Do Auditors Care About Real Earnings Management in their Audit Fee Decisions?

Auditor Tolerance of Accrual-Based and Real Earnings Management in Boardrooms of Politically Connected Nigerian Firms

“…The present study argues that an auditor's tolerance of any of the earnings management methods will be influenced by the client choice of earnings management proxy as well as the auditor's reputation and litigation risk (Sohn 2011). The accrual earnings management falls within the Generally Acceptable Accounting Practices (GAAP), which is utilised towards the accounting year-end, but before the issuance of the annual report, when the managers can ascertain that their earnings meet set targets (Gunny 2010).…”

“…In the unpublished work of Sohn (2011), the author finds that auditors consider the implication of their client's earnings management choice through real activities manipulation in their pricing decision. Sohn (2011) reports a positive association between audit fees and real earnings management and that the relationship exceeds the effect of accrual and other earnings management proxies, most specifically for firms with internal control problems (i.e., agency problems). The findings of Sohn (2011) resonate with the assertion by Kim and Park (2009) that auditors are concerned with their client's real earnings management activities.…”

“…Sohn (2011) reports a positive association between audit fees and real earnings management and that the relationship exceeds the effect of accrual and other earnings management proxies, most specifically for firms with internal control problems (i.e., agency problems). The findings of Sohn (2011) resonate with the assertion by Kim and Park (2009) that auditors are concerned with their client's real earnings management activities. Accordingly, auditors charge more audit fees to compensate for the litigation risks associated with clients that extensively engage in real activities manipulation.…”

The Relationship Between Segment-Level Manipulations And Audit Fees

“…Prior work has found that auditors charge higher fees to clients that engage in aggressive reporting behavior such as accruals management (Choi et al 2010, Abbott et al 2006, Gul et al 2003, Schelleman and Knechel 2010. There is also evidence that auditors price real earnings management even though it is in compliance with GAAP (Sohn 2011). This suggests that even if segment-level manipulations technically comply with GAAP standards, the auditor may still elect to price them.…”

The effect of real earnings management on audit fees in listed companies in Tehran Stock Exchange

“…He reported that the level of audit fees could increase in client firms' size, operation complexity, and inherent audit risk because more quantity of resources utilized by the auditor in performing the audit examination would be needed and auditors were exposed to larger possible litigation risks when auditing become more complex. After controlling these three groups of fee determinants, subsequent studies explored additional audit fee determinants including auditor size, non-audit services, auditor change, auditor change direction, auditor brand name and industry specialization, client satisfaction, client risks, client bargaining power, audit committee characteristics, internal control quality, SOX passage, crosslisting and country's legal regimes, education requirement for new accountants, and audit market competition (Sohn, 2011;Palmrose 1986aPalmrose , 1986bFrancis & Simon 1987;Simon & Francis 1988;Craswell et al, 1995;Behn et al, 1999;Craswell & Francis, 1999;Johnstone & Bedard, 2001;Whisenant et al, 2003;Abbott et al, 2003;Ashbaugh et al, 2003;Chaney et al, 2004;Hay et al, 2006, Huang et al, 2007Hogan & Wilkins, 2008;Huang et al, 2009;Choi et al, 2009;Allen & Woodland, 2010, Hay & Knechel 2010Fudenberg & Tirole, 1995;Hoitash et al, 2008).…”