Do adjustments bring auditors peace of mind? The effect of previous audit adjustments on current-year audit pricing
ISSN: 0268-6902
Article publication date: 28 October 2022
Issue publication date: 28 February 2023
Abstract
Purpose
This paper aims to investigate the effect of prior years’ audit adjustments, a proxy for auditors’ private information regarding the persistence of their clients’ audit risk, on audit pricing in the current year.
Design/methodology/approach
The authors use unique data sets of audit adjustments and audit fieldwork days from China, and a regression approach, to test their hypothesis.
Findings
The authors find that larger previous audit adjustments are associated with higher current-year audit fees, which is partially attributed to increased audit effort. The authors further document that the results are more pronounced when audit adjustments are consistently made in the same direction or more recent; in these cases, a larger percentage of the total effect is also attributable to the risk premium, instead of audit effort. Finally, the authors find that the effect of previous audit adjustments on current-year audit fees is stronger for firms with younger chief executive officers and specialist auditors.
Originality/value
To the authors’ best knowledge, they are the first to test the implication of auditors’ private information in setting audit fees. In addition to demonstrating that audit fees consist of a risk premium and a component to cover related costs, the authors further show variations in the relative importance between costs and risk premium under various contexts.
Keywords
Acknowledgements
The authors appreciate comments from Jie Zhou (Editor-in-Chief), Elizabeth Brunson (Associate Editor) and the two anonymous reviewers. We also appreciate comments from workshop participants at 2018 American Accounting Association (AAA) annual Meeting in Maryland (Washington, DC). The authors are thankful for the financial support of the Natural Science Foundation of China (Grant No. 71672009 and 71972011) and Start-up Research Fund for Young Teachers of Capital University of Economics and Business (Grant No. XRZ2022034).
All authors contribute equally.
Citation
Chen, S., Magnan, M., Tian, Z. and Yao, L. (2023), "Do adjustments bring auditors peace of mind? The effect of previous audit adjustments on current-year audit pricing", Managerial Auditing Journal, Vol. 38 No. 3, pp. 241-263. https://doi.org/10.1108/MAJ-02-2022-3461
Publisher
:Emerald Publishing Limited
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