BKAA 5013 ISSUES IN AUDITING & INVESTIGATION

SUMMARY 1 The Effect Of Auditor Changes On Audit Fees, Audit Hours, And Audit Quality Donald R. Deis, Jr. and Gary Giroux (1996)

This research is to investigates the effect of independent auditors changes on audit fees, audit hours which was measured as independent audit effort and independent audit quality. The research was conducted by local and regional public accounting firms of

independent school districts which are located at Texas. Several studies had been carried out and one of it was evaluation of the potential determinants of actual independent audit quality by using a metric of audit quality. The authors examined other aspects of audit economics. As for example, they conducted research on brand name, specialization and product costs and effects of them on audit market. However, their main focus is on how both audit fees and audit hours are influenced by audit quality. From the evidence, the authors suggested that independent auditors will not sacrifice their quality in order to obtain a new audit client and even there were lower audit fees detected among initial audit engagements, independent auditors will be hold strong their principles. So, in short if audit effort declines with audit fees on initial audits, so audit quality also will decline. Basically, there are no studies that compared audit fees and audit hours with both audit service quality and independent auditor changes in a single analysis. There are research about initial audits which may lower fees (low balling) but there are no any great deal of research on showing relationship to audit effort, According to DeAngelo (1981a,pp.114, 118-120; 1981b,pp.187-194), he suggested that audit effort will be maintained so that it will be easier for incumbent auditors to generate quasi rents in future. From the introduction, the authors had already brief about their research. They included prior research on initial audits whereby conventional wisdom suggests that whenever public accounting firms offer price discounts, it is for capturing new clients and audit quality will be compromised. It is called as low balling in audit term. The effect low balling is a problematic barring measurement of audit quality. The reason why it said so because if public accounting firms low ball so that they can gain future profits, their audit quality should be threatened by the excessive price discounts. In short, the more the firms do low balling, the more their audit quality get affected (lower) by the low balling.

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BKAA 5013 ISSUES IN AUDITING & INVESTIGATION

Research has demonstrated that independent auditors changes are associated with decreased audit fees as cited from DeAngelo (1981a,pp.114, 118-120; 1981b,pp.187-194). Even though lower fees for initial audit engagements, but it still maintain the product quality. Most independent audit fees do not have data on audit hours or engagements specific measures of audit quality. Plamrose(1986) supported that audit hours whereby she did research on Big Eight audit firms which are high quality audits. She found that the firms commanded higher fees not because of monopoly power but because their higher quality audits. She reiterated that audit hours declined with audit firm tenure while audit fees remained stable. Most of the researches utilized government oversight agency reviews of public accounting firm working papers and audit reports. Deis and Giroux(1992, pp.475-476) indicated that audit quality tends to decline as independent auditor tenure lengthens. Banker et al.( 1992), reported that a positive relationship between audit hours and audit quality. For the research, the authors chose their sample on 232 working paper reviews which is also called as quality control reviews (QCRs) of public accounting firm audits of Texas ISDs which are obtained from Texas Education Agency (TEA) files. They also eliminated 10 accounting firms because lack of fee and hour data. Each OCR culminates in a letter of findings to the public accounting firm by the agencys audit director. It served as the basis from a comprehensive, direct measure of audit quality. Through the review of the article , there are five independent variables which are used in this research namely auditee characteristics, brand name and industry experience, audit production costs, initial audits and product differentiation are selected to test the effect of independent auditor changes on fees, independent audit hours and audit quality. These five independent variables are chosen due to several effects that could generalize the idea on any significant result for those dependent variables. The researchers emphasized on size and per capita income in audit characteristics. The size of the auditee is one of the most important determinant of audit fees and audit hours. Usually, increases in size are associated with increases in audit fees. Meaning that, increases in size of audit firms could potentially increased the volume of audit work concomitantly need for more audit efforts (hours) to accomplish all audit works especially during initial audit engagements where it is assumed this situation is consistent with the determination of set-up costs during the first year audit.

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BKAA 5013 ISSUES IN AUDITING & INVESTIGATION

While brand name and industry experience is selected as one of independent variables due to increased of awareness among business people nowadays about the importance of the reliability of audit firms. This consideration is taking into account because it is a logical thing that many people who have some form of relation with audits would want to know on how audits fees are determined and what are the other elements constitutes in the audit fees charged. It is obvious from common sense that established audit firms with better brand name or reputation and already could potentially to demand higher audit fees as clients are often willing to pay for the brand and experience they had. Therefore, higher fees are expected for risk firms because the audit firms are also at greater risk. Usually, higher fees are also expected to be involving such a qualified or modified opinion because these firms would usually look for more investigation efforts from the audit firms. Audit production costs is a systematic and accurate verification of the cost accounts and records and checking of adherence to the objectives of the cost accounting. In cost audit, it is important for an auditor to examine the correctness of the cost records maintained by the concern and also to report as to whether the cost accounting plans have been adhered to or not. In this research, the researchers focused on three other categorical variables namely a comprehensive annual financial report, internal accounting controls and qualified audit opinions. The comprehensive annual financial report provides a valuable insight into what actually was spent and the status of assets and liabilities at the end of the fiscal year that served a number of purposes for the general public, investors and other interested groups. In side of the auditors responsibility is also to express an opinion on fair presentation of the basic financial statements in conformity with GAAP and indicates that the audit was conducted in conformity with generally accepted auditing standards. Qualified audit opinion is not a good thing since auditors that deem audits as qualified opinons are advising whomever is reading the document that the information within the audit is not complete or there is a possibility that the methods of accounting used by the company do not follow the GAAP. Due to that situation, apart some improvements of audit opinion need to be improved, a potential alternative is that of by paying a higher audit fee to the auditor in order to come out with an improvement in auditing outcome. Indirectly, to improve the audit opinion it will involve a sufficient audit effort to detect any significant noncompliance or a lack of reasonable in business practices. It same goes to internal accounting controls whereby it has been used by auditors to issue a report on the internal

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BKAA 5013 ISSUES IN AUDITING & INVESTIGATION

controls tested as part of the financial statement audit. Audit fees for and audit efforts for companies with internal control problems. Under initial audits, two categorical variables namely as YEAR 1 indicated as the audit was an initial engagement while YEAR 2 indicated as the audit was a second year engagement. The auditors may offer fee discounts on initial engagements in order to attract more new clients and on the other situation, if there is increased in audit risk and thus it seems to increase audit effort and would expect the possibility to increase in initial audit engagement fees. While the second year audit fees and audit efforts are usually predicted smaller than audit fees paid and audit efforts spent due to audit adjustments made in the first year. In terms of product differentiation, the audit fees charged can be varied constituting of the quality of the audits that the audit firms can provide to their clients. To come up with better quality, they must be performing above GAAP by undertaking additional audit procedures. It would be expected that better quality of audits usually tied to some higher audit fee charges and require more audit efforts by external audit firm in order to produce better quality of their audit product. If the auditors already met the legal requirements, why would clients still want the extra quality of the audit? Then, the product differentiation can explain in terms of better quality audits that audit firms provide to its clients. The result of this study showed that auditee characteristics which have been tested for a relationship audit fees are size of of the firm, willingness to offer reduced initial audit fee (lowballing) to auditees. It was confirmed that this lower audit fees is not for the purpose to attract new clients so had to forego the quality of audits provided. Since the results indicated that initial year of audit engagement is associated with lower fees, higher quality and higher audit hours, we could relate it that audit risk is greater for clients that are decreasing in size than for those that are growing. Firms that are decreasing in size will likely have risk factors that require greater audit efforts and quality to be presented. While growing firms may have an increase in risk but not to the same extent. Usually, audit fees are contracted between auditee and auditor before the commencement of the audit. However, the audit fee charges could be varied since the auditor is allowed to perform extra work and to charge for the extra work in case of unforeseen circumstances such as the existence of going concern issues or other audit risk factors. The debate over lowball audit pricing in relation with audit quality has started several years ago since many literature researchers always questioned on the quality of audit on initial
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BKAA 5013 ISSUES IN AUDITING & INVESTIGATION

year low ball engagements. Many say that audit quality remains a largely unresolved issue since we cannot really assure that no fraud is being perpetrated. This is proved by the Financial Reporting Councils Audit Inspection Unit, until 2009 this council found that there was still a lack of audit quality in some of the Big Four and mid-tier audits. The collapse of multiple commercial banks in 2009 also indicated severe lack of audit quality. However, through the article under review, the authors have sugessted in terms of audit quality by improving it through investments made by audit firms specialized in industry expertise and voluntary peer review section. Beside that, they also suggested the declination of audit quality associated with the length of audit tenure. This latest research finding also consistent with De Angelos explaination of opportunistic behavior among incumbent auditors and complacency effect which has been described by Muatz and Sharaf (1961).

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