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    Financial Restatements, Audit Fees, and the Moderating...
    research summary posted April 23, 2012 by The Auditing Section, last edited May 25, 2012, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 02.02 Client Risk Assessment, 02.03 Management Integrity Assessments, 06.06 Earnings Management, 14.0 Corporate Matters, 14.01 Earnings Management 
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    Title:
    Financial Restatements, Audit Fees, and the Moderating Effect of CFO Turnover
    Practical Implications:

    This study provides evidence that auditors consider a client restatement as an increase in the audit risk of a client for future periods.  This increase in audit risk is factored into the audit fee possibly through additional hours or higher hourly rates.  This study also provides evidence that when a company has a change in CFO, auditors view this positively. 

    Citation:

    Feldmann, D.A., W.J. Read, and M.J. Abdolmohammadi. 2009. Auditing: A Journal of Practice and Theory 28 (1): 205-223.

    Keywords:
    audit fees; financial restatements; executive turnover
    Purpose of the Study:

    Restatements increased in frequency throughout the period 2000-2005.  Companies who restate their financial statements face reputational costs. For example, extant literature has documented an association between restatements and higher costs of capital, stock price declines, and higher likelihood of litigation.  One strategy a company may employ to mitigate negative consequences of a restatement is through termination of the executive officers in place during the restated period (i.e. disassociate the firm from those perceived as responsible for the restatement).  The authors suggest that by replacing the CEO and/or CFO after a restatement the company is providing evidence to outside stakeholders (including auditors) that they are attempting to address the weaknesses that caused the restatement.

    This study examines the effect of restatements on future audit fees, which represent another cost associated with a restatement, and whether terminating executive officers after the restatement moderates an increase in audit fees.

    Design/Method/ Approach:

    The authors collect restatements of the fiscal year 2003 by searching the EDGAR online database during the period January 1, 2004 through March 31, 2005.  For the restating firms identified, the authors gather audit fee and executive turnover information from subsequent proxy statements. 

    Findings:
    • Companies that restate have significantly higher executive turnover after the restatement than firms who do not restate.
    • Companies who restate have significantly higher audit fees after the restatement relative to firms who do not restate
    • Companies who terminate the CFO after a restatement do not experience higher audit fees after the restatement.
    Category:
    Client Acceptance and Continuance, Corporate Matters
    Sub-category:
    Audit fee decisions, Client Risk Assessment, Management Integrity Assessments, Earnings Management, Earnings Management
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