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  • Jennifer M Mueller-Phillips
    Abnormal Audit Fees and Restatements
    research summary posted October 20, 2014 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 12.0 Accountants’ Reports and Reporting, 12.03 Restatements 
    Title:
    Abnormal Audit Fees and Restatements
    Practical Implications:

    The conclusion that audit fees are associated with the risk of audit failure may impact auditors as they face pressure to reduce audit fees. Auditors should consider this risk based on the client’s position as well as trying to minimize risk related to audit fee reductions. Similarly, client’s audit committee should consider the trade-off between current fees and the risk of restatement. With the changes that SOX introduced, regulators should review how changes in audit fees affects the quality of financial statements over time.

     

     

    For more information on this study, please contact Dr. David Hurtt.

    Citation:

    Alan I. Blankley, David N. Hurtt, and Jason E. MacGregor. 2012. Abnormal Audit Fees and Restatements. Auditing: A Journal of Practice & Theory: 31 (1): 79-96.

    Keywords:
    Restatements, audit fees, audit quality
    Purpose of the Study:

    Overall, this paper investigates whether there is a relationship between audit fees and subsequent financial statement restatements. The authors investigated whether audit firms charged more for audit services prior to a restatement compared to non-restatement clients. Past research finds that this relationship has a positive correlation. However, the authors revisited this relationship for the post-SOX period based on multiple factors:

     

    • The relationship of audit fees to future restatements is unclear since high fees may increase restatement probability due to independence issues, while low fees may increase the probability of future restatement because they potentially reflect lower levels of service or effort.
    • SOX affects the auditor-client relationship through changes such as partner rotation and prohibiting some non-audit services provided to audit clients. Research revealed a shift in firms increasing pricing for risk.
    • With the recent economic downturn, companies trying to decrease audit fees could be focusing on cutting cost instead of focusing on the quality of the financial statements.
    • Past research was inconclusive on the relationship between future restatements and audit fees because of the time frame studied as well as the omission of an internal control strength variable.

     

    Finding a clear relationship between audit fees and future restatements could have implications in how auditors, audit committees, and regulators view audit fees in a post-SOX business environment. As a result, the study could impact fee negotiations from the standpoint of audit quality.

    Design/Method/ Approach:

    Audit fee and restatement data was collected from Audit Analytics for the 2002 through 2009 period. The authors used two statistical models to study the association audit fees may have with future restatements. First, using an audit fee model based on prior research, the authors derived the abnormal or unusual audit fee after controlling for audit risk, client complexity, internal control strength and other influences on fees. In the second model, the authors tested a robust logistic regression model where the variable of interest was the abnormal audit fee derived from the first model. 

    Findings:
    • The authors find that abnormal audit fees are negatively associated with the probability of future financial statement restatements.
    • When audit fees are noticeably high, the likelihood of restatement is low. When audit fees are noticeably low, the likelihood of restatement is high.
    • When audit fees are abnormally low, there may be pressure for auditors to maintain the profitability of the engagement by minimizing hours to complete the audit.
    • This relationship is robust when the model included or excluded a variety of internal control and restatement variables.
    Category:
    Accountants' Reporting, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Restatements
  • Jennifer M Mueller-Phillips
    Business Strategy, Financial Reporting Irregularities, and...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
    Title:
    Business Strategy, Financial Reporting Irregularities, and Audit Effort
    Practical Implications:

    This study provides several important contributions to the existing accounting literatures on financial reporting irregularities. The authors provide evidence that the differences in the client business risk of companies’ choice of business strategies is an underlying determinant of financial statement quality. Also, the findings provide evidence that auditors appear to recognize and adjust audit effort based on clients’ business strategies. This study is important because it identifies organizational business strategies as an important determinant of both financial reporting irregularities and audit effort based off publicly available data.

    For more information on this study, please contact Kathleen, A. Bentley.
     

    Citation:

    Bentley, K. A., T. C. Omer, and N. Y. Sharp. 2013. Business Strategy, Financial Reporting Irregularities, and Audit Effort. Contemporary Accounting Research 30 (2).

    Keywords:
    business strategies; audit effort; financial statement quality.
    Purpose of the Study:

    This study examines the effect clients’ business strategies have on the occurrence of financial reporting irregularities and the level of audit effect. Using Miles and Snow’s (1978, 2003) strategy typology, the authors attempt to provide evidence that increases the understanding of underlying determinates of financial reporting quality. They provide a measure of business strategy that requires only publicly available information and is generalizable across industries. Using these measures, this study is able to provide evidence of whether companies’ business strategies exhibit differences in the occurrences of financial reporting irregularities.

    Design/Method/ Approach:

    The authors of this study use the organizational strategy theory of Miles and Snow to develop a comprehensive measure of business strategy using publicly available data. Relying on this theory, the authors developed a discrete STRATEGY composite measure, which proxies for the organization’s business strategy. Higher STRATEGY scores represent companies with prospector strategies and lower score represent companies with defender strategies. Using logistic regression, the authors determine whether the company strategies are associated with financial reporting irregularities. Level of audit effort was determined using audit fee data. All of this data is combined and analyzed to produce overall conclusions.

    Findings:
    • Companies following a prospector strategy are more likely than companies following a defender strategy to experience financial reporting irregularities across three samples of irregularities: SEC AAERs, shareholder lawsuits related to alleged accounting improprieties, and accounting restatements.
    • The business strategy measure represents client business risk and is not a substitute for financial reporting risk.
    • Clients following prospector strategies have higher audit fee, suggesting that auditors expend greater audit effort for these clients.
    • Despite higher audit fees for prospectors, fees are not high enough to account for the riskiness of these clients.
       
    Category:
    Client Acceptance and Continuance, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Business Risk Assessment (e.g. industry - IPO - complexity)
  • The Auditing Section
    Audit Fees at U.S. Non-Profit Organizations
    research summary posted May 2, 2012 by The Auditing Section, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
    Title:
    Audit Fees at U.S. Non-Profit Organizations
    Practical Implications:

    This study identifies relationships between attributes specific to non-profit organizations (see above) and external audit fees, and it has practical implications for non-profit organizations as well as auditors in negotiating audit fees.  The audit fee model can be useful for non-profit organizations that seek to benchmark their audit fees.  Additionally, this study shows that non-profits with higher quality internal oversight are willing to incur additional costs for monitoring by external auditors. Further, this study shows that Big 4 auditors earn a premium for their services in the non-profit sector (similar to the for-profit sector).

    Citation:

    Vermeer, T. E., K. Raghunandan, and D. A. Forgione. 2009.  Audit Fees at U.S. Non-Profit Organizations.  Auditing: A Journal of Practice and Theory 28 (2): 289-303.

    Keywords:
    Non-profit organizations, auditing, liquidity, audit committees, benchmarking
    Purpose of the Study:

    The purpose of this study is to examine audit fee determinants for non-profit organizations.  The study examines audit fee determinants applicable to all businesses, as well as non-profit specific attributes that are associated with audit fees.                   

    This study is motivated by recent scandals and governance failures in non-profit organizations (United Way, New Era Philanthropy, and American Cancer Society), which have led to increased scrutiny and regulations over these organizations and have resulted in increased external audit requirements.  Given the significant differences between non-profit organizations and for-profit businesses  culture, organizational structure, financial needs, accounting rules, financial reporting, financial statement users, and audit risk environment), the role of auditing can be significantly different for non-profit organizations.  Despite the economic significance of these organizations, little is known about determinants of audit fees for non-profit organizations.  

    This study uses survey data from large non-profit organizations to determine whether the following factors impact audit fees at non-profit organizations: 

    • Complexity, including size and asset composition
    • Need for resources, including donor contributions, external debt, and single audit requirements (federal awards)
    • Monitoring mechanisms, including internal audit and audit committee
    • Control variables, including financial stress, Big 4 auditor, industry, and non-audit fees
    Design/Method/ Approach:

    The authors obtained data on fiscal 2002 and 2003 audit fees and background information from surveys sent to chief financial officers of the largest non-profit organizations per GuideStar, Inc. Financial data are obtained from the GuideStar database. The authors used these data to examine the relationship between audit fees and the factors listed above. 

    Findings:
    • Traditional determinants of for-profit audit fees appear to have a similar impact on audit fees for non-profit organizations.
    • Larger asset size and greater complexity are associated with higher audit fees.
    • Non-profits in poorer financial condition pay higher audit fees.
    • Greater debt leads to higher audit fees.
    The Big 4 audit fee premium also exists for non-profit clients. 
    • Non-profit organizations with a single audit incur higher audit fees. 
    • Audit fees are lower for non-profits in regulated industries (healthcare and education). 
    • Monitoring by external auditors complements, rather than substitutes for, other internal monitoring mechanisms such as audit committees and internal auditing departments. This is evidenced by the following:
      • Higher quality audit committees (i.e., audit committees being fully independent, having at least one CPA or other financial expert, and meeting at least twice per year) are associated with higher audit fees.
      • The presence of internal auditing is associated with higher audit fees.

    The authors argue this suggests that non-profits with quality internal oversight are willing to incur additional costs for monitoring by external auditors. 

    • Greater non-audit fees as a percentage of total fees leads to lower audit fees.  This suggests that the joint provision of audit and non-audit services may lead to increased efficiencies in auditing.
    Category:
    Client Acceptance and Continuance, Engagement Management
    Sub-category:
    Audit fee decisions, Audit Fees & Fee Negotiations
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