Accrual reversals and audit fees: the role of abnormal audit fees^*

*Accepted by Hong Hwang upon recommendation by Phyllis Mo

Abstract

This study examines whether abnormal audit fees impair auditor independence or reflect auditors’ efforts by using accruals reversal. All accruals must ultimately reverse, but those reversals have different effects on earnings persistence. Management may communicate the private information by different kinds of accruals. Therefore, auditors that have inside information should be able to identify managers who use their reporting discretion accruals to signal private information to investors. Our results suggest that normal audit fees reflect audit effort to identify different kinds of accruals reversal, but positive abnormal audit fees impair audit quality.

Keywords:

• Accruals reversal
• abnormal audit fees
• internal control
• earnings persistence
• audit fees

Notes

* Accepted by Hong Hwang upon recommendation by Phyllis Mo

1. Sox 201 prohibits nine kinds of services: (1) bookkeeping or other services related to the accounting records or financial statements of the audit client; (2) financial-information system design and implementation; (3) appraisal or valuation services, fairness opinions, or contribution-in-kind reports; (4) actual services; (5) internal audit outsourcing services; (6) management functions or human resources; (7) broker or dealer, investment adviser, or investment banking services; (8) legal services and expert services unrelated to the audit; and (9) any other services that the board determines, by regulation, are impermissible.

2. We measure variance inflation factor (VIF) to examine potential multicollinearity problems in regression analyses. The maximum value of VIF (3.7045) is well below the threshold of 10 (Marquardt 1980; Gujarati 1995).