use internal auditors as assistants or to rely on work previously performed by the IAF.  This paper also addresses which of the two methods of reliance results in a greater reduction in the external audit fee.

    The conflict mentioned earlier between the results of previous research using surveys and experiments versus those found in archival studies have led a number of researchers to call for additional work in the area.  This paper also suggests an explanation for the divergent findings in the experimental and archival studies in this area.

    Design/Method/ Approach:

    The data set examined in the research is from the IIA’s GAIN database relating to fiscal years 2000 to 2005.  The authors restricted their analysis to these years because of availability of IIA data (they have no data after 2005) and because of availability of external audit fees (audit fee data were not made public before 2000).  

    Findings:
    • The authors find that external audit fees are negatively associated with internal audit contribution.
    • The authors find that the amount of time internal auditors spend performing tasks of a financial nature is not associated with lower external audit fees, but that the time spent working under direct supervision of the external auditor is associated with lower external audit fees.
    • The authors find that proxies used in past archival studies are positively associated with measures of the host companies’ size and complexity, and are negatively associated or are not associated with this study’s relatively direct measures of the contribution of the IAF to the external audit. In other words, proxies used in past archival studies likely did not do a good job of capturing IAF contribution, which explains their contradictory results.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Reliance on Internal Auditors
  • Jennifer M Mueller-Phillips
    Non-Timely 10-K Filings and Audit Fees
    research summary posted December 1, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
    Title:
    Non-Timely 10-K Filings and Audit Fees
    Practical Implications:

    A practical implication from the findings for public companies is that as they consider the costs associated with non-timely filings, they also need to include in their calculations future costs arising from heightened risk assessment by auditors. The results also highlight the fact that there are significant differences in the market for audit services of accelerated and non-accelerated firms, and reinforce the view that there are differences between the two types of firms in terms of the consequences associated with internal control weaknesses.

    For more information on this study, please contact Kannan Raghunandan (raghu@fiu.edu).

    Citation:

    Wang, C., K. Raghunandan, and R. A. McEwen. 2013. Non-Timely 10-K filings and audit fees. Accounting Horizons 27 (4): 737-756

    Keywords:
    Late filings, Client acceptance and continuance, Audit fees.
    Purpose of the Study:

    The SEC has long been concerned about the need for the timely disclosure of information, and requires that registrants that are unable to file annual or quarterly statements by the applicable deadlines file a notice of non-timely filings (Form NT filings) with the Commission. Section 409 of SOX Act mandated that the SEC require registrants to disclose information “on a rapid and current basis.” Subsequently, the SEC acted to reduce the time permitted for registrants to file annual and quarterly statements with the Commission. 

    This paper examines the association between Form NT-10K filings and audit fees.  The authors argue that after an NT-10K filing auditors would have reduced confidence in the systems and processes behind the collection of information underlying client financial statements. This in turn will lead auditors to assign a higher risk of material misstatement for such clients; in turn, this would lead to higher levels of audit effort associated with the planned reduction in detection risk. Further, the many possible adverse consequences associated with non-timely filings can also lead to auditors assessing a higher business risk when a client files a Form NT-10K. Taken together, a Form NT-10K filing can be expected to be associated with higher audit fees either because auditors increase the audit effort for such clients or due to a risk premium.

    Design/Method/ Approach:

    The sample includes 11,024 firm-year observations during the years 2007 and 2010. The proportion of late filings is 4.34 percent for accelerated filers (347/7992) and 11.81 percent for non-accelerated filers (358/3032).

    Findings:
    • In the case of accelerated filers, audit fees are 26 (12) percent higher for those firms that had a Form NT-10K filing in the prior (current) year, after controlling for other factors associated with audit fees.
    • Non-timely filings are not associated with significant increases in audit fees for non-accelerated filers; this finding is driven by clients with non-Big 4 auditors.
    Category:
    Client Acceptance and Continuance, Engagement Management
    Sub-category:
    Audit Fee Decisions, Audit Fees & Fee Negotiations
  • Jennifer M Mueller-Phillips
    The Impact of Mandatory IFRS Adoption on Audit Fees: Theory...
    research summary posted November 25, 2014 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 15.0 International Matters, 15.02 IFRS Changes – Impacts 
    Title:
    The Impact of Mandatory IFRS Adoption on Audit Fees: Theory and Evidence
    Practical Implications:

    This study should be of interest to regulators and policy makers. IFRS adoption influences audit complexity and financial reporting quality, which have countervailing effects on audit fees. On the one hand, IFRS are generally believed to be superior to local accounting standards; hence the adoption of IFRS potentially improves financial reporting quality. This reduces audit risk and thus audit fees. On the other hand, IFRS are comprehensive, fair-value oriented, and principles-based. Using them generally requires accountants and auditors to make more complex estimates and use greater professional judgment. In other words, IFRS adoption increases the complexity of audits, which can increase audit fees. Our results suggest that, on average, the effect of audit complexity dominates the effect of improvement in financial reporting quality, leading to an overall increase in audit fees in the post-IFRS period. Moreover, our cross-country analysis sheds light on how the institutional features of different countries, including legal environments and characteristics of pre-IFRS domestic accounting standards, affect the audit fee increase associated with IFRS adoption.

    For more information on this study, please contact Xiaohong Liu.

    Citation:

    Kim, J.-B., X. Liu, and L. Zheng. 2012. The impact of mandatory IFRS adoption on audit fees: Theory and evidence. The Accounting Review 87 (6): 2061-2094.

    Keywords:
    IFRS adoption, audit fees, audit complexity, reporting quality, legal regime
    Purpose of the Study:

    This study examines the impact of International Financial Reporting Standards (IFRS) adoption on audit fees. Over 100 countries now require or permit IFRS reporting for domestically listed companies. Recent academic research mainly focuses on the economic benefits of adopting IFRS. Very few studies directly examine the costs associated with IFRS adoption. A survey conducted by the Institute of Chartered Accountants in England and Wales revealed that EU companies ranked increases in audit fees as one of their largest IFRS-related costs. This study aims to provide systematic evidence on the cost side of mandatory IFRS adoption, with a focus on audit fees. Specifically, we examine changes in external audit fees from 2004 to 2008 to determine whether the EU decision to mandate IFRS increased the fees paid to auditors. In addition, we investigate how the institutional features of different countries affect the audit fee increase associated with IFRS adoption. These institutional factors include (i) the increase in audit complexity arising from IFRS adoption, (ii) the change in financial reporting quality brought about by IFRS adoption, and (iii) the strength of a country’s legal regime. The findings of this study provide insights into the channels through which IFRS adoption impacts audit fees.

    Design/Method/ Approach:

    We examine audit fee changes from the pre-IFRS adoption period to the post-IFRS adoption period during 2004–2008. We employ a difference-in-difference design to control for the general trend or changes in the economic environment unrelated to IFRS adoption. Specifically, we use IFRS adopter firms from EU countries as the treatment sample and the non-adopter firms from non-EU OECD (Organization for Economic Co-operation and Development) countries as the control sample.

    Findings:
    • IFRS adoption causes an increase in audit fees. The audit fee increase is on average 5.44 percent greater for the adopter firms, compared with that for the non-adopter firms in our control sample.
    • The IFRS-related audit fee increase is positively related to the increase in audit complexity brought about by IFRS adoption.
    • The IFRS-related audit fee increase is negatively related to the improvement in financial reporting quality brought about by IFRS adoption.
    • The IFRS-related audit fee increase is negatively related to the strength of a country’s legal regime. 
    Category:
    Engagement Management, International Matters
    Sub-category:
    Audit Fees & Fee Negotiations, IFRS Changes – Impacts
  • Jennifer M Mueller-Phillips
    Fee Pressure and Audit Quality
    research summary posted November 10, 2014 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 11.0 Audit Quality and Quality Control, 11.08 Proxies for Audit Quality 
    Title:
    Fee Pressure and Audit Quality
    Practical Implications:

    The results of this study are important evidence that a large proportion of audit engagements during the Recession were characterized by positive fee pressure, and that fee pressure was associated with lower audit quality during the Recession. The results suggest that auditors who experienced fee pressure from clients during the Recession were not able to maintain or increase audit effort in line with client risks due to pressure on fees. These results should be of interest to the PCAOB who expressed concern that audit fee pressure may have had negative effects on audit quality during the Recession.

     

    For more information on this study, please contact Mike Ettredge.  

    Citation:

    Ettredge, M., E. E. Fuerherm, and C. Li. 2014. Fee pressure and audit quality. Accounting, Organizations and Society 39 (4):247-263

    Keywords:
    Audit fee, audit quality, fee pressure, recession, misstatements, PCAOB
    Purpose of the Study:

    The purpose of this study is to investigate the association of audit fee pressure with audit quality during the recent recession. The Recession started in December 2007 and officially ended in June 2009. Regulators expressed concerns that clients may expect their auditors to share in the economic pain of the Recession by agreeing to fee reductions and that fee pressure might cause auditors to ease up on the rigor of audits or to curtail necessary audit work to cope with falling revenue. However, it is not clear that auditors would respond to fee pressure by reducing audit quality given the litigious climate in which they operate. Prior research suggests that auditors have incentives to maintain or increase audit effort when faced with greater engagement risk. This paper addresses this question empirically by:

    • Developing a model to proxy for fee pressure
    • Comparing the existence of fee pressure in pre-recession years (2006-2007), during the Recession (2008), and the year the Recession ended (2009)
    • Studying the association of fee pressure with misstatements of the financial statements, an inverse proxy for audit quality, during the Recession. 
    Design/Method/ Approach:

    The data for the main analysis are collected for public companies in 2008, the main year of the Recession. The authors compare each client’s actual fee in the test year (2008) with a benchmark audit fee to identify fee pressure. The benchmark audit fee is calculated using actual audit fee data from previous year (2007) to predict audit fees for the test year (2008). The authors use misstatements of financials as an inverse measure of audit quality. All else equal, a higher quality audit should lead to fewer misstatements of the audited financials. 

    Findings:
    • The authors find that fee pressure is significantly greater in 2008 than in both 2006 and 2007 suggesting that auditors faced increased fee pressure from clients during the Recession.
    • The authors find that fee pressure is positively associated with financial misstatements during the Recession (2008), but is not associated with misstatements in 2007 and 2009 and is only weakly associated in 2006. This suggests that the decrease in audit quality during the Recession year is related to fee pressure from audit clients.
    • In sensitivity analyses, the authors find that the impact of fee pressure does not differ for Big 4 vs. non-Big4 auditors or larger vs. smaller audit offices.
    • In sensitivity analyses, the authors find that fee pressure in 2008 is positively associated with the occurrence with severe misstatements, but not less severe misstatements. This result suggests that fee pressure during the Recession was associated with serious decreases in audit quality, not just with small errors in the financial statements. 
    Category:
    Audit Quality & Quality Control, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Proxies for Audit Quality

Filter by Type

Filter by Tag