Audit Fees and IAS/IFRS Adoption: Evidence from the Banking Industry

• Date: 01 July 2014
• DOI: http://doi.org/10.1111/ijau.12019
• Author: Pietro Perotti,Mara Cameran
• Published date: 01 July 2014

Audit Fees and IAS/IFRS Adoption: Evidence from the Banking Industry

Mara Cameran1and Pietro Perotti2

1Università Bocconi,Milan, Italy

2University of Graz,Austria

The adoption of International Accounting Standards/International Financial Reporting Standards (IAS/IFRS) has

two opposite effects on audit fees: on the one hand, greater effort is required from auditors, which is likely to be

reflected by higher fees; on the other hand, if IAS/IFRS improve the quality of financial reporting, expected

liability costs could decrease and lower fees may be demanded. We consider a large sample of Italian banks and

we examine the effect of IAS/IFRS adoption on audit fees. The results show that higher fees (19.29 per cent in real

terms) are paid after the switch to the new standards. Using a standard earnings management model, we do not

find support for the idea that financial reporting quality is affected by the adoption of IAS/IFRS. The observed

increase in fees is positively associated with the presence of financial derivatives held for hedging purposes. This

paper extends the findings of prior research on the effect of IAS/IFRS adoption on audit fees; contrary to prior

contributions, our analysis concentrates on the banking industry. Furthermore, unlike prior works, we consider

both listed and non-listed firms.

Key words: Audit fees, banking industry, IAS/IFRS adoption, IFRS transition, financial derivatives, hedge

accounting

1. INTRODUCTION

Auditing activity is a critical aspect of the switch to new

accounting standards, and audit fees represent a part

of the related implementation costs. In this paper we

investigate how the introduction of the international

accounting standards (IAS/IFRS) influences auditors’fee

determination in the Italian banking industry. We argue

that IAS/IFRS adoption has two opposite effects on fees.

On the one hand, the use of IAS/IFRS – which are

principle-based and fair value oriented standards, as

opposed to previous Italian regulation – implies greater

effort for auditors; this is likely to be reflected by higher

fees. On the other hand, if IAS/IFRS improve the quality

of financial reporting, the expected liability costs for

auditors decrease, which may, therefore, lead to lower

fees.

The effect of the adoption of IAS/IFRS on fees paid to

auditors is at the centre of a debate among practitioners.

The professional press reports an increase in audit fees

paid in Europe in 2005 due to the adoption of IAS/IFRS

(Accountancy Magazine, 2005). Some anecdotal evidence

based on UK FTSE 100 audit fees confirms this view

(Accountancy Magazine, 2005, 2006), while an ICAEW

(Institute of Chartered Accountants in England and

Wales)survey conducted among investors, preparers and

auditors across 23 EU countries shows that ‘the costs of

auditing IFRS implementation were significant, ranking

as the second highest cost for companies with turnover

below €500m and the third highest for larger companies’

(ICAEW, 2007, p. 61). According to the same source, 67

per cent of the auditors said that ‘their audit fee for the

first set of IFRS financial statementswas higher as a direct

consequence of IFRS’ (ICAEW, 2007, p. 72). It has also

been argued that the demand for auditing work is

expected to increase with the adoption of IFRS in the US

(Accountancy Age, 2008).

Only a few academic works are concerned with the

change in audit fees after IAS/IFRS adoption. Griffin,

Lont and Sun (2009) find an audit fee increase associated

with the adoption of IAS/IFRS and the concurrent

introduction of new corporate governance rules in New

Zealand. Vieru and Schadewitz (2010) investigate fee

determination in the transition year to the IAS/IFRS for

small and medium-sized Finnish companies. Kim, Liu

and Zheng (2012) develop an analytical audit model to

examine the effect of IAS/IFRS adoption on fees through

audit complexity and financialreporting quality; they test

the predictions of the model using datafrom 14 European

countries and excluding the financial industry. The

aforementioned studies generally find an increase in fees

after IAS/IFRS adoption. The sample of all the analyses is

limited to listed firms.

We extend the findings of prior research on IAS/IFRS

adoption and audit fees as we concentrateon the banking

industry. Furthermore, unlike previous works, we

consider both listed and non-listed firms.

The relationship between auditors and banks is a

critical regulatory issue. The recent credit derivatives

market turmoil highlighted the importance of internal

and external control mechanisms in the banking industry.

As argued by previous empirical studies on the

divergence of opinions among market participants and

analysts (Morgan, 2002; Flannery, Kwan & Nimalendran,

2004), banks’ financial statements are more opaque than

those of non-financial firms. The bottom line is that

intermediation risk and, specifically, loans and financial

assets are hard to monitor from the outside; as a

consequence, in such an opaque environment, auditing

activity plays a particularly important role in mitigating

information asymmetries.

Our analysis focuses on the Italian banking industry.

One benefit of using datafrom a single industry is that our

analysis does not suffer from the industry effect problem

(Carson, 2009; Reichelt & Wang, 2010; Francis, 2011).1

Weargue that Italy is a suitable setting for our study for at

least three reasons. Firstly, according to Italian regulation

(see Section 2), all Italian banks are obliged to use

IAS/IFRS in their annual accounts. This allows us to

Correspondence to: Mara Cameran, Università Bocconi, Dipartimento

Accounting, via Röntgen, 1, 20136 Milano, Italy. Email: mara

.cameran@unibocconi.it

International Journal of Auditing doi:10.1111/ijau.12019

Int. J. Audit. 18: 155–169 (2014)

© 2013 John Wiley & Sons Ltd ISSN 1090-6738