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Empirical Tests of Audit Budget Dynamics
Michael L. Ettredge, University of Kansas
Jean C. Bedard, Bentley College
Karla Johnstone, University of Wisconsin - Madison
ABSTRACT. Prior research suggests that managers design budgets based on prior performance relative to budget targets, and that this “ratcheting” response can be asymmetrical (i.e., a greater increase in target following good performance than a decrease in target following correspondingly bad performance). This implies a dynamic view of budgeting, in which the budget is an endogenous feature of the business environment, a perspective not previously applied in the auditing literature. We test for and find asymmetric budget ratcheting by audit firm management in a sample of actual audit engagements. Further, we find that engagement teams’ reported hours also vary asymmetrically with prior budget variance. Our findings suggest temporal interdependence between audit firm management and engagement teams as both parties act strategically to adapt budgeting and reporting behavior based on prior budget variances, with associated implications for audit quality.
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