The Effect of Write-Offs on Audit Fees: Theory and Evidence

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Journal Title
Journal ISSN
Volume Title
School of Business | Master's thesis
Date
2018
Major/Subject
Mcode
Degree programme
Accounting
Language
en
Pages
59 + 7
Series
Abstract
The objective of this master’s thesis is to examine the effect of write-offs on audit fees. The research focuses on a question whether the audit fee increases if the amount of write-offs increases and in what magnitude. In addition, other determinants of audit fees, auditor and auditee characteristics, are studied. The study also presents general principles and processes related to writing off an asset as well as some challenges related to them also from auditors’ point of view. The empirical tests are executed with a regression analysis. The data is collected from Compustat and Audit Analytics databases and it includes write-offs that are done during the period between 2005 and 2017 by US listed companies. After adjusting the data, the final sample consists of 5809 observations. The data includes observations from all industries (excluding financial institutions) and write-offs of different accounts. Companies’ audit fee and financial information are merged by using companies’ CIK codes. Prior research literature presents a common audit fee pricing theory in which the audit fee is a proxy for audit effort and different auditee and auditor characteristics impact on the amount of the fee. When combining write-offs into the fee model, audit effort is expected to raise as the write-offs and impairment tests are prone to management manipulation as the fair value estimates are partly made based on their own judgements. The unverifiable results create challenges for auditors to give an audit opinion whether the companies’ financial statement are free from material misstatements and the information is accurate. In addition, auditee characteristics such as company size, profitability, riskiness and complexity are factors affecting the audit effort. Also, whether the auditor is a one of the Big 4 companies, is studied to have an increasing effect on audit fees. The results of this thesis suggest that one percentage point increase in write-offs, increases audit fee by 0.011 %. The effect is positive as hypothesized but it is minor. However, companies with large annual write-offs encounter raise in their audit fee. The research findings also support the audit fee determinants with results that indicate that the larger the company, as in more assets and sales, the higher the audit fee is. In addition, Big 4 auditors’ audit fees are 53.8 % higher than non-Big 4 auditors’. These study results extend and support the prior research literature of write-offs and audit fees with a conclusion that write-offs, as well as other discussed determinants, have an effect on audit fees. Companies and auditors can further exploit the findings in business practice.
Description
Thesis advisor
Jarva, Henry
Keywords
write-off, impairment, audit fees, accounting conservatism
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