Previous studies generally suggest that internal control and external auditing can substitute for each other, so that better internal control will be associated with lower audit fees. However, their empirical results do not support this view. In contrast, previous studies of the interaction between corporate governance and external audit services often assume that they are complementary, and that improved governance is associated with higher audit fees, although the evidence about this issue is also mixed. We examine whether the 'substitution' or 'complementary controls' views apply. We find that measures of internal auditing, corporate governance, and concentration of ownership are all positively related to audit fees, consistent with the explanation that controls are complementary. The study makes a contribution by assisting regulators in understanding the effects of regulation of corporate governance, and by showing auditors and auditing standard setters that the view that internal controls can substitute for external auditing may not be helpful. We also find that these relationships hold only in a relatively less-regulated environment.
SUMMARYMost previous research that examined relationships among external audits and other sources of control (e.g., internal auditing) is based on an assumption that decisions about risk reduction reflect the potential substitution of one control for another. In contrast, previous studies of the interaction between corporate governance and external audit services often suggest that they are complementary, although the evidence on this issue is also mixed. We present arguments that controls, governance and auditing are complements, not substitutes, and that an increase in one will lead to an increase in the others. Our results are consistent with these propositions. This issue of the relationship between internal control and audit fees is of interest because there are two contrary views expressed in the literature regarding internal control on the one hand and Correspondence to David Hay,
Patients exposed to a surgical safety checklist experience better postoperative outcomes, but this could simply reflect wider quality of care in hospitals where checklist use is routine.
Purpose
Changes to the auditor’s report have been proposed and issued internationally to provide more relevant information to users and enhance the perceived value of financial statement audits. This paper aims to investigate the impact of audit reporting changes on audit quality and audit fees in the New Zealand context.
Design/methodology/approach
The authors examined audit quality measured by absolute abnormal accruals and audit fees for New Zealand listed companies.
Findings
The evidence suggests the enhanced audit reports were followed by an improvement in audit quality as proxied by a reduction in absolute abnormal accruals upon the adoption of the new audit reporting requirements. There was also a significant increase in audit fees.
Practical implications
Although the new auditor reporting requirements are associated with improvements in audit quality, such benefit does not come without cost.
Originality/value
The study provides evidence about the impact of this recent substantial reform to auditing.
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