The association between abnormal audit fees and audit quality after IFRS adoption. Evidence from Korea

• Published date: 01 August 2016
• DOI: https://doi.org/10.1108/IJAIM-07-2015-0044
• Date: 01 August 2016
• Pages: 252-271
• Author: Soo-Jung Jung,Bum-Joon Kim,Ju-Ryum Chung
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

The association between

abnormal audit fees and audit

quality after IFRS adoption

Evidence from Korea

Soo-Jung Jung

Business School, Seoul National University, Seoul, Korea

Bum-Joon Kim

School of Business Administration, The Catholic University of Korea,

Buchen, Korea, and

Ju-Ryum Chung

School of Business, Yonsei University, Seoul, Korea

Abstract

Purpose – This paper aims to examine how the relationship between abnormal audit fees and audit

quality changed after adoption of the International Financial Reporting Standards (IFRS) in Korea.

Design/methodology/approach – Using empirical data collected over the period from 2008 to 2013,

this study analyzes the association between abnormally high/low audit fee and audit quality. This

study uses linear regression to test the hypothetical relation using discretionary accrual as a proxy for

audit quality.

Findings – This study nds that there exists no signicant relationship between abnormally high

audit fees and audit quality measured by the magnitude of discretionary accruals in the pre-IFRS

adoption period. However, the relationship between abnormally high audit fees and the magnitude of

discretionary accruals turns to be positive in the post-IFRS adoption period. These nding suggests that

the IFRS enables some clients to engage more discretion in the choice of discretionary accruals and

auditors charge higher audit fees in return for allowing the discretion for such clients.

Practical implications – This study provides insight to regulators of the need to review carefully the

nancial statements of rms with abnormally high audit fees, and to investors to be more cautious when

using nancial information about these rms.

Originality/value – To the best of authors’ knowledge, this is the rst study to assess IFRS impact on

audit fee-quality relation. Also, unique Korean audit market with intensifying competition and

discounting audit fee provides interesting setting to review the impact of abnormal audit fee on audit

quality.

Keywords IFRS adoption, Audit quality, Abnormal audit fee

Paper type Research paper

This paper is developed from the master’s thesis of Soo-Jung Jung, Seoul National University in

2015. The authors appreciate the invaluable comments from Young-Min Kwak (discussant) and

participants at the Korea Accounting Association Annual Meeting in 2015 as well as anonymous

reviewers. Specially, Soo-Jung Jung thanks Jong-hag Choi (academic advisor) for his sincere

supports and suggestions. The authors take responsibility for any remaining errors.

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1834-7649.htm

IJAIM

24,3

252

Received 10 July 2015

Revised 15 September 2015

Accepted 28 September 2015

InternationalJournal of

Accountingand Information

Management

Vol.24 No. 3, 2016

pp.252-271

©Emerald Group Publishing Limited

1834-7649

DOI 10.1108/IJAIM-07-2015-0044

1. Introduction

The purpose of this study is to identify how the association between abnormal audit fees

and audit quality changed after adoption of the International Financial Reporting

Standards (IFRS). In particular, we investigate how audit fees above or below normal

levels are associated with audit quality, and then how this relationship changed after

adoption of the IFRS.

Prior studies show asymmetry in the relationship between audit fees and audit

quality (Larcker and Richardson, 2004;Higgs and Skantz, 2006;Hope et al., 2009;Mitra

et al., 2009;Choi et al., 2010). Thus, we analyze this relation separately depending on the

sign of abnormal audit fees.

A review of the literature reveals two conicting viewpoints on abnormally high

audit fees. One is based on economic bonding theory, which states that audit

independence may be threatened by the economic dependence of auditors on client fees,

which may lower audit quality. Economic bonding occurs when clients overpay

auditors in return for them allowing managerial discretion in nancial reporting (Choi

et al., 2010). The other viewpoint is based on audit effort theory, which states that

abnormally high audit fees compensate for auditors’ additional efforts to increase audit

quality (Eshleman and Guo, 2014).

In Korea, there is erce competition in the audit market; therefore, clients frequently

demand discounts, which accounts for the fee discounting phenomenon so prevalent in

the rst year of auditing for so many Korean rms (Lee and Liu, 2011;Lee et al., 2011).

This practice also prevents appropriate fee increases from reecting relevant risks, as

assessed by auditors (Lee et al., 2009). In addition, audit risk is relatively lower in Korea

than in other developed countries, especially litigation risk as measured by the Wingate

litigation index (Wingate, 1997;Choi et al., 2008). As a result, auditors have less incentive

to provide high-quality audit services. In this situation, if clients pay higher than normal

fees in anticipation of gaining their auditor’s approval for specic accounting practices,

auditors and clients can form an economic bond, which often relates to impaired audit

quality (Choi et al., 2010;Reynolds et al., 2004).

On the other hand, in the Korean local audit market, where audit fees are generally

discounted due to high competition, abnormally high audit fees may compensate

auditors for effort that has not been adequately compensated before, which may

contribute to an increase in audit quality to some extent. In this case, economic bonding

theory may not be applicable. By contrast, auditors may be paid abnormally low fees.

This may indicate that the client rm has greater bargaining power, especially in the

competitive Korean market (Asthana and Boone, 2012); however, it may also indicate

low audit effort, which impairs audit quality. Alternatively, when the audit risk is low,

as assessed by the auditor, audit fees would not be associated with audit quality.

The IFRS is a principle-based accounting standard that outlines accounting policies;

however, how each principle should be implemented is not prescribed in detail. This

situation inevitably triggers use of managerial discretion and subjectivity (Ahmed et al.,

2013). Accordingly, auditors’ professional judgment about the extent and effects of

managers’ discretion is required. Auditors must make additional efforts, examining a

wider range of accounting choices and dealing with increased complexity because of the

IFRS (Kim et al., 2012). As a result, audit fees increased in many rms to reect

additional audit efforts after adoption of the IFRS. In addition, the IFRS affords rms

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Audit fees and

audit quality