Misclassification of Audit-Related Fees as a Measure of Pre-Audit Financial Reporting Quality: Implications for Financial Reporting and Audit Quality.

• In Event: Audit Pricing

Abstract

Financial reporting quality (FRQ) is a product of both the accounting system that produced the financial statements and the effort exerted by the auditor to correct errors in the financial statements (audit quality). In this study, we attempt to disentangle these two components to assess whether a higher quality auditor improves financial reporting quality. We suggest that a misclassification of audit-related fees in the unaudited disclosures of the annual report is a proxy for low pre-audit financial reporting quality (PAFRQ). Consistent with our expectation, we find that firms that misclassify audit-related fees are more likely to report a material weakness when compared to firms that correctly classify audit-related fees. Further, firms that misclassify audit-related fees (i.e., low PAFRQ firms) tend to have greater abnormal accruals (lower FRQ) than firms that correctly classify audit-related fees. Finally, low PAFRQ firms audited by a higher quality auditor (Big 4 or Tier 2 auditor) have lower abnormal accruals (higher FRQ) than low PAFRQ firms audited by a lower quality auditor (triennially inspected auditor). In contrast to prior literature suggesting that there is minimal difference in audit quality across auditors (Lawrence et al. 2011), our findings suggest higher quality auditors do improve FRQ.

Authors

• Joseph Legoria, Louisiana State University

• William L Buslepp, Louisiana State University

• Regina Cavalier Rosa, University of New Orleans

• Danny Shaw, Louisiana State University