Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

research summary

    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 
    648 Views
    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