Are Audit Fees Linear in Accruals?

Abstract

This study examines the role of accruals in the pricing of financial statement audits. We posit that both large positive and large negative accruals represent increases in the auditor’s inherent risk, resulting in a nonlinear relation between accruals and audit fees. Consistent with our expectations, we find that both large negative and large positive total accruals are associated with higher audit fees. Further, the nonlinear relation between total accruals and audit fees is asymmetric, with a steeper slope on positive total accruals than negative total accruals. We next partition total accruals into specific asset accruals using an approach developed by Casey, Gao, Kirschenheiter, Li, and Pandit (2016, 2017) and find that accruals originating from different transactions exhibit predictably nonlinear relations with audit fees. On the whole, our results suggest that auditors respond asymmetrically to accruals based on the magnitude and source of the accrual.