Willie E. Gist

Empirical evidence on the functional relation between audit planning and total audit effort

In this study we examine the relation between the extent of audit planning and total audit effort. While it is well recognized in the literature that the effectiveness and efficiency of an audit is dependent upon audit planning, no empirical evidence has been presented that demonstrates whether audit planning in fact leads to a more effective or efficient audit. A modified version of the basic audit pricing model used throughout the literature introduced by Simunic (1980) is used to examine the relationship between an independent variable measuring the extent of audit planning and a dependent variable measuring total audit effort, expressed in hours. We provide evidence that audit planning reduces total audit effort and is subject to diminishing returns. This outcome appears to support the contention with respect to the extent of the tradeoff between audit planning and audit verification hours when audit effectiveness is taken into consideration.

Forced auditor change, industry specialization and audit fees

Purpose - The purpose of this study is to explore the effect of industry specialization on the absorption and competitive pricing (or lack thereof) of audits of large Andersen clients (S&P 1500 companies) who switched to the remaining Big 4 international accounting firms in 2002 due to the demise of Arthur Andersen LLP (Andersen). Did the audit clients pay a premium or discount in audit fees to their new auditor who specialized in their industry? Design/methodology/approach - Ordinary least squares regression is used to test hypothesis of a positive association between industry specialization and audit fees charged to former Andersens audit clients in 2002 following Andersens demise. This study provides more control over size effects by design. Test variables are constructed based on national market share of audit fees within an industry. Logistic regression is used to examine the likelihood of choosing new auditor that is an industry specialist. Findings - Results support hypothesis, consistent with auditor differentiation explanation. Proportion of clients that had engaged an industry specialist in 2001 increased from 38 percent (84 clients) to 48 percent (105 clients) in 2002. No evidence of price-gouging in 2002 although clients who aligned with industry specialist paid a 23.2 percent premium in audit fees. Large clients lost bargaining power to negotiate lower fees. Findings are robust to the inclusion of additional alternative measures of company size. Research limitations/implications - Results of logistic regression analysis imply that large audit clients with former auditor of tarnished reputation, long auditor tenure and high leverage are more likely to switch to an industry specialist to possibly signal audit/financial reporting quality. Large sample companies may limit the ability to generalize findings to smaller companies. Practical implications - Mandatory audit firm rotation (currently being debated in the profession) will have costly effect on the pricing of Big 4 audits for companies wanting to signal audit and financial reporting quality to affect market perception, and large companies would likely lose their ability to bargain for lower audit fees. Originality/value - The paper focus on the alignment of Andersen clients and impact on audit fees with Big 4 industry specialists resulting from the sudden increase in audit market concentration. Prior to Andersens collapse, evidence on the association of audit fees premium and industry specialists was mixed, and little attention has been given to the influence of auditor industry specialization on both audit fees and alignment of former Andersen clients with a Big 4 specialist. This paper fills that void.

How audit fees are affected by a client under SEC investigation

We examine the effect of a US Securities and Exchange Commission (SEC) investigation of the audit client on audit cost. Ordinary least-squares models along with a match-paired design and publicly available auditor fees data are used to analyse the relation between an SEC investigation event and audit fees. The finding of a positive and significant relation supports our hypothesis that the business risk of a client under investigation by this regulatory agency is perceived to be higher than that of a client not under investigation. This finding is important given that certain factors may work against observing an effect. This study contributes to the literature by determining that auditors charge a statistically and economically significant average audit fees premium that ranges from 49.9% to 56.2% to clients under SEC investigation. One implication is that client management has fee-related incentives to avoid regulatory misconduct/scrutiny and produce financial statements free of material misstatement.

The predictive ability of accounting operating cash flows: a moving window spectral analysis

In this paper, evidence is provided on the predictive ability of quarterly operating Cash Flows (CFs). The inability of creditors and investors to anticipate future CFs based on historical CFs, with any degree of accuracy, may suggest that historical forecasting models are underspecified. Indeed, the discontinuities, variability, seasonality and trend in CF data may require additional, and as of yet, undisclosed variables, to enhance the predictability of extant forecasting models. In this study, Moving Window Spectral (MWS) analysis, a frequency domain approach, is applied to accounting time series data for the first time in an effort to assess the predictability of aggregate operating CFs. This method is adopted due to its ability to capture trend and multiple cyclical components in the data. Our results show that CFs can be reliably predicted using aggregate data on a firm-by-firm basis. In addition, our results outperform the results previously reported in the accounting literature. This research provides insight into the properties of accounting time series data not possible from a strictly time domain analysis. The implications of this and other findings for accounting and auditing are discussed.