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What are the implications of major customer dependency, i.e., the degree of a supplier firm’s dependency on its major customers, for external auditors? While the conventional view emphasizes the negatives of major customer dependency for client business risk, we find that suppliers with more concentrated customer bases spend less on audit fees. The evidence is consistent with reduced audit effort due to efficiency gains in the audit process, especially when suppliers with more concentrated customer bases share the same auditors with their long-standing major customers. The audit fee discount we identify does not imply that audit quality declines with customer-base concentration. In fact, we find that suppliers with more concentrated customer bases are less likely to experience material restatements of previously audited financial statements. Taking the external auditors’ perspective, our study provides new managerial insights on the costs and benefits of major customer relationships for supplier firms.

We examine the relationship between residual audit fees and the ability to predict future earnings. Recent research suggests that residual audit fees contain information about accounting quality. However, residual audit fees could either represent high accounting quality or a risk premium for low accounting quality. We extend this literature by providing evidence that residual audit fees are indicative of a lower quality information environment which has a negative impact on investors’ ability to anticipate future earnings. Specifically, we first show that residual audit fees are negatively associated with the ability of current earnings to predict future earnings. Furthermore, residual audit fees are negatively associated with analyst forecast accuracy and positively associated with the dispersion in analyst forecasts. Overall, our results are consistent with the notion that residual audit fees are indicative of poor earnings quality, and that this lower quality manifests itself in a lower quality information environment for investors and analysts. [ABSTRACT FROM AUTHOR]

Copyright of Contemporary Accounting Research is the property of Canadian Academic Accounting Association and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use. This abstract may be abridged. No warranty is given about the accuracy of the copy. Users should refer to the original published version of the material for the full abstract. (Copyright applies to all Abstracts.)

We contribute to the debate on whether the "Big N effect" on audit quality is due to client self-selection by controlling for pre-audit earnings quality. Using data from the Chinese Institute of Certified Public Accountants, we find that pre-audit earnings quality is higher for Big 4 clients. Controlling for pre-audit earnings quality, restatement frequency is lower for Big 4 clients than for non-Big 4 clients, but there is no significant difference in discretionary accruals between Big 4 and non-Big 4 clients. Our findings indicate that Big 4 and non-Big 4 auditors in China pursue different strategies to enhance audit quality. The Big 4 enhance audit quality by recruiting and retaining clients with higher earnings quality and acting more conservatively toward clients with a higher risk for earnings restatement. In contrast, non-Big 4 auditors enhance audit quality by requiring more downward audit adjustments. [ABSTRACT FROM AUTHOR]

The issue of whether audit pricing reflects the effectiveness of the audit committee is of fundamental interest to auditors, managers, and others. Auditors are expected to price the effectiveness of the audit committee because it relates to the control risk and thus, the overall audit risk. This study examines the relation between audit fees and a key determinant of the audit committee's effectiveness—that is, the financial expertise of the audit committee. Though the Sarbanes-Oxley Act mandates the disclosure of a financial expert, the Securities and Exchange Commission (SEC) broadly defined experts to include accounting or nonaccounting financial experts. Does audit pricing differentiate between accounting and nonaccounting financial expertise? For a sample of Standard & Poor's (S&P) 500 firms for the years 2000 through 2002, we find that after controlling for several board and audit committee characteristics and firm characteristics, audit pricing is negatively related to accounting financial expertise. However, this finding is conditional upon the strength of the overall governance structure. We do not find a significant relation between audit fees and accounting financial expertise for observations with weak governance structure. Overall, our evidence is consistent with the SEC's initial narrow definition to include only the accounting financial experts. The lack of a significant relationship between nonaccounting financial expertise and audit fees suggests that auditors perceive that only accounting financial expertise contributes to audit committee's effectiveness. [ABSTRACT FROM AUTHOR]

The accounting profession is facing a credibility crisis precipitated by the failure of several high-profile companies and the alleged failure of their auditors to detect and persuade their clients to recognize economic losses in earnings in a timely fashion. Investors, regulators, analysts, and the public are interested in identifying factors that enhance the timeliness of earnings, particularly about bad news. This study provides empirical evidence on one such factor--auditors' industry expertise. Using a large sample of clients of Big 6 auditors, this research examines the association between auditor industry expertise, measured in terms of an industry's share in the auditor's portfolio of client industries, and the speed with which publicly available bad news about future cash flows is recognized in earnings. The findings indicate that the earnings of clients of specialist auditors are more timely in reflecting bad news than earnings of clients of nonspecialist auditors. This finding is consistent with the notion that auditors' industry expertise moderates the tendency of auditees to delay the recognition of economic losses in earnings. [ABSTRACT FROM AUTHOR]

Copyright of Contemporary Accounting Research is the property of Canadian Academic Accounting Association and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use. This abstract may be abridged. No warranty is given about the accuracy of the copy. Users should refer to the original published version of the material for the full abstract. (Copyright applies to all Abstracts.)

The global accounting convergence and the often discussed probable adoption of International Financial Reporting Standards (IFRS) by U.S. regulators is a timely topic. We contribute to the literature by examining a more recent mandatory IFRS adoption by Canada. Canadian GAAP (CGAAP) is often considered a close substitute for U.S. GAAP. One key feature of this setting is that two earnings numbers are available for fiscal year 2010 since Canadian firms were required to reconcile earnings under CGAAP with earnings under IFRS. We run a \horse race" of earnings quality between earnings under CGAAP and IFRS. We find that on average, relative to IFRS-earnings, earnings under CGAAP have greater association with next period cash flows and higher degree of persistence. Further, when the difference between earnings under CGAAP and IFRS is large, IFRS-earnings are less value-relevant and less persistent. These results strongly support the notion that higher earnings quality is associated with CGAAP. Finally, the results also indicate that differences between CGAAP and IFRS with regard to accounting for financial instruments and investments significantly impair the quality of IFRS-earnings. Our findings are potentially informative to any revival of policy debates on the possible adoption of IFRS by U.S. firms. [ABSTRACT FROM AUTHOR]

Capitalization of software research and development costs (SDC) under SFAS No. 86 is the only exception to SFAS No. 2 that calls for immediate expensing of R&D costs. Although intangible assets have become increasingly relevant for firm valuation, they remain largely unexplored in audit research. This is an important topic because intangible assets, especially those that are internally developed, pose greater challenges in assessing audit risk relative to tangible assets. Capitalization of SDC offers a unique opportunity to study how auditors assess audit risk associated with the recognition of this intangible asset. While capitalized SDC could shed light on software products' potential commercial success and inform the auditor about the client's business risk, the accounting flexibility allowed by SFAS No. 86 also increases the risk of earnings management, and thus implies higher audit risk. Using audit fees as a proxy for audit risk, our results indicate that capitalized SDC are negatively associated with audit fees for firms where capitalization is inconsequential to beating analysts' forecasts, and also for firms with low analysts' following. These results support the notion that capitalized SDC signal lower business risk, especially for firms with low earnings management risk or high private information. [ABSTRACT FROM AUTHOR]

We investigate whether book-tax differences are associated with higher audit fees, a proxy for auditor risk assessments and auditor effort. Our evidence suggests that there is a significantly positive relation. Further, this association is larger for firms that appear to have managed earnings (i.e., have high accruals) relative to those that are tax avoiders (i.e., have low cash effective tax rates). Our evidence is consistent with large book-tax differences representing an observable proxy for earnings management that is associated with auditor decisions. Our study contributes to capital market research that examines audit fees, as well as other research that examines the usefulness of book-tax differences for market participants. [ABSTRACT FROM AUTHOR]

We examine the auditor perception of recognized vs. disclosed obligations as they relate to two key decisions auditors make: determining audit fees and whether to issue a going-concern opinion. We study two pairs of obligations - capital leases and operating leases and on-balance sheet and off-balance sheet pension obligations. We find that operating leases are positively and significantly associated with audit fees but not capital leases. We also find that on-balance sheet and off-balance sheet pension obligations have a similar association with audit fees. For going-concern decisions, auditors regard off-balance leases as real liabilities. However, pension obligations (both on- and off-balance sheet) are not associated with going-concern decisions. Overall, the findings shed light on how auditors regard recognized vs. disclosed obligations in their decisions that are communicated to capital market participants. [ABSTRACT FROM AUTHOR]

The purchase of non-audit services from incumbent auditors has generated considerable attention. Surprisingly, limited empirical evidence exists on the association of non-audit services with firm value. Focusing on services related to financial information system (FIS), we find that the market value of equity is greater for firms that purchase FIS-related services from their incumbent auditors relative to firms that do not. The levels of FIS fees are also positively related to firm value after controlling for total other fees, or total other non-audit fees. Hence, despite the negative perception associated with non-audit services, investors regard FIS-related services as value-adding activities. [ABSTRACT FROM AUTHOR]

This paper provides evidence consistent with firms with Last-in-first-out (LIFO) inventory policy being priced by the market as having lower information risk than First-in-first-out (FIFO) firms. Furthermore, the paper shows that this pricing differential is sustained after controlling for accruals quality, suggesting that the inventory policy signals some information risk characteristics that are not captured by accruals quality measure. We investigate the relation between inventory policy and accruals quality and find that accruals quality is systematically worse for FIFO firms than for LIFO firms after controlling for correlated omitted variables and known firm attributes. These findings complement the currently established relationship between the cost of capital, market pricing and accruals quality by focusing on the need for understanding the incremental effects of individual accounting policies. [ABSTRACT FROM AUTHOR]

We examine the role of investment opportunities as a determinant of the relative importance of cash flows from operations (CFO) and accruals in firm valuation. We find that at low investment-opportunity levels, CFO value-relevance increases with investment opportunities. When investment opportunities are high, accrual value-relevance declines as investment opportunities increase. Consequently, earnings value-relevance first varies directly and then inversely with investment opportunities. We show that the increase in CFO value-relevance is consistent with cost differentials between internal and external financing causing CFO to be an increasingly important determinant of the realization of investment opportunities. The decline in accrual value-relevance at high investment-opportunity levels appears to be attributable to accounting measurement deficiencies. [ABSTRACT FROM AUTHOR]

We investigate whether the use of a high-quality auditor and increased regulatory monitoring of R&D reporting influence both the level of R&D expenditure capitalized by Australian companies from 1992 to 2002 and the market's perception of the reliability of these figures. The results indicate that firms with a higher quality auditor capitalize lower levels of R&D costs, and that in the period following increased regulatory monitoring, firms capitalize fewer R&D costs. Analysis of the value relevance of R&D expenditure indicates that the market positively values R&D costs when expensed as incurred. These results are consistent using both price and returns models. Results are less persistent for capitalized R&D amounts. The finding from the returns model indicates that the quality of the auditor appears to enhance the reliability of capitalized R&D costs, while the price model suggests that the cumulative R&D asset is less relevant in the period following ASC monitoring. [ABSTRACT FROM AUTHOR]

Accrual-based earnings is considered superior to cash flows. Accruals allow managers to communicate their private and inside information and thereby improve the ability of earnings to reflect underlying economic value. However, managers could engage in aggressive reporting of accruals that would seriously undermine the informativeness of reported earnings. Since outsiders cannot directly observe earnings, high-accrual firms face greater agency costs relative to low-accrual firms. Auditing plays an important role in mitigating these agency costs by constraining opportunistic management of accruals. This study examines whether there is a linkage between audit quality and pricing of discretionary accruals. The findings indicate that the association between stock returns and discretionary accruals is greater for firms audited by Big 6 auditors than for firms audited by non-Big 6 auditors. Further, discretionary accruals of clients of Big 6 auditors have a greater association with future profitability than discretionary accruals of clients of non-Big 6 auditors. [ABSTRACT FROM AUTHOR]

This paper investigates whether interperiod income tax allocation, a controversial accounting accrual, facilitates prediction of cash flows. Preparers of financial statements contend that interperiod tax allocation is too complex and costly. Similarly, users of financial statements, particularly financial analysts, often ignore deferred tax information in their assessments of solvency and corporate performance (White et al. 1994). The Financial Accounting Standards Board (FASB), however, maintains that nonallocation of a corporation's income tax expense hinders the prediction of its future cash flows. Our research contributes to this debate by performing an empirical verification of the usefulness of interperiod tax allocation in predicting cash flows. The hypothesized linkage between deferred taxes and future cash flows rests on a linkage between deferred taxes and future income tax payments.We first provide evidence that deferred tax information aids in predicting future tax payments. We then use Lorek and Willinger's (1996) multivariate cash flow prediction model as a benchmark model and provide evidence that the inclusion of deferred tax information enhances prediction of future operating cash flows. This is especially true when deferred tax amounts are large. Overall, our results are consistent with the FASB's view that interperiod tax allocation enhances the prediction of cash flows. [ABSTRACT FROM AUTHOR]