Investigating the Impact of Audit Fees on Financial Audit Quality

This report meticulously examines the intricate relationship between audit fees and the quality of financial audits. It begins by defining audit and its significance, subsequently exploring the correlation between audit fees and audit quality, including the associated advantages and disadvantages. The report delves into the responsibilities of auditors and the potential impact of increased audit fees. A case study is presented to provide practical insights and illustrate the concepts discussed. The report then defines audit quality, analyzes the effects of audit fees on quality, and offers concluding remarks. Furthermore, the report highlights the importance of auditor independence and the potential for conflicts of interest, especially in the context of non-audit services. Examples of real-world scandals, such as the Satyam scandal and the Lehman Brothers bankruptcy, are used to underscore the consequences of compromised audit quality.

Impact of Audit Fees
on the Audit Quality

1
By student name
Professor
University
Date: 25 April 2018.
1 | P a g e

2
Executive Summary
A report has been prepared on the impact of the audit fees on the audit quality and what are the
impact areas and how the same can be resolved. The report highlights the relationship between
the two terms and what are the pros and cons of the audit and who are the stakeholders being
impacted. A case study has also been given in the assignment and the brief analysis has been
done basis which conclusion on the topic has been drawn.
2 | P a g e

3
Contents
Introduction.................................................................................................................................................4
Audit- Its Meaning.......................................................................................................................................4
Relationship between Audit Fees and Audit Quality...................................................................................4
Responsibility towards the Auditors............................................................................................................6
Pros and Cons of increased Audit fees........................................................................................................6
Case Study...................................................................................................................................................7
Audit Quality- Its meaning...........................................................................................................................7
Analysis of Audit fees and its Quality..........................................................................................................8
Conclusion...................................................................................................................................................9
References.................................................................................................................................................10
3 | P a g e

4
THE IMPACT OF AUDIT FEES IN AUDIT QUALITY
Introduction
The audit of the financial statements of the entity hold immense importance in the modern world
as there are a lot of stakeholders whose decision is dependent on and guided by the financial
statements. Off late, it has been seen that there have been a widespread impact of the audit fees
on the quality of the financial statements and therefore agencies all round the world are trying to
establish the link between the audit fess and the audit quality. The same has been demonstrated
below along with the impact areas and the recommendations.
Audit- Its Meaning
Audit refers to a systematic independent examination and verification of books of accounts,
transactions, and other relevant documents of the organisation and physical inspection of
inventories.
Independence in relation to audit means that the external as well as the internal auditors are
independent from parties/client Company who may have a financial interest in the business being
audited. They should not influence the opinion of the Auditors given on the financial statements
(Appelbaum, et al., 2018).
The independent declaration forms the part of Directors report presented in the annual report
which has been given in accordance with the appropriate Standards of the country. Further, there
should be no digression from the ethical requirements of the Accounting Professional and Ethical
Standards.
Relationship between Audit Fees and Audit Quality
It has been hereby said to have a critical discussion regarding the increased/decreased audit fees
which affect the quality of audits conducted. As debated, it is said that more the audit fees the
4 | P a g e

5
greater would be the quality of audit performed by the auditors. The pros and cons are hereby
stated (Axelsen, et al., 2017).
Audit procedure is unique and different among other professional services because of the
following two reasons:
 First, auditors being hired and paid in terms of audit fees by the client for whom they
work and audit the organisation, but their service is actually beneficial for the investors
who invest in the company looking at the financial position, and all other stakeholders of
company to whom they are responsible too. (Belton, 2017).
 Secondly, the quality of audit cannot be judged before and even after conducting the
audit of the organisation. It is only understandable when the auditors give a written
statement in the Audit report stating its opinion on the financial statement off the
company. Thus, due to unavailability of records of the quality of audits one should check
into the reputation and the goodwill of the auditor as well as the audit firm respectively.
Ways in which the quality of audit can be affected by the fees paid to the auditors:
When auditors are paid high amount of fees to enhance the quality of audits it seems that the
efforts put in by the auditor increases as well. But the fact being services which are not related to
audit termed as non-audit services brings a undue influence by the client towards the auditors
where resulting in the failure of conducting such audits the cots are borne by the auditor himself
(Bumgarner & Vasarhelyi, 2018). There is a difference on how fee structure and client
importance affect the independence of the auditor which is the biggest quality of the auditor
himself. It is concluded that the reason for the independence of the auditor is related to the efforts
put in by the auditor and not the increased fees as the efforts would result in good reputation and
goodwill of the audit firm. Abnormal fees is charged only on the basis of the size of the client
company, how difficult and huge it is to audit such a company as well as the risk involved in
auditing. (DeZoort & Harrison, 2016).
It is said that the fees paid to the auditors are merely considered as a substitute for an increased
quality of audit. Whereas, a high amount of fees equalises the efforts put in the conduction of
audit resulting in high maintenance of audit. The auditors give the client greater contribution on
commenting on the financial statements resulting in a qualified audit opinion due to high fees
paid. Examination on the dependency of audit fees and earnings quality is an essential
5 | P a g e

6
component of a higher audit quality performed by the auditing firms (Sithole, et al., 2017).
According to the auditing and finance perspective, there has been a factual proof regarding the
inverse relation between audit fees and its earning capacity affecting the audit quality, whereas
inverse relationship hereby relates to where increased audit fees doesn’t affect the quality of the
audit precisely and vice versa.
Responsibility towards the Auditors
The expectations from the auditors is that they perform efficient and high quality audits keeping
in mind the professional norms and policies and working according to the Generally Accepted
Auditing Standards. The audit valves and the audit itself has provided for different techniques to
imply a decent understanding for an independent audit result from the auditors. The auditors are
also taken care of while performing audits in a company. (Linden & Freeman, 2017).
The goodwill relies on the way they conduct their services with utmost best professional attitude
and the loss of the same in the way of gaining of reputation being at stake by being violating the
independence of the auditor.
The size of the firm matters while conducting audits as bigger the size the greater would be the
losses due to the failure of efficient audits because their goodwill in turn affects the society in a
way and will therefore provide higher quality audits.
Auditors who are paid high fees in an abnormal manner will allow the client company to make
the auditor dependent on it (Dichev, 2017).
Pros and Cons of increased Audit fees
This shows that increased audit fees is good as well as bad for the auditors. In case where
auditors are given high fees it has the tendency to be a victim to the demands of the clients as the
clients are financially overpowering the auditors whereas if the client stops the services provided
by the auditors where the losses are suffered (Lessambo, 2018).
6 | P a g e

7
Case Study
A case study for a better understanding has been illustrated below which says:
An analysis was conducted to ensure on the Bank Charging Companies that the higher fees of the
auditors affect the quality of the audits or not. Auditors play an important role to show a true
view of the financial statements prepared by the clients and according to the GAAP as stated
above as are relevant in the countries. (Knechel & Salterio, 2016).
The laws and regulations which is given to the audit quality and the fees paid has given
tremendous amount of importance and kept it on priority.
Understanding the relationship between earnings quality and audit fees is of mandatory
importance (Kew & Stredwick, 2017). It has been found that many top officials and managers of
the company trust that many companies, around 20%, manage earnings even when they are
within the boundaries of GAAP. Therefore, it shows that the audit fees plays a significant role in
the overall quality of the audit.
Audit Quality- Its meaning
The quality of audit is judged by the auditor’s power to detect any false representation of the
financial statements and thus provide an opinion upon it. The Auditing standards relevant in
countries provides a reasonable understanding for the auditors to provide good quality audit
where knowledge and understanding of the policies and procedures of the audits are conducted
upon. (Bailey, et al., 2017). As said above that the audit quality cannot be measured that
whether it’s of good or bad inference so considering it difficult.
The auditor is given fees for the audit conducted by himself or rather by the audit firm. Fees is
charged on the quality of audit performed by the auditor which has been analysed and examined.
Various models was placed in order to conclude to a statement showing the relationship between
audit fees and audit quality.
 Simunic (1980) developed a model where the fees of the auditors is according to the
performance of audit and any abnormal loss incurred. (Goldmann, 2016).
7 | P a g e

8
 Dye (1995) analysed and developed a model that the auditor has to incur both direct costs
and indirect cost which is all the costs incurred towards performing the audit to remove
the losses.
 Bedard and Johnstone (2004) show that auditors can tackle risk by putting in much effort
and effectively using the auditing standards for the same.
Analysis of Audit fees and its Quality
The actual research has examined the link between audit fees and earnings quality. Some said
that abnormal audit fees is a positive effect of good quality audits but some denied the same
statement saying that it has a negative impact on the auditor’s reputation while performing
audits, but their results hold only when the auditors are paid at a higher rate which is termed as
premium and where paid at a lower rate it is termed aa discount. (Meroño-Cerdán, et al., 2017).
On the other hand, the clients keep an undue influence on the auditor if they are charged high
fees from the client company and thus can result in a misrepresentation of the financial statement
according to the auditing standards relevant in the country in which it operates. The client
company makes it sure that the audit firm listens to their demands because of which they are
giving higher amount of fees to them (Trieu, 2017). In the failure of it, the client company can
stop or halt the services provided by the auditor resulting in the losses which has to be borne by
the auditor himself. This finding would be consistent with yet another above stated model.
Examples:
One of the examples which is appropriate here is the Satyam scandal which took place in the
year 2009 in India where the auditors were Price Waterhouse Coopers (PWC). When the
chairman accepted the misstatement of the financial statement the statutory auditors being the
PWC was penalised with a fine and has been barred from conducting audits for a stipulated
number of years for not obeying the rules and laws of the auditing standards relevant in India and
therefore, being a victim of the consequences.
8 | P a g e

9
The second example is of the case of Lehman Brothers which took place in New York in the year
2008 Bankruptcy case. It involved the auditors Ernst & Young who were also kept for the fraud
charges. The case was that Lehman Brothers was charged for negligence in the financial
statements of the company which has shown the wrong position to the Stakeholders. A clear
audit report was given by the auditors of this company despite of the fact that it was under huge
debt and was incurring losses. E&Y had been charging a high amount of audit fees during those
years to which Lehman Brothers had accounted for and henceforth, a case was filed on the
auditors for charging a high amount of fees to conduct the audit which was later disclosed.
These examples show that the increased audit fees doesn’t always result in high quality audits
and can cause the client company to exercise an undue influence upon the auditors to show a
false representation of the client company.
Conclusion
Therefore, we derive that if we provide high audit fees it affects the independence of the auditors
sometimes and the auditors becomes biased for the client company resulting in the manipulation
of the financial statements and that can lead to scandals. The examples, definitions and all the
complexities which assemble and form part of the auditors opinion does conclude that In this
critical discussion it is hereby concluded that audit fees whether increased or decreased does
affect the quality of audit which makes the auditor dependent on the client company and also
doesn’t affect the quality of audit which hereby maintains the auditor’s independence and giving
a unbiased audit opinion in the audit report.
9 | P a g e

10
References
Appelbaum, D., Kogan, A. & Vasarhelyi, M., 2018. Analytical procedures in external auditing: A
comprehensive literature survey and framework for external audit analytics.. Journal of Accounting
Literature, 40(1), pp. 83-101.
Axelsen, M., Green, P. & Ridley, G., 2017. Explaining the information systems auditor role in the public
sector financial audit. International Journal of Accounting Information Systems, 24(1), pp. 15-31.
Bailey, C., Collins, D. & Abbott, L., 2017. The Impact of Enterprise Risk Management on the Audit
Process: Evidence from Audit Fees and Audit Delay. Auditing: A Journal of Practice & Theory, 37(3), pp.
25-46.
Belton, P., 2017. Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat
International ltd.
Bumgarner, N. & Vasarhelyi, M., 2018. Continuous auditing—a new view.. Continuous Auditing: Theory
and Application, 20(1), pp. 7-51.
DeZoort, F. & Harrison, P., 2016. Understanding Auditors sense of Responsibility for detecting fraud
within organization. Journal of Business Ethics, pp. 1-18.
Dichev, I., 2017. On the conceptual foundations of financial reporting. Accounting and Business
Research, 47(6), pp. 617-632.
Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business.
Financial Environment and Business Development, 4(3), pp. 103-112.
Kew, J. & Stredwick, J., 2017. Business Environment: Managing in a Strategic Context. second ed.
London: Chartered Institute of Personnel and Development.
Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.
Lessambo, F., 2018. Audit Risks: Identification and Procedures. Auditing, Assurance Services, and
Forensics, 3(1), pp. 183-202.
Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making. Business
Ethics Quarterly, 27(3), pp. 353-379.
Meroño-Cerdán, A., Lopez-Nicolas, C. & Molina-Castillo, F., 2017. Risk aversion, innovation and
performance in family firms. Economics of Innovation and new technology, pp. 1-15.
Sithole, S., Chandler, P., Abeysekera, I. & Paas, F., 2017. Benefits of guided self-management of attention
on learning accounting. Journal of Educational Psychology, 109(2), p. 220.
10 | P a g e

11
Trieu, V., 2017. Getting value from Business Intelligence systems: A review and research agenda.
Decision Support Systems, 93(1), pp. 111-124.
11 | P a g e