How Auditors Price Business Risk: A Framework and Experiment

Posted: 20 Aug 2001

See all articles by Richard W. Houston

Richard W. Houston

University of Alabama

Michael F. Peters

University of Maryland

Jamie H. Pratt

Indiana University - Kelley School of Business - Department of Accounting

Date Written: Undated

Abstract

In this study, we develop and test a framework suggesting that auditors consider three sources of business risk when setting audit fees: (1) the level of audit investment and residual (acceptable) audit risk, (2) litigation exposure unrelated to audit risk, and (3) residual business risk. Residual business risk includes all risks and/or opportunities associated with the audit not captured by sources (1) and (2). We test the framework through an experiment with audit partners and managers. The results support the framework and suggest that audit fees reflect the different roles that auditors assume: auditor, insurer, and businessperson. We also discuss how researchers can apply the framework, especially residual business risk, to clarify some unresolved issues regarding audit fees and current issues faced by the audit profession.

JEL Classification: M49

Suggested Citation

Houston, Richard W. and Peters, Michael F. and Pratt, James H., How Auditors Price Business Risk: A Framework and Experiment (Undated). Available at SSRN: https://ssrn.com/abstract=280508

Richard W. Houston

University of Alabama ( email )

Culverhouse School of Accountancy 310 Alston, Box 870220
Tuscaloosa, AL 35487
United States
205-348-8392 (Phone)
205-348-8453 (Fax)

Michael F. Peters (Contact Author)

University of Maryland ( email )

Department of Accounting Van Munching Hall
College Park, MD 20742-1815
United States
301-405-7118 (Phone)
301-405-0359 (Fax)

James H. Pratt

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812-855-2657 (Phone)
812-855-8679 (Fax)

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