Increased Audit Risk Research Articles

Fair value and investment property in accounting literature: a review

Purpose This study aims to provide a timely review concerning the determinants and economic consequences of fair value reporting in real estate industry, as these topics have been gaining momentum in accounting literature recently. Design/methodology/approach Diverse editorial sources (e.g. Elsevier, Emerald, Meridian Allenpress, Springer, Sage, Taylor & Francis and Wiley-Blackwell) were consulted to identify relevant studies for this review. Keywords used to collect studies include “fair value” and “IAS 40” or “investment property” and “fair value or “fair value and real estate.” This search yields 33 studies published between 2009 and 2023. Findings The synthesis of reviewed papers suggests that studies were mainly conducted in the European countries after the mandatory adoption of international financial reporting standards (IFRS) in 2005 and the Australian setting. The first stream of research deals with the choice of fair value approach. Reported empirical findings suggest that corporate size and market-to-book ratio are negatively associated with fair value choice, whereas ownership dispersion increases the likelihood of choosing fair value approach. The empirical evidence concerning the determinants of fair value magnitude suggests the type of appraiser represents a key predictor of the extent of fair value use. The second stream of research examines the impact of fair value reporting in real estate industry. Findings suggest that empirical evidence is still limited with respect to creditors, managers and financial analysts; fair value reporting is generally associated with higher level of value relevance for investors; and the use of Level 3 inputs in fair value estimates for investment properties is associated with high degree of estimation uncertainty for external auditors leading to increased audit risk and fees. Practical implications With respect to regulators, this review emphasizes that the beneficial impacts of fair value reporting are linked to institutional characteristics (e.g. legal system, the degree of market development), the reliability concerns regarding fair value estimates and the independence of appraiser. Because real estate industry is generally characterized by the lack of active market, regulators may adopt regulations requiring the independence external appraiser. Originality/value This literature review represents a historical record and an introduction for accounting scholars, in emerging economies and other settings, where fair value accounting has gained wide acceptance among the investment community. It also offers guidance for future research avenues.

WITHDRAWN: Rank-and-file employee stock options and audit pricing: Evidence from S&P 1500 firms

In this study, we examine the impact of rank-and-file employee stock options on audit fees. We document compelling evidence that option grants to rank-and-file employees are positively related to audit fees. Further analyses show that this positive relation is more pronounced when a firm's real earnings manipulation risk is higher and when rank-and-file employees are more sensitive to monetary incentives. We also find that options granted to rank-and-file employees are positively related to audit efforts. The evidence suggests that auditors perceive options to rank-and-file employees to be associated with increased audit risk.

Foreign exchange risk and audit pricing: Evidence from U.S. multinational corporations

Foreign exchange volatility challenges auditors for not only demanding more audit efforts but also imposing heightened audit risk. We first show foreign exchange risks increase cash flow uncertainty and reduce financial reporting quality, supporting our premise that foreign exchange risks increase audit risk. Next, we find audit fees are higher for MNCs with greater exposure to foreign exchange volatility, but not when MNCs use financial hedging against foreign exchange risk. Furthermore, we show that the impact of foreign exchange risk on audit fees is attenuated by auditor MNC expertise, auditor busyness, and MNC’s operation diversity, whereas the impact is exacerbated for companies facing high pressure to avoid missing earnings targets and for auditors with high market concentration. Overall, our study provides novel evidence of the implications of MNCs’ exposure to foreign exchange risk on financial reporting and auditing, thereby enriching our understanding of MNCs.

Rookie independent directors and audit fees: Evidence from China

This study investigates whether the presence of rookie independent directors (rookie IDs) is associated with audit fees and finds a positive association. Moreover, the positive effect of rookie IDs on audit fees is accentuated for firms whose rookie IDs have no academic background, are appointed by CEOs and are college alumni of CEOs, for firms whose incumbent audit firms have industry specialization and higher reputation, and auditors are risk averse, and for firms with ineffective internal control and operating in a region with a weak legal environment. The study further finds that rookie IDs are less likely to cast dissenting votes, indicating that they do not seem to perform their corporate governance role effectively, therefore increasing audit risk and higher audit fees. This study contributes to the growing literature on rookie IDs and audit fees and facilitates our understanding of the potential cost of appointing rookie IDs in China.

The economic consequences of money laundering: a review of empirical literature

PurposeThe purpose of this study is to provide a timely synthesis of the empirical literature focusing on the economic consequences of money laundering, as this topic has been gaining momentum among policymakers and academic researchers due to its adverse effects.Design/methodology/approachEmpirical studies are collected by consulting accounting and finance journals in diverse digital sources (e.g. Science Direct, Blackwell, Taylor and Francis, Springer, Sage and Emerald). Key words used to identify relevant papers include “money laundering” and “anti-money laundering regulations,” with specific focus on the economic consequences. Our search strategy includes 24 published papers over the period of 2018–2023.FindingsFindings show that most studies represent cross-country investigations; the main topics investigated focus on accounting field (e.g. audit fees, real and accrual earnings management), tax evasion, financial stability, sustainability, economic indicators (inflation, economic growth, foreign direct investment) and financial inclusion; and the economic consequences of money laundering have been also examined within banking industry (e.g. banking profitability, banking stability). Reported findings of reviewed studies suggest that money laundering has diverse adverse impacts at the country level (e.g. increased tax evasion, higher inflation rate, less sustainability and foreign direct investments), at the firm level (e.g. increased audit risk and aggressive real and accrual earnings management) and within banking industry through negative impact of money laundering on bank’s loan portfolio quality, stability and profitability.Practical implicationsWith respect to policymakers, strengthening anti-money laundering regulations may play a critical role in reducing money laundering activities. Furthermore, financial institutions should implement specific rules dealing with anti-money regulations to ensure adequate compliance and disclosure. Finally, policymakers should be aware about the importance of digital transformation to combat money laundering activities since it facilitates the detection of financial crimes due to their traceability.Originality/valueThe summary of the empirical literature focusing on the economic consequence of money laundering represents a historical record and an introduction for accounting researchers. It also urges them to further explore the economic implications of anti-money laundering disclosure within banking industry.

Pengaruh Risiko Audit Dan Stres Kerja Terhadap Motivasi Auditor Pada Kantor Akuntan Publik Kota Padang

This research aims to find out how much influence audit risk and work stress have on the motivation of auditors at the Padang City Public Accounting Firm. In this research, the population is all auditors in public accounting offices in Padang City. The population in this study was 92 people consisting of several employees who had different positions/groups in KAP Padang City. The sampling method used was the accidental sampling method. The regression analysis carried out was multiple linear regression analysis. The research results obtained based on the partial test (t test) showed: (a) The audit risk variable has a positive and significant effect on auditor motivation. (b) The work stress variable has a positive and significant effect on auditor motivation. Meanwhile, the simultaneous test of audit risk and work stress has a positive and significant influence on auditor motivation. Auditors may be motivated by the challenge of performing high-quality audits in the face of increased audit risk. These challenges can provide a sense of accomplishment and satisfaction for auditors who successfully navigate risks and complete high-quality audits. The stress faced in challenging work situations can motivate individuals to try harder and challenge themselves. When someone feels that they can overcome or cope with a difficult task, this can increase their motivation to succeed.

Research on Audit Risk Prevention and Control in Ruihua Accounting Firm

With the rapid development of the market economy, the market environment has become more complex and the forms of economic activities have become increasingly diverse, leading to an increasing audit risk. In recent years, there have been frequent incidents of audit failures in accounting firms, which have greatly impacted the market economy. As a result, people's trust in accounting firms has declined, and doubts have been raised about the professional competence of auditors. This paper takes the audit of Kangdexin by Ruihua Accounting Firm as a research object, aiming to identify specific instances of inadequate quality control in the audit process and propose strategies and recommendations to strengthen audit risk prevention and control.

The Cost of Becoming Informed and Audit Fees

Auditing standards instruct external auditors to read public information to mitigate management’s information advantage in hiding earnings management and fraud. The transparency of this information, and thus the cost of becoming informed using public information, varies across firms. We argue this cost of becoming informed creates an opportunity for earnings management, increasing audit risk. This study finds that higher costs of becoming informed are related to higher audit fees. In addition, we show that executive equity risk-taking incentives and an attitude towards aggressive reporting exacerbate the effect of the cost of becoming informed on audit fees, suggesting complementary effects of these fraud dimensions on audit pricing. These results are more likely due to audit firms charging risk premiums rather than doing additional audit work. This paper contributes to recent research on the costs of becoming informed and to research on the relation between management compensation and auditor compensation.

Economic policy uncertainty, audit quality, and earnings manipulation

ABSTRACT This study examines how audit quality is related to the risk of earnings management when economic policy uncertainty increases. After analyzing 10,524 firm-year samples in Korea from 2012 to 2019, we find that when economic policy uncertainty is high, audit quality, measured by audit fees, audit hours, revised disclosure of financial reports, and discretionary accruals, increases. This implies that auditors increase audit quality at a time of economic policy uncertainty, which results in the improvement in financial information quality. Also, we find that during periods of high economic policy uncertainty, companies with high risk of earnings manipulation disclose higher quality financial information, but pay less audit fees. This suggests that auditors who audit firms with high risk of earnings manipulation adjust to increased audit risk by putting more effort into improving financial information quality, but such increased audit efforts are not reflected in audit fees. The results of the study imply that auditors’ efforts to control audit risks contribute to improving financial information quality in the presence of earnings manipulation risk where information asymmetry increases due to economic policy uncertainty.

The Association between Stock Liquidity and Audit Pricing

SUMMARY Prior research finds that firms' stock liquidity is associated with more aggressive discretionary accruals and revenues, suggesting that firms face pressure to make more aggressive accounting decisions when liquidity is high. However, the literature has yet to examine whether the effects of liquidity on financial reporting quality are severe enough to impact audit risk. We address this gap and offer three main findings. First, we find a positive association between stock liquidity and the probability of restatements, suggesting that the pressures from liquidity to engage in aggressive reporting decisions are severe enough to increase audit risk. Second, we find a positive association between stock liquidity and audit fees, suggesting that auditors at least partially incorporate the audit risk from liquidity into their pricing decisions. Finally, we find that the positive association between liquidity and audit pricing is concentrated in firms with poor corporate governance mechanisms. JEL Classifications: G12; G30; M42.

Does explanatory language convey the auditor’s perceived audit risk? A study using a novel big data analysis metric

PurposeThe purpose of this study is to examine the relationship between explanatory language, audit fees and audit hours to demonstrate that auditors use explanatory language in audit reports to explain perceived audit risk.Design/methodology/approachThe authors construct the sentiment value, a novel audit risk proxy derived from audit reports, using big data analysis. The relationship between sentiment value and explanatory language is then investigated. The authors present the validity of their new metric by examining the relationship between sentiment value and accounting quality, taking audit fees and hours into account.FindingsThe authors first find that reporting explanatory language is positively related to audit fees. More importantly, the authors provide an evidence that explanatory language in audit reports is indicative of increased audit risk as it is negatively correlated with sentiment value. As a positive (negative) sentimental value means that the audit risk is low (high), the results indicate that auditors describe explanatory language in a negative manner to convey the inherent audit risk and receive higher audit fees from the risky clients. Furthermore, the relationship is strengthened when the explanatory language is more severe, such as reporting the multiple numbers of explanatory language or going-concern opinion. Finally, the sentiment value is correlated with accounting quality, as measured by the absolute value of discretionary accruals.Originality/valueContrary to previous research, the authors’ findings suggest that auditors disclose audit risks of client firms by including explanatory language in audit reports. In addition, the authors demonstrate that their new metric effectively identifies the audit risk outlined qualitatively in audit report. To the best of the authors’ knowledge, this is the first study that establishes a connection between sentiment analysis and audit-related textual data.

Институциональный аспект раскрытия ключевых вопросов аудита в аудиторском заключении

Th e article considers the application of ISA 701 “Informing about key audit issues in the auditor’s report”, taking into account industry risks and the signifi cance of audited organizations, including as participants in public procurement. An analysis was made of the selection of key audit issues as areas of increased audit risk, their use to increase the information content of stakeholders about the quality of audit procedures, an approach was formulated to typology of information disclosed in the audit process, taking into account the institutional specifi cs of the audited organizations.

Audit fees and hours of Chinese companies listed on the South Korean stock market

ABSTRACT The number of Chinese companies directly listed on foreign exchanges in the form of offshore holding companies has increased with China’s rapid economic growth. However, different regulations and audit environments between China and other countries as well as the unique characteristics of offshore holding companies may increase audit risk. This study investigates the audit quality of Chinese companies listed on the Korean stock market compared to Korean companies. We find that auditors charge higher overall audit fees and hourly rates and spend more hours auditing Chinese holding companies than Korean companies. We also find that while abnormally high audit hours enhance audit quality of Korean companies, the audit quality of Chinese companies is not improved. Our findings indicate that auditors perceive Chinese companies listed in Korea as having a higher audit risk.

Related party transactions and audit risk

Related Party Transactions (RPTs) are perceived as genuine transactions, which fulfill the economic needs of a company. However, the controlling shareholders may use RPTs as a tool for transferring the firm’s resources for their private benefit. The dual effect of RPTs, i.e., transaction efficiency and conflict of interest between the controlling shareholders and minority shareholders, increase audit risk and as a result, increases the audit fee. The Companies Act, 2013, and Clause 49 of the SEBI listing agreement mandate arm’s length principle of pricing of RPTs. However, there are situations in which the regulations are silent about the method of pricing, and this increases the risk of auditors for auditing RPTs. This study intends to examine the relationship between RPTs and audit risk in India, based on a sample of 1,182 firms covering a period from 31 March 2011 to 31 March 2018. Panel data methodology has been applied for empirical analysis and the results show that higher audit fee is an indication of resource transferring RPTs. The results prove that instead of reducing the complexity associated with RPTs, the new RPTs regulations increase audit fee as a result of the increases in audit risk.

Related Party Transactions and Audit Risk

Related Party Transactions (RPTs) are perceived as genuine transactions, which fulfill the economic needs of a company. However, the controlling shareholders may use RPTs as a tool for transferring the firm’s resources for their private benefit. The dual effect of RPTs, i.e., transaction efficiency and conflict of interest between the controlling shareholders and minority shareholders, increase audit risk and as a result, increases the audit fee. The Companies Act, 2013, and Clause 49 of the SEBI listing agreement mandate arm’s length principle of pricing of RPTs. However, there are situations in which the regulations are silent about the method of pricing, and this increases the risk of auditors for auditing RPTs. This study intends to examine the relationship between RPTs and audit risk in India, based on a sample of 1,182 firms covering a period from 31 March 2011 to 31 March 2018. Panel data methodology has been applied for empirical analysis and the results show that higher audit fee is an indication of resource transferring RPTs. The results prove that instead of reducing the complexity associated with RPTs, the new RPTs regulations increase audit fee as a result of the increases in audit risk.

Sounds Good to Me: How Communication Mode and Priming Affect Auditor Performance

SUMMARYAudit associates routinely interact with clients to request explanations and evidence regarding financial statement account balances. Client explanations may be vague or incomplete. We examine whether auditors' assessments of the quality of client explanations and their decision to follow-up with the client are influenced by (1) communication modes that vary in media richness, and (2) a prime that is intended to stimulate skeptical behavior. Media richness refers to the amount of data inherent in the communication mode. We predict that richer communication modes, such as video, can be more distracting than less rich communication modes, such as email. More distracted auditors will assess the quality of the client's response as higher and are less likely to follow-up with the client—potentially impairing audit quality and increasing audit risk. We predict and find that a prime that focuses auditors on the verifiability of the client's response will mitigate this behavior.

Accounting Personnel Quality, Audit Risk, and Auditor Responses

Auditing standards and anecdotal evidence suggest that accounting personnel’s lack of financial reporting competencies can increase audit risk. This study draws on human capital theory to measure the quality of accounting personnel based on their education level and obtains evidence of how the quality of accounting personnel affects audit risk through examining audit outcomes. It shows that auditors charge higher fees and are more likely to make audit adjustments to companies whose accounting personnel have a lower level of education. The relationship between accounting personnel’s education and audit fees (audit adjustments) is robust to the propensity score matching approach and stronger in companies with more complex operations. Audit firms strategically assign more experienced partners to audit companies whose accounting personnel have a lower level of education. Taken together, these findings suggest that the quality of accounting personnel affects audit risk and audit outcomes.

To Outsource or Not? Evidence from Changes in Component Auditor Use after the Disclosure of An Internal Control Material Weaknesses

This paper investigates how increases in client audit risk influence the use of component auditors. Auditors respond to increases in audit risk by making adjustments to the audit engagement such as increasing fees and/or increasing effort. As more audit resources are demanded by clients with increased audit risk, one way for the lead auditor to free up resources is to allocate more work to component auditors. Using a difference-in-difference research design, with the revelation of an internal control material weakness (ICMW) as an event for increased audit risk, we find that component auditor use increases after the revelation of an ICMW, and increases even more when the ICMW is severe. We also find that the increase in component auditor use after an ICMW is positively associated with the likelihood of ICMW remediation. Thus, we identify a situation where component auditor use enhances audit quality and provides a benefit to the company (i.e., increased likelihood of ICMW remediation). Our study should be of interest to regulators, given the criticism by the PCAOB regarding firms’ use of component auditors and the evidence in prior literature on how component auditor use influences audit quality.

Fair Value Exposure, Changes in Fair Value and Audit Fees: Evidence from the Australian Real Estate Industry

AbstractThis paper investigates the relationship between audit fees and both fair value exposure and changes in fair value of investment properties. The study is motivated by the limited and inconclusive evidence on the effect on audit fees of full fair value reporting for illiquid assets. Using hand‐collected data from the Australian real estate industry, we find a negative (positive) association between audit fees and fair value exposure (changes in fair value of investment properties). Our findings also indicate that the use of unobservable inputs in fair value estimates for investment properties does not significantly increase audit risk and audit fees. Further, we find that audit fees are higher for firms with fair values of investment – properties estimated by external and mixed valuers – compared to firms with fair values estimated by directors alone. This study enriches the audit fee literature by documenting auditors’ pricing decisions in an area that involves significant estimation and valuation risks.

The Price of Stock Liquidity: The Effect of Investor Disagreement on Audit Risk

Prior research finds that the liquidity of a firm’s equity shares is associated with that firm having more aggressive discretionary accruals and revenues, suggesting that firms face pressure to make more aggressive accounting decisions when liquidity is high. However, the literature has yet to examine whether the effects of liquidity on financial reporting quality are severe enough to impact audit risk. We address that gap in the literature and offer three main findings. First, we find a positive association between the liquidity of a firm’s equity shares and the probability of a financial statement restatement, as well as the likelihood it receives a going concern opinion. These findings suggest that the pressures from liquidity to engage in aggressive reporting decisions are severe enough to result in outcomes that would increase audit risk. Second, we find a positive association between the liquidity of a firm’s equity shares and audit fees, suggesting that auditors appear to incorporate the increased audit risk from liquidity into their pricing decisions. Finally, we find that the positive association between stock liquidity and audit pricing is concentrated in firms with poor corporate governance mechanisms. Overall, our results suggest that the effects of liquidity on financial reporting incentives are strong enough to result in outcomes that increase audit risk, that auditors appear to recognize this fact in their pricing decisions, and that these effects are diminished when firms have otherwise strong corporate governance mechanisms.