Do adjustments bring auditors peace of mind? The effect of previous audit adjustments on current-year audit pricing

Abstract

Purpose This paper aims to investigate the effect of prior years’ audit adjustments, a proxy for auditors’ private information regarding the persistence of their clients’ audit risk, on audit pricing in the current year. Design/methodology/approach The authors use unique data sets of audit adjustments and audit fieldwork days from China, and a regression approach, to test their hypothesis. Findings The authors find that larger previous audit adjustments are associated with higher current-year audit fees, which is partially attributed to increased audit effort. The authors further document that the results are more pronounced when audit adjustments are consistently made in the same direction or more recent; in these cases, a larger percentage of the total effect is also attributable to the risk premium, instead of audit effort. Finally, the authors find that the effect of previous audit adjustments on current-year audit fees is stronger for firms with younger chief executive officers and specialist auditors. Originality/value To the authors’ best knowledge, they are the first to test the implication of auditors’ private information in setting audit fees. In addition to demonstrating that audit fees consist of a risk premium and a component to cover related costs, the authors further show variations in the relative importance between costs and risk premium under various contexts.

Audit adjustments and the discontinuity in earnings distribution around zero

“…However, these outlier observations do not cause severe concern for the inferences of our paper. As a robustness check, we follow Chen et al (2023) and measure audit adjustment using an alternative measure (ADJUST it = (Pre_E it − Post_E it )/|Pre_TA it |). The results in Panel B2 in Table 2 show the downward adjustments are also larger (27.11%) than upward adjustments (−9.95%) for the full sample.…”

All my rowdy friends: the effect of Super Bowl hosting on audit and financial reporting timeliness

“…Audit fees can reflect the amount of audit effort (e.g. additional audit procedures or expert personnel) required for the audit (Ettredge et al, 2014(Ettredge et al, , 2007Bell et al, 2001;Johnstone and Bedard, 2001;Simunic and Stein, 1996;Davis et al, 1993;Chen et al, 2023). Thus, if audit firms are unwilling to absorb the cost of host-city audit inefficiencies themselves, we would expect to see a positive relationship between Super Bowl hosting and audit fees.…”