Financial versus operating liability leverage and audit fees

Abstract

We argue that different types of leverage have different implications for audit risk and audit fees, and hence need to be separately examined. Using data from the years 2004 to 2016, we find that operating liability leverage is positively associated with audit fees and that financing leverage is negatively related to audit fees. The results suggest that the benefits from monitoring effects of financial leverage outweigh the costs associated with the risk of financial distress and financial misreporting. We also find that estimated operating liability leverage has a bigger effect on audit fees than contractual operating liability leverage, consistent with suggestions that auditors are more conservative in the presence of higher estimation risk. Thus, our findings highlight the importance of recognizing sources of leverage in audit risk in general and audit fee models in particular.

Current Year Audit Opinion and Next Year Audit Fees: Does Family Ownership Matter?

“…This result is consistent with Joshi and Al-Bastaki (2000) and Smith et al (2019). Also, consistent with Barua, et al (2019) and Smith et al (2019), COMPLEXITY is positively associated with audit fees, implying that the risks related to such accounts will require auditors to make special auditing procedures such as confirmation, and this will make auditors ask for a fee premium.…”

“…Consistent with Barua et al (2019) and Bhattacharya and Banerjee (2020), regression results show that AGE is positively associated with audit fees at the 1% significance level, suggesting that as firms become older and more involved in transactions, they will need more efforts and sometimes require higher experience level. This will put pressure on auditors to incur higher costs and so will ask for higher audit fees.…”

“…Based on a sample of 223 firms that changed their fiscal year ends during the period from 2004-2014, the authors found that changing fiscal year ends to a nonbusy season, audit fees and efforts will be significantly reduced. In U.S. also, Barua et al (2019) In India, Bhattacharya and Banerjee (2020) examined the determinants of audit fees and the effect of financial distress on audit pricing. Based on a sample of 22,644 firm year observations of Indian firms during the period from 1990-2015, the authors found that audit fees are positively associated with affiliation to Big4 audit firms, have industry specialization and offering audit and non-audit services.…”

“…Following Barua et al, 2019, Bedard et al, 2019and Smith et al, 2019, complexity is measured by the percentage of receivables and inventory to total assets as those accounts are considered risky balance sheet components and require special audit procedures (Simunic, 1980;Caneghem, 2010;Hay, 2013). It is recommended to use both accounts as a proxy for inherent risk than examining each account separately (Hay et al, 2006).…”

What is it going to cost? Empirical evidence from a systematic literature review of audit fee determinants

“…Therefore, we can support the assumption that the auditor will increase the audit fees when the client is not making profits. Nonetheless, there are some studies with conflicting results (Vafeas and Waegelein 2007; Ittonen and Peni 2012; Barua et al 2019). In addition, we identified different studies that use a proxy for audit fees if (not only) the profit of the actual period or prior periods is negative.…”