Abnormal Audit Fees Research Articles

Accrual reversals and audit fees: the role of abnormal audit fees

This study examines whether abnormal audit fees impair auditor independence or reflect auditors’ efforts by using accruals reversal. All accruals must ultimately reverse, but those reversals have different effects on earnings persistence. Management may communicate the private information by different kinds of accruals. Therefore, auditors that have inside information should be able to identify managers who use their reporting discretion accruals to signal private information to investors. Our results suggest that normal audit fees reflect audit effort to identify different kinds of accruals reversal, but positive abnormal audit fees impair audit quality.

Audit Fee Determinants and Audit Quality in Ethiopian Commercial Banks

The audit profession has been highly scrutinized among researchers and regulators following the fall of giant companies in the west. One of the issues that gained momentum has been to analyze the audit fee structure and the various auditor-client relationships. This study investigates the determinants of audit fees and the ex-ante audit quality based on variables unique to the banking firms and considered important by regulators in Ethiopian commercial banks. The study also examined whether auditors value factors considered important by the regulatory bank, which result in better alignment of interests of auditors and regulators. The study used panel data for eight commercial banks from the year 2004-2012. The panel fixed effect regression result revealed bank size, liquidity, efficiency, loan growth, capital adequacy and auditor size are significant determinants of audit fees in Ethiopian commercial banks. However, among the factors considered important by the regulatory bank, credit risk is found to be insignificant. With regard to audit quality, the study did not find significant relationship between the extent of earning management and abnormal audit fees, indicating that auditors do not seem to compromise audit quality to secure abnormally higher audit fees. The researcher recommends auditors to further align audit fee valuation with the interests of regulatory bank, particularly in respect of credit risk.Keywords: audit fees, regulatory risks, audit quality, earning management, Loan Loss Provision.

Opportunities to improve the measurement of audit quality: a call for collaboration between the profession and academics

Audit research relies on a wide range of publicly available measures to examine which factors influence the quality of financial statement audits. While research to date has to rely largely on remote proxies due to a lack of access to proprietary data, there is considerable doubt about the validity of these proxies and the inferences drawn based on these proxies. In order to provide insight into the reliability of these measures, Rajgopal, Srinivasan & Zheng (2015) investigate whether commonly used proxies for audit quality (i.e. auditor size, abnormal audit fees, accrual quality, and the propensity to meet and beat analyst targets) are associated with deficiencies reported in SEC investigations and class-action lawsuits. Such alleged deficiencies reflect how external stakeholders assess audit performance. Their study indicates that the use of such proxies is highly problematic and that the performance of these measures, with the exception of auditor size, is poor.

Abnormal Audit Fees and Accounting Quality

We provide evidence that distinguishes between competing production cost-based explanations of how to interpret unusually high (or low) audit fees and their expected relation with accounting quality. Abnormally high or low fees are typically proxied by the residuals obtained from fee models. Whereas prior research assumes these residuals are independent from one year to the next, we argue that the inherent “stickiness” in audit fee residuals also means that measures of unexpected fees will be serially correlated. Our results strongly support this view, and suggest that audit fee residuals reflect a limitation of the standard audit fee model in capturing attributes of the auditing environment that are not well captured at the client-firm level. However, we also argue that the extent to which residual fees differ from the recent past can clarify their relation to accounting quality. We show that the “jump” in fee residuals relative to their long-run “sticky” average is strongly associated with lower accounting quality. Hence, a “jump” in fee residuals is a suitable proxy for lower accounting quality, as it likely reflects reactive auditor effort and/or an additional risk premium. We then show that long-run fee residuals are also negatively associated with subsequent accounting quality, a result which further contradicts the argument that higher abnormal audit fees capture increased proactive effort and therefore reflect “investments in auditing”. Overall, our results suggest that risk, rather than proactive effort, is a better explanation for higher than expected audit production costs.

The association between abnormal audit fees and audit quality after IFRS adoption

Purpose This paper aims to examine how the relationship between abnormal audit fees and audit quality changed after adoption of the International Financial Reporting Standards (IFRS) in Korea. Design/methodology/approach Using empirical data collected over the period from 2008 to 2013, this study analyzes the association between abnormally high/low audit fee and audit quality. This study uses linear regression to test the hypothetical relation using discretionary accrual as a proxy for audit quality. Findings This study finds that there exists no significant relationship between abnormally high audit fees and audit quality measured by the magnitude of discretionary accruals in the pre-IFRS adoption period. However, the relationship between abnormally high audit fees and the magnitude of discretionary accruals turns to be positive in the post-IFRS adoption period. These finding suggests that the IFRS enables some clients to engage more discretion in the choice of discretionary accruals and auditors charge higher audit fees in return for allowing the discretion for such clients. Practical implications This study provides insight to regulators of the need to review carefully the financial statements of firms with abnormally high audit fees, and to investors to be more cautious when using financial information about these firms. Originality/value To the best of authors’ knowledge, this is the first study to assess IFRS impact on audit fee-quality relation. Also, unique Korean audit market with intensifying competition and discounting audit fee provides interesting setting to review the impact of abnormal audit fee on audit quality.

The Relation between Excess Audit Fees and Credit Ratings

Credit rating agencies and auditors are complementary certification agents subject to a conflict of interest inherent in their compensation structure. We examine client firm credit ratings to test alternative hypotheses of abnormal audit fees. We predict and find both cross-sectional and time series variation in our results. Excess audit fees are associated with less favorable credit ratings, but only among speculative grade issuers. Among firms certified investment grade, we find evidence of economic bonding: excess fees are associated with more favorable ratings. As predicted by economic theory, economic bonding effects obtain during economic expansions when the probability of consequence is low. During economic contractions – when audit failure and ratings inflation are more likely consequential – certification agents protect their reputation value. Overall, our results suggest that excess compensation paid to one certifying agent might be useful to learn about the actions of the other.

The Association between Information Technology Investments and Audit Risk

ABSTRACTAdvances in information technology (IT) have changed the way that companies conduct business, prepare their financial statements, and have their financial statements audited. On one hand, IT decreases audit risk by improving operation and internal control effectiveness, which may decrease inherent and internal control risk. On the other hand, the complexity of IT introduces unconventional risks for companies and their auditors, especially by creating challenges for auditors when auditing the effectiveness of internal controls and detecting accounting irregularities. Thus, the relationship between clients' IT investments and audit risk deserves research attention. Using IT data of U.S. firms from 2000 to 2009, we find that IT investments are positively related to audit fees (and abnormal audit fees), the probability of auditors' issuance of a going-concern opinion, and the likelihood of auditors' Type II errors. Furthermore, we find that auditor tenure moderates the relationship between IT investments and audit fees due to the learning effect.

Auditor Conservatism and Banks' Measurement Uncertainty during the Financial Crisis

During the most recent financial crisis, the economic difficulties, along with potentially high uncertainties associated with fair value estimates, increased the audit risks for bank auditors. We analyze a sample of US public banks during the crisis (2008–09) and after the crisis (2010–11), and provide contrasting evidence concerning auditors' role in conservative financial reporting (proxied by higher discretionary loan loss provisions). Specifically, we document a significant positive association between discretionary loan loss provisions and the role of auditors (proxied by higher amounts of audit fees and abnormal audit fees) during the crisis. However, the positive association disappears following the financial crisis. Similarly, we document that during the crisis, auditors are less likely to issue unmodified audit opinions to banks that subsequently filed for bankruptcy. Thus, our evidence is consistent with elevated auditor conservatism for the sample banks during the financial crisis. Our evidence also suggests that bank auditors raise fees more to maintain accounting quality than to price protect from aggressive accounting choices.

Accruals Quality, Disclosure Costs, and Management Guidance

Research examining managers’ propensity to provide earnings guidance generally focuses on external costs and benefits of such disclosure. Motivated by voluntary disclosure theory, I argue that internal costs of disclosure likely play a significant role in the forecasting decision. Prior research suggests accruals quality (AQ) provides an indication of the quality of managers’ earnings-related information, as accruals that are of higher (lower) quality presumably arise from higher (lower) quality information. I contend that innate and discretionary components of AQ have opposite relations with information acquisition costs, an important theoretical determinant of disclosure. Specifically, higher levels of innate AQ suggest managers bear low information acquisition costs, leading to a positive theoretical association with voluntary disclosure. Conversely, higher discretionary AQ indicates greater information acquisition costs, which offsets the benefit of high quality information. Using forecast occurrence, frequency, timeliness, and specificity as proxies for the quality of voluntary disclosures, I find evidence consistent with these predictions. Further, improvements in innate AQ correspond to a higher (lower) likelihood of starting (stopping) a policy of forecasting. Finally, I show that the quality of “low-cost” information (innate AQ) moderates the effects of several previously identified determinants of forecasting, including institutional holdings, abnormal audit fees, product market competition, and litigation risk. Overall, my results are consistent with theory suggesting information acquisition costs play important roles in managers’ forecasting decisions.

Relative bargaining power in light of the current debate on audit market regulation

This study examines relative bargaining power of a continuous auditor-client relationship in the German audit market to determine whether auditors can exert their power at the expense of clients. It responds to findings published by the UK Competition Commission in 2013 which assumes audit market features to impair clients' bargaining power, resulting in adverse effects on competition. By relating bargaining power to the fee negotiation process, we treat the existence of companies with positive abnormal audit fees (with negative abnormal audit fees) over the entire period of study as an indicator for auditors' bargaining power being greater than clients' bargaining power (clients' bargaining power being greater than auditors' bargaining power) for these auditor-client relationships. Our results do not suggest that the CC's assumption, i.e., auditors' bargaining power to be greater than clients' bargaining power during a continuous auditor-client relationship, holds for the audit market segment of study.

ABNORMAL AUDIT FEES, NON-AUDIT FEES AND AUDITOR-CLIENT RETENTION DECISIONS

ABNORMAL AUDIT FEES, NON-AUDIT FEES AND AUDITOR-CLIENT RETENTION DECISIONS

Unexpected Audit Fees and Audit Quality: Do Audit Fee Premiums Trigger Error Announcements and Earnings Management?

This study investigates the economic auditor-client dependency issue by examining the association between abnormal audit fee pricing and audit quality. Our study is the first to analyze this phenomenon empirically for the institutional setting of German IFRS firms by using a sample of 2,334 firm-year observations for the period from 2005 to 2010. Our empirical results demonstrate that positive abnormal audit fees are negatively associated with audit quality and imply that the audit fee premium is a significant indicator of compromised auditor independence due to economic auditor-client bonding. Audit fee discounts generally do not lead to a reduced audit effort, or respectively, audit quality is not impaired when client bar-gaining power is strong. The association of positive abnormal audit fees and audit quality is robust to different audit quality surrogates such as absolute discretionary accruals, financial restatements, and meeting or beating analysts’ earnings forecasts.

Abnormal audit fees and audit quality: initial evidence from the German audit market

This study investigates the economic auditor–client dependency issue by examining the association between abnormal audit fee pricing and audit quality. Our study is the first to analyze this phenomenon empirically for the institutional setting of German IFRS firms by using a sample of 2,334 firm-year observations for the period from 2005 to 2010. Our empirical results demonstrate that positive abnormal audit fees are negatively associated with audit quality and imply that the audit fee premium is a significant indicator of compromised auditor independence due to economic auditor–client bonding. Audit fee discounts generally do not lead to a reduced audit effort, or respectively, audit quality is not impaired when client bargaining power is strong. The association of positive abnormal audit fees and audit quality is robust to different audit quality surrogates such as absolute discretionary accruals, financial restatements, and meeting or beating analysts’ earnings forecasts.

Determinants of audit report lag in the banking industry: updated evidence

This study examines the determinants of audit report lag (ARL) in the banking industry. Using data from 2001–2010 and models developed from prior research for banks, the pooled sample results show that bank size measured by market capitalisation and profitability measured by return on assets are associated with shorter ARL. Extraordinary items and higher abnormal audit fees are associated with longer ARL. We find that these results are driven by large banks that are subject to internal control requirements under the Federal Deposit Insurance Corporation Improvement Act and Sarbanes-Oxley Act. We find that the audit of internal controls over financial reporting and the presence of material weaknesses in internal controls are associated with longer ARL in the large bank subsample. The study provides updated evidence on the determinants of audit report lag in the banking industry and finds that the determinants of ARL have changed over a period of regulatory and economic changes in the last decade.

The Effects of Types of Non-audit Services on Abnormal Audit Fees

The Effects of Types of Non-audit Services on Abnormal Audit Fees

Abnormal Audit Fees and Stock Price Synchronicity: Iranian Evidence

The main objective of this research is to investigate the association between stock price synchronicity. Stock price synchronicity as a criterion for stock market reaction has been the subject of this study for the first time in Iran. For fulfilling the objectives of this research, the post event research method has been applied and for testing the hypothesis the data panel method has been employed. This research sample encompasses 71 accepted firms in Tehran stock market from 2006 to 2010. The results of this research indicate that stock market reaction positively to abnormal audit fees. In other words, the investors tend to assume that abnormal audit fees lead to more information of firm into stock prices and this will enhance audit quality.

Abnormal Audit Fees and Audit Quality: The Importance of Considering Managerial Incentives in Tests of Earnings Management

SUMMARYAre high audit fees a signal that the auditor exerted more effort or a signal that the auditor may be losing her independence? Prior literature offers conflicting evidence. In this paper, we reexamine the issue on a sample of clients who have both the incentive and the ability to use discretionary accruals to meet or beat the consensus earnings forecast. We find a negative relationship between the level of abnormal audit fees paid by the client and the likelihood of using discretionary accruals to meet or beat the consensus analyst forecast. The evidence is consistent with the notion that abnormal audit fees are indicative of greater effort on the engagement. In other words, the results suggest a positive relationship between abnormal audit fees and audit quality. We show that the conflicting evidence in prior research was caused by research designs that did not consider the incentives of the manager.JEL Classifications: M42; M41.Data Availability: All data are available from public sources quoted in the text.

The Effect of Abnormal Audit Fees and Non-Audit Fees on Accounting Conservatism - Focusing on the Model of Khan and Watts(2009) -

The Effect of Abnormal Audit Fees and Non-Audit Fees on Accounting Conservatism - Focusing on the Model of Khan and Watts(2009) -

Are Extensive Audits 'Good News'? Market Perceptions of Abnormal Audit Fees and Fair Value Disclosures

Although the role of auditing is to increase the reliability of financial statements, surprisingly little is known about addressees’ perceptions of the auditor-client relationship. Using a sample of more than 1,000 U.S. bank-years from 2008 to 2011, we analyze the economic consequences of the joint announcement of audit fees and the level breakdown of fair value assets. We confirm prior findings that audit fees are higher for banks with larger proportions of Level 3 fair values. Moreover, we find that the market perception regarding fair value assets depends on the extent of managerial discretion in the estimation process. Most importantly, we find evidence consistent with the notion that addressees’ interpret abnormal audit fees as an indication of additional risk. Thus, unexpected audit fees are not interpreted as a signal for a more reliable audit, but further increase the market discount on Level 3 fair values. Bank managers have to consider these negative consequences in their reporting strategy.

Client Risk Management: A Pecking Order Analysis of Auditor Response to Upward Earnings Management Risk

SUMMARY: This study examines Big N auditors' client risk management strategy in response to the risk of upward (i.e., income-increasing) earnings management in the post-SOX era. Specifically, we empirically study the relation between clients' signed discretionary accruals and subsequent audit pricing and auditor resignation decisions. We find that audit fees and resignations are positively associated with the risk of upward earnings management. We document a pecking order of auditor responses and find that auditors are more likely to respond in the order of charging higher abnormal audit fees if the trade-off between upward earnings management risk and return is within an acceptable level, and then resign if the risk is more severe and exceeds the auditors' tolerance level. Our results are robust to alternative accruals measures, controlling for clients' internal control quality and corporate governance characteristics.