The Effect of Abnormal Audit Fees and Audit Hours on Discretionary Accruals
Asian Tax Journal Vol. 10 No. 3 (2009), pp. 257-293
Abstract
This paper investigates the effects of abnormal audit fees and abnormal audit hours on audit quality. We test the effect of audit quality on earnings management. Audit quality is defined as the joint probability that an existing material error is detected and reported by an audit auditor(DeAngelo 1981). Prior studies primarily investigate whether earnings management is related to factors that could impair auditor independence and also its studies have regarded the audit fees(or hours) as the proxy of the audit quality but they have not examined the relationship between the unusually high or low audit fees(or hours) and discretionary accruals of auditee. This research decomposes actual audit fees(hours) into two parts, normal audit fees(hours) and abnormal audit fees(hours), and pays attention to the case where abnormal audit fees(hours) are excessively high or low. Earnings management is captured by discretionary accruals as a proxy for unobservable audit quality that are estimated using a performance－matched discretionary accruals(Kothari et al. 2005). We expected greater audit quality(audit fees or audit hours) to reduce the extent to which managers report aggressively high earnings. To test this prediction, we utilize audit fees data from 3,238 firms－year observations 1999－2005 period and audit hours data from 1,897 firms－year observations 2000－2005 period. The sample firms are all listed firms in Korean Stock Exchange, December year－end firms, and firms do not belong to banking industry. The data on audit fees and audit hours are collected from the DART(Data Analysis, Retrieval and Transfer System) of Financial Supervisory Service. Other firm－specific financial data is collected from KIS－VALUE II database. The results show that the discretionary accruals of auditee are higher than expected when abnormal audit fees are much lower. This implies that excessively low audit fees would deteriorate audit quality, but the results of abnormal audit hours are a weak evidences. In addition, when auditors devote audit hours much more than the normal level, the discretionary accruals become lower. This suggests that greater audit effort constrains earnings management and improves the audit quality. Meanwhile, we cannot find significant earnings management when audit fees are highly paid or auditors spend much less audit hours. These findings provide some assurance that audit fees and audit hours are a reasonable proxy for audit quality. The results of this paper may provide useful information to investors and regulatory bodies that evaluate the reliability of external audit by using audit fees and hours information.
Keywords
- Abnormal Audit Fees
- Abnormal Audit Hours
- Audit Fees
- Audit Hours
- Discretionary Accruals
- Audit Quality
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