The Effect of Auditing Standard No. 5 on Audit Fees

Posted: 12 Sep 2011

See all articles by Jagan Krishnan

Jagan Krishnan

Temple University - Department of Accounting

Jayanthi Krishnan

Temple University - Department of Accounting

HakJoon Song

California State University, Dominguez Hills

Date Written: March 2011

Abstract

In June 2007, the PCAOB issued Auditing Standard No. 5 (AS5), superseding Auditing Standard No. 2 (AS2). AS5 significantly changed the rules relating to audits of internal control over financial reporting (ICFR). Policymakers expected AS5 to lead to improvements in audit efficiency and thus a general reduction in audit costs, and specifically a reduction in fees for smaller and less complex companies that were disproportionately affected by AS2.

We investigate the impact of the change from AS2 to AS5 on audit fees. We restrict our analysis to stable client-auditor combinations to ensure that auditors had prior AS2 experience with the client before the transition to AS5. We find that, after controlling for other factors, audit fees were lower in the first two years of implementation of AS5 relative to the last year of AS2. The decrease in fees was the highest for companies that had remediated material weaknesses in their internal control and thus moved from an adverse opinion under AS2 to a clean opinion under AS5. Further, firms that received first-time adverse opinions on their internal control in the AS5 period paid lower fee premiums (relative to firms with clean opinions) than did firms with adverse reports in the last AS2 year. Finally, in contrast to policymakers’ expectation that AS5 would generate cost savings by allowing the ICFR audits to be “scaled” for small and less complex firms, there is no evidence that the smallest firms benefited. Specifically, audit fee savings were found only for relatively more complex firms (measured by multiple segments and international operations).

Keywords: Audit fee, AS5, Audit Quality, PCAOB, SOX 404

JEL Classification: G38, L84, M41, M49

Suggested Citation

Krishnan, Jagan and Krishnan, Jayanthi and Song, HakJoon, The Effect of Auditing Standard No. 5 on Audit Fees (March 2011). Auditing: A Journal of Practice & Theory, Vol. 30, No. 4, 2011, Available at SSRN: https://ssrn.com/abstract=1925917

Jagan Krishnan (Contact Author)

Temple University - Department of Accounting ( email )

Fox School of Business & Management
1801 Liacorous Walk
Philadelphia, PA 19122
United States
215-204-8126 (Phone)
215-204-5587 (Fax)

Jayanthi Krishnan

Temple University - Department of Accounting ( email )

Philadelphia, PA 19122
United States
215-204-3085 (Phone)

HakJoon Song

California State University, Dominguez Hills ( email )

1000 E. Victoria Street, Carson, CA
Carson, CA 90747
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
2,378
PlumX Metrics