Are abnormal audit fees informative about audit quality? The moderating role of office resource availability

• Published date: 01 January 2024
• Author: Gopal V. Krishnan,Paul Tanyi
• Date: 01 January 2024
• DOI: http://doi.org/10.1111/ijau.12311

ORIGINAL ARTICLE

Are abnormal audit fees informative about audit quality? The

moderating role of office resource availability

Gopal V. Krishnan

1

| Paul Tanyi

2

1

Department of Accountancy, Bentley

University, Waltham, Massachusetts, USA

2

Department of Accounting, University of

North Carolina Charlotte, Belk College of

Business, Charlotte, North Carolina, USA

Correspondence

Paul Tanyi, Department of Accounting,

University of North Carolina Charlotte, Belk

College of Business, 9201 University City

Blvd., Charlotte, NC 28223, USA.

Email: ptanyi@uncc.edu

Funding information

There was no external funding for this

research project.

We contribute to the literature on the relation between client-level abnormal (excess)

audit fees and audit quality by offering a novel perspective. We posit that audit

office-level resource availability moderates the relation between client-level audit

fees and audit quality. This is because office-level resources (audit partners, staff,

technology and administrative support) are generally shared across engagements and

can augment those engagements that are resource constrained. We first provide evi-

dence that office-level resource availability is informative about audit quality incre-

mental to client-level abnormal fees and several other client and auditor

characteristics, including office size. More importantly, we find that client-level

abnormal fees are informative about audit quality only for audit offices that are

resource-constrained but not for offices that are not resource-constrained.

KEYWORDS

abnormal accruals, audit quality, financial statement divergence score, going concern opinion,

misstatements, office-level attributes, resource-based view

1|INTRODUCTION

Although prior research has examined the relation between abnormal

(excess) audit fees and audit quality reports, it is not clear whether

higher abnormal audit fees are associated with higher or lower audit

quality (Asthana & Boone, 2012; Choi, Kim, & Zang, 2010;

Eshleman & Guo, 2014; Hribar et al., 2014). We contribute to the lit-

erature by offering a novel perspective. We posit that audit office-

level resource availability moderates the relation between client-level

audit fees and audit quality. This is because office-level resources

(audit partners, staff, technology and administrative support) are gen-

erally shared across engagements and can augment those engage-

ments that are resource constrained. Thus, an underpriced client

engagement may not necessarily imply a client resource constraint,

especially if the overall office-level resource availability is adequate.

The audit office may also prioritize the audits of clients paying a pre-

mium when the overall office-level resource availability is inadequate.

The objective of this study is to empirically examine whether audit

office-level abnormal (excess) fees moderate the relation between

client-level abnormal audit fees and audit quality.

We begin with the notion that a successful audit requires ade-

quate resources. Not surprisingly, auditing standards emphasize the

adequacy of resources in performing an audit.

1,2

Indeed, prior

research notes that resource constraints pose a significant risk to

audit quality and can impact auditors' risk perceptions and responses

(Asare et al., 2000; Houston, 1999). Therefore, we conjecture that an

adequately resourced audit office is one where engagements are

priced in such a way that there are enough resources to be allocated

among the various audit engagements without sacrificing the quality

of audit services provided to any one client. Following the resource-

based view (RBV) of the firm (Wernerfelt, 1984), we posit that offices

that are better equipped with financial resources are likely to provide

a higher quality audit than offices with resource constraints.

3

We develop a measure of audit office resource availability that

captures the overall resources available to the audit office based on

how the office prices its entire portfolio of audit clients. Specifically,

for each audit engagement, we estimate normal audit production costs

(expected audit fee) that reflect the amount of resources required to

perform the audit at an acceptable level of quality. The difference

between the total audit fee charged to the client and the normal audit

Received: 22 June 2021 Revised: 8 December 2022 Accepted: 28 February 2023

DOI: 10.1111/ijau.12311

Int J Audit. 2024;28:1–23. wileyonlinelibrary.com/journal/ijau © 2023 John Wiley & Sons Ltd. 1

production costs represents the excess of audit fees (auditor rent/fee

premium) or the deficit of audit fees (auditor loss/fee discount)

derived from that specific engagement. By aggregating the total

excess or deficit of audit fees across the audit office's entire client

portfolio, we can evaluate whether the audit office is reasonably

resourced or not.

4

We calculate the excess or deficit of audit fees as the residual

from a regression of client audit fees on a set of audit fee determi-

nants, including financial misstatements, internal control weaknesses,

auditor expertise and other variables. We estimate the audit fee

model separately for clients of Big 4 and non-Big 4 auditors by year.

Our audit fee model is estimated using more than 44,000 observa-

tions representing years 2004 through 2020. The extent of resources

available to an audit office is the sum of the residual audit fees of all

clients of that office scaled by the sum of the natural logarithm of the

audit fees paid by those clients within a given year. Positive (negative)

values indicate higher (lower) resource availability.

5

Before we test the moderating role of audit office resource avail-

ability on the relation between client-level abnormal audit fees and

audit quality, we first examine whether our measure of audit office-

level resource availability is associated with audit quality. We employ

four proxies of audit quality: abnormal accruals, financial statement

divergence (FSD) score (Amiram et al., 2015), accounting misstate-

ments and the likelihood of issuing a going concern opinion. We find

that incremental to client-level abnormal audit fees and other office-

level variables, absolute abnormal accruals, FSD score and the likeli-

hood of a severe misstatement are decreasing, and the likelihood of

issuing a going concern opinion is increasing, in office-level resource

availability. These results indicate that our measure of audit office

resource availability is incrementally informative about audit quality

over client-level abnormal audit fees and other audit office and client

attributes. Interestingly, we do not find a significant relation between

client-level abnormal audit fees and FSD score, accounting misstate-

ments and going concern opinion.

Turning to our research objective, we find that office-level

resource availability moderates the relation between client-level

excess and audit quality. Specifically, we find that in offices that are

not resource-constrained (i.e., offices with a positive office-level

excess of audit fees), a client-level excess or deficit of audit fees is not

associated with audit quality proxies, consistent with the notion that

excess resources at the office-level can be transferred to resource-

constrained engagements. However, in offices that are resource-

constrained (i.e., offices with a negative office-level deficit of audit

fees), a higher client-level deficit of audit fees (expected audit fee is

greater than actual audit fees charged to client) is significantly associ-

ated with lower audit quality. This is consistent with the notion that

an office that has greater constraints on financial resources may not

have adequate resources to transfer to underpriced audit engage-

ments, resulting in lower audit quality.

We make several contributions to the literature. First, we con-

tribute to the literature on the relation between abnormal audit

fees and audit quality by introducing a perspective that has not

been considered in prior research: the moderating role of office-

level resource availability on the relation between client-level

abnormal audit fees and audit quality. This missing link sheds light

on contexts where client-level audit fees are informative about

audit quality. Specifically, we find that client-level abnormal audit

fees are informative about audit quality only for audit offices that

are resource-constrained but not for offices that are not resource-

constrained.

Second, we contribute to the growing literature on the relation

between office-level attributes and audit quality (Choi, Kim, & Zang,

2010; Francis & Yu, 2009) by providing empirical evidence that incre-

mental to auditor attributes, such as tenure, specialization, auditor

type, office size and office-level growth, office-level abnormal audit

fees are negatively associated with absolute abnormal accruals, FSD

score and severe misstatements and positively associated with the

likelihood of issuing a going concern opinion. Collectively, the results

support the notion that office-level resource availability is an audit

quality indicator.

Third, while prior research has primarily used the agency theory

to explain auditor behaviour and audit quality, we illustrate the appli-

cation of the resource-based theory of the firm from the strategy lit-

erature to understand audit quality.

6

Thus, our research adds to the

nascent literature that explains audit outcomes using insights from

the strategy literature (Bentley et al., 2013; Maijoor &

Witteloostuijn, 1996).

2|PRIOR RESEARCH AND HYPOTHESES

DEVELOPMENT

Francis and Yu (2009) find that larger offices (based on total audit fees

of all clients) of Big 4 audit firms are more likely to issue going concern

opinions, and clients of larger offices are less likely to engage in

aggressive earnings management behaviour. These findings are con-

sistent with the notion that larger audit offices have greater in-house

experience in performing audits. Similarly, Choi, Kim, Kim, and Zang

(2010) provide evidence that office size is positively related to audit

quality (lower abnormal accruals) and audit fees. In a follow-up study,

Francis et al. (2013) find that Big 4 office size is associated with fewer

client restatements, suggesting higher audit quality. In a concurrent

study, Nagy et al. (2018) find that the availability of non-Certified Pub-

lic Accountants (CPA) personnel at the office-level enhances audit

quality. We contribute to this growing literature by proposing a rela-

tive measure of resource availability that reflects the extent of

resources available at the audit office relative to the extent of

resources required to perform its audits, instead of using office size

alone to gauge resource availability. We also control for office size

and other office-level attributes, such as auditor specialization.

Extending the work of Nagy et al. (2018), our measure captures a

broader set of resources that are available to perform the audit not

just the availability of non-CPAs. Also, to the best of our knowledge,

ours is the first study to examine the interrelationship between office-

level and client-level audit fees in enhancing audit quality. This analy-

sis sheds light on the inconsistent findings of prior research on the

2KRISHNAN and TANYI