Study: Expensive Audits Not Necessarily Good Audits

By:
Chris Gaetano
Published Date:
Nov 15, 2017
small sock

A study looking at differential audit fee shocks by large versus small accelerated filers has found that there's no substantive relationship between the size of the audit fee and the quality of the audit, measured as decreases in discretionary accruals and a lower likelihood of subsequent restatements of audited financial reports.

The paper, Effects of SOX 404(b) Implementation on Audit Fees by SEC Filer Size Category, which will soon be published in the Journal of Accounting and Public Policy, used a sample of 4,028 firm-year observations of 2,014 firms between Nov. 15, 2003 and Nov. 14, 2005, representing the pre- and post-404(b) period for companies. This sample included 1,342 large accelerated filer firm-years from 671 firms, 1,470 small accelerated filer firm-years from 735 firms, and 1,216 non-accelerated filer firm years from 608 firms. 

The study's authors―Michael Ettredge from the University of Kansas, Matthew G. Sherwood from the University of Massachusetts Amherst, and Lili Sun from the University of North Texas―said that the higher audit fees that occurred in the wake of the Sarbanes-Oxley Act's 404(b) provisions should imply higher audit quality as well. This, it was found, was not the case, at least when looking at audit quality through the lens of subsequent restatements and discretionary accruals. 

"While we cannot speak to the topic as a whole, through this study, we show that the increase in fees associated with 404(b) compliance does not translate to higher audit quality," said the paper's conclusion. 

The study also found that small accelerated filers experience relatively greater audit shocks from 404(b) compliance than large accelerated filers (107.8 percent versus 84.6 percent), which the authors attribute to audit offices' bargaining power relative to their clients. It also said that 404(b) "generated an immediate increase in demand for audit services with no corresponding sudden increase in supply of experienced audit personnel, enabling audit firms to charge higher prices for all filers including [non-accelerated filers]." 

Click here to see more of the latest news from the NYSSCPA.