The Auditors Report

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Sudip Bhattacharjee, Virginia Tech
Duane Brandon, Auburn University
Gary Peters, University of Arkansas and
Reed Smith, Indiana University-Purdue University Indianapolis

"The Impact of Competition on Audit Planning, Review, and Performance", by J. Bierstaker, R. Houston, A. Wright, Journal of Accounting Literature, (Volume 25, 2006): 1-58.

This paper reviews prior studies on audit quality and other questions related to the effects of competition in the audit market. Due to increased competition, concerns have been raised that competition was a driving force in the occurrence of several alleged audit failures in recent years. The paper identifies a number of promising research opportunities in response to issues not fully considered in prior studies and to the new post Sarbanes-Oxley Act landscape. The authors indicate that, while some may say that competition is no longer of concern in the current environment where quality is of highest priority, in the long run audits must be cost-effective in fulfilling their societal role. The issue for auditors is one of balancing professional and competitive priorities.

"Client Importance and Non-Big 5 Auditors' Reporting Decisions" by A. K. Hunt and A. Lulseged. Journal of Accounting and Public Policy (Volume 26, Issue 2, March-April, 2007):

The authors examine the effect of the trade-off between economic dependence and reputation protection on the link between client size and the audit reporting decisions of non-Big 5 auditors. They find that non-Big 5 auditors, like Big 5 auditors, do not allow their larger clients greater leeway to manage earnings. In fact, there is some evidence that non-Big 5 auditors treat their larger clients more strictly. They also report that, non-Big 5 auditors, like Big 5 auditors, are at least as likely to issue a going-concern report to their potentially financially distressed larger clients as they are to their otherwise smaller clients.

"Non-Audit Services, Auditor Quality and the Value Relevance of Earnings" by F. A. Gul, J. Tsui, and D. S. Dhaliwal. Accounting and Finance (Volume 46, Issue 5, December, 2006):

The authors examine whether there is an inverse relation between non-audit services (NAS) provided by a firms auditor and the value relevance of earnings and that this relation is weaker for firms with Big 6 auditors. The paper is motivated by the argument that the provision of NAS by the external auditor is likely to adversely affect investors' perceptions of the credibility of financial reports, and that Big 6 auditors, because of reputational capital and litigation costs, are likely to mitigate the adverse effects of NAS. Results, using Australian companies, document a statistically significant inverse relationship between NAS and the value relevance of earnings, and this inverse relationship is weaker for Big 6 auditors.

"The Chief Financial Officer's Perspective on Auditor-Client Negotiations", by M. Gibbins, S. A. McCracken, S. E. Salterio, Contemporary Accounting Research, (Volume 24, Issue 2, 2007): 387-422.

This paper reports how a sample of Canadian CFOs viewed the negotiation process and context during auditor-client negotiation about difficult client accounting issues. Results indicate that the CFOs saw negotiation with the auditors as a consequence of change in accounting and disclosure standards or personnel influential to their financial reporting or business changes. Negotiation was thrust upon the CFO, and the CFO then had to manage it. The CFOs informed other management and was aware of their interests, but did not generally seek their help. Informing the Board or the audit committee of the issue was much less frequent. The issue being negotiated was seen as complex, requiring research and analysis, and dependent on knowledge and expertise, with the result more likely reflecting form over substance.

"Internal Audit Professionalism and Section 404 Compliance: The View of Chief Audit Executives from Northeast Ohio", by A. L. Nagy and W. J. Cenker, International Journal of Auditing, (Volume 11, 2007): 41-49.

This study explores the notion that the recently heightened regulation over public company reporting limits the amount of professional judgment required by internal auditors, and in the long run may reduce the overall value and professionalism of the internal audit group. The study reports the results of face-to-face interviews with Chief Audit Executives (CAEs) from 17 publicly listed companies. The authors find that despite several short-term benefits from the Section 404 work for the individual auditor (e.g., increased pay and job security), the compliance work may be a threat to the long-term reputation of the internal audit profession. Based on the existing literature and the CAEs' responses, the Section 404 work does appear to be driving the internal audit profession down a new path.

"Relation between External Audit Fees, Audit Committee Characteristics and Internal Audit" by J. Goodwin-Stewart and P. Kent. Accounting and Finance (Volume 46, Issue 3, September, 2006): 387-404

The study examines whether the existence of an audit committee, audit committee characteristics and the use of internal audit are associated with higher external audit fees. Higher audit fees imply increased audit testing and higher audit quality. The authors find that the existence of an audit committee, more frequent committee meetings and increased use of internal audit are related to higher audit fees. The expertise of audit committee members is associated with higher audit fees when meeting frequency and independence are low. These findings are consistent with an increased demand for higher quality auditing by audit committees, and by firms that make greater use of internal audit.

"Auditor Fees, Market Microstructure, and Firm Transparency" by B. R. Danielsen, R. A. Van Ness, and R. S. Warr. Journal of Business Finance and Accounting (Volume 34, Issue 1/2, Jan/Mar, 2007): 202-221.

The authors examine whether auditors price their knowledge of firm opacity in their audit fees by examining two competing hypotheses. The first states that higher audit fees may reflect the greater risk that the auditor faces in auditing an opaque firm. Under this hypothesis, market based measures of opacity will be positively correlated with higher fees. The second hypothesis states that firms buy reputational capital from their auditor by paying high fees in an attempt to improve the market's perception of the firm's transparency. In this case, higher audit fees are negatively correlated with market based measures of opacity. The results are consistent with the first hypothesis, that auditors price opacity risk into their fees.

"Non-Audit Services and Auditor Independence: A Review of the Literature" by A. Schneider, B. K. Church, and K. M. Ely. Journal of Accounting Literature (Volume 25, 2006):

The authors review and synthesize research on NAS and auditor independence. The studies included investigate perceptions of auditor independence, investor behavior and market reactions, and the role of corporate governance in the perception of the auditor's provision of NAS. The authors conclude that fees generated from NAS do not affect investors' perceptions of auditor independence. Management's decision to retain the auditor could cause auditors to compromise decisions/judgments in the interests of audit relationship, thus impairing independence. One consistent finding across three stakeholder groups (users, auditors, and managers) is that NAS can impair independence in appearance but does not seem to impair independence in fact.

"Auditor Fees and Audit Quality" by R. Hoitash, A. Markelevich and C. A. Barragato. Managerial Auditing Journal (Volume 22, Issue 8, 2007): 761-786

The paper examines the relation between fees paid to auditors and audit quality. The authors use proxies based on client size, complexity and risk to estimate abnormal fees. The authors use two metrics to assess audit quality - the standard deviation of residuals from regressions relating current accruals to cash flows and the absolute value of performance-adjusted discretionary accruals. Results indicate a statistically significant negative association between total fees and both audit quality proxies over all years examined. The results (pre- and post-SOX) are consistent with economic bonding being a determinant of auditor behavior rather than auditor reputational concerns.

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