Audit Firms' Characteristics Paper Example

Audit Fees and Audit Cost

Audit fee refers to the remunerations done to auditors for their delivery of the services of auditing. The audit fee incorporates the overall cost through the work of auditing, profit demand, and risk compensation. The audit fee affects the audit industry, the accounting firm's development and audit quality. The original work of research on audit fee by Simunic (1980) highlights the auditor and client's attributes that are related to the level of the audit fees. Mate analysis is used in testing of the effects that arise from the independent variables identified as the drivers for the audit fees. Through meta-analysis, researchers are able to come up with more valid inference concerning the topic under investigation.

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Audit cost represents adherence to amount required in accounting plan and cost accounts verification. The cost ensures that there is conformity in plans, objectives, cost accounting principles and procedures. Cost audits can get performed to help the management, or as a directive by the federal government. The government performs the cost audit in cases where there arises a need for financial help or protection of the citizens against overpricing.

In this paper, the driving forces of audit fees will be evaluated according to the existing literature. The audit fees vary depending on the audit fees determinants. Such determinants are used by scholars as the variables. Some audit clients are able to recognize the auditor characteristics that suggest a high-quality audit (Francis & Stokes, 1986). The characteristics that the clients evaluate will be discussed. The existing literature also highlights demand and supply among the factors that can affect the audit fees (Hay, Knechel, & Wong, 2006). The literature on demand and supply considers the seasons that the audit services demand goes through within a business year.

Importance of audit

Auditing assists a firm to evaluate its weaknesses and strengths (Schneider, 1985). The weaknesses present the firms with areas that require improvement while the strengths act as motivating factors towards the firm's goals. Through auditing firms are able to detect gaps that expose the firm to fraud. Not only does auditing detect chances of fraud but also serve as a protective measure against accounting irregularities and fraud.

Literature Review

The study of audit fees is marked by Simunic (1980) study after the realization that the auditing industry had eight firms being accused of monopolizing the industry. The study by Simunic was aimed at exposing the existence of competition in the auditing industry. The competition evidence was based on the evaluation of a sample of audit fees. The study aimed at providing an explanation of why the market should be shred lather than being dominated by a group of auditing firms.

The available pieces of literature for audit fee focus on the issue in two dimensions; that is, audit firms and audit clients.

Audit Clients

From the view of the audit clients, a practical strategy was used by Simunic (1980) in determining the driving forces for the audit fee. The study found out that the size of business assets and its complexity affect the number of audit fees. On a different study, Firth (1985) conducted a study whose results are in line with Francis and Stokes (1986) idea that the size of a business and its complexity are among the major audit fees determinants. Clearly, complex businesses have complex financial structures and require a lot of auditors' efforts during the auditing process. The effort involved can be a clear suggestion for the higher audit fees. Moreover, complex businesses tend to have many transactions that require keenness during audit contributing to extended audit period.

Many scholars have been trying to evaluate the correlation between audit fees and the governance of a company. Gregory and Collier tried to examine the audit fee governance correlation and found out that the audit fees can get influenced by the presence of an audit committee. In their argument, they suggest that the audit committee ensures auditors integrity and reduce the chances that the auditors reduce the time allocated for auditing thereby resulting into the rise of the audit fees (Collier & Gregory, 1996). The study of Gregory and Collier got based on the audit market in the UK. From a survey conducted by Carcello, Hermanson, Neal, and Riley (2002) on the information sourced from a list of 1000 Fortune companies, the researchers found out that there were higher chances that companies with professional management, diligent and independent will get charged a higher audit fee. Research by Cai (2007) found out that the sizes of shareholder holdings, a board of directors, nature of the enterprise and CEO duality all affect the audit fees. Cai Jifu found out that the audit fees can get reduced by the efficiency of the company. Liu Wei and He Weifeng (2015) found out that if the managers of a company possess more abilities, they are likely to pay a lower amount of audit fees. The management thus has a lot of influence on the fee charged on an audit.

Other scholars have studied the influence of the business and cooperate risks on audit fees. One of the studies found out that as the risk in a client business increase, the time of audit increases. The increase in the audit period does not affect the audit fees, indicating that business risk must have gotten a consideration when setting the audit fees (Bell, Landsman, & Shackelford, 2001). Litigation risk affects the auditing fees whereby it increases with a positive discretional accrual. In another research on the correlation of the earnings of the management and the audit fees, it was concluded that the audit fees are likely to be higher for the companies whose managerial staff earn a more elevated amount of salaries (Zhao & Wang, 2008). The audit fees were also found to be higher for the companies suffering from penalties.

The client attributes can be categorized into business size, profitability, inherent risks, ownership, complexity, and leverage. In such categories, the aspect of firm size determines the time, amount of work and the intensity of the audit. The size of a firm gets delineated by the size of the assets that the client firm owns. The revenue generated can be used as an allotment of the firm's size. The size of a firm is transformed using the law data natural logarithm to modify the relationship they possess with the audit fees. The variations observed on the scale exceed 70% with the percentage being lower in smaller firms. Eighty-seven studies conducted on the relation bounded by audit fees and firm size used assets in size determination. A positive coefficient of similarity got obtained from the researches (Francis, 1984).

It becomes harder to audit complex clients. When dealing with sophisticated clients, the auditors tend to use a lot of time and require to make complex decisions. In such audits, the auditing firms tend to charge a higher fee. Researchers exploring client's complexity suggest that the number of subsidiaries can be used in the estimation of the levels of complexity. Other measures of a firm's complexity include foreign subsidiaries, standard industrial classification, foreign assets, business segments, audit locations and the ratings provided by auditors on the complexity. The studies conducted leave no doubt on the affirmative and significant homogeneity between complexity and scrutiny fees.

The profitability of the client measures the risk since it reflects the levels to which the audit possess is prone to lose in a case where the client lacks financial viability. In general terms, audit fees are supposed to get higher where the organization under the audit has a poor performance. The ration of the net income to the total assets gets used in the measurement of the performance. A negative relationship gets observed on the return on assets and audit fees correlation. The audit fees and return on asset relationship maybe not linear since losing money does not possess a similar impact as to when the company is making a profit. Loss dummy gets treated by the auditors as a crude metric which needs low calibration thus does not have a clear reflection on the states at which the auditing firm considers high risk.

Audit Firms

From the auditing firms' point of view, a high number of business school individuals assume that the factors are based on the firm alone. The size of the audit firm, however, does not possess a lot of influence on the audit fees as compared to the client firm. Wang and Li (2006) based their argument on the A-share information about the firms that were listed. The conclusion they drew was that the audit fees do not get a significant effect from the size of the audit firm (Li & Wang, 2006). However, the study done by Stokes and Francis affirms that the size of a firm correlates considerably with the audit fees. The study was supported by the information sourced from the firms listed in from Australia (Francis & Stokes, 1986). Wu Lina, a domestic scholar, affirmed the information from the Chinese registered firms in 2001 and 2000 and discovered that the top accountancy companies charged higher audit fees.

Apart from the realization that the specialization of a firm in trade can affect the audit fees, an Australian study conducted by Tylor, Craswell, and Francis (1995) revealed the concept differently. The study exposes a supportive fact that the top 5 ranked auditing firms in the trade earn 34 audit fees premiums compared to the other different corporations in Australia. The information exposed that the audit shoppers focus more on the quality of the audit process, therefore, are ready to pay more for the services from the top firms. One of the indicators of quality as depicted by the study was higher audit fees. The audit shopper level determinants of audit fees were found and suggested to remain distinct considering the differences in the individual auditor level (Carson & Fargher, 2007).

The previous studies as evident from the reviewed works of literature focus mainly on audit fees determinants at the perspective of the audit client. This study identified a gap in the contributing factors to a qualifying amount of the audit fees at the audit firms. The study will widely focus on these determinants.

Audit Firms' Characteristics

The study aims at exposing the possibility of whether a client is likely to put in mind the individual auditor level when selecting a firm to hire for audit services. The study will also focus on the possibilities that a client can pay premiums to the auditing firms that have a high-quality legacy. From the available kinds of literature, it is clear that the determinants of the size of audit fees have a possibility of getting measured from the auditor's level and audit client level. It is also clear that the quality of the audit is a likely reason which contributes to high audit fees. The audit fees and quality correlation contrast the conclusion of some scholars on the auditor's characteristic. The correlation suggests a difference among the individual auditors since their attributes affect the decision-making process and the cognitive styles were thereby interfering with the quality of an audit.

The users of the audit services lack knowledge and information, and access to the financial statements. The result is the formation of opinions about the quality of the audit services basing their arguments on the extended attributes that can determine the quality of an audit. Such broad measures include the size and th...