Multi-period Accounting Bias and Audit Pricing

Abstract

This paper addresses the impact of the interaction between the auditor's audit quality choice and the client firm's accounting choice on audit pricing. In a multi-period model, I focus on a central feature of accounting: reversing accruals. I find that low-balling arises independently from the direction of the accounting bias, but increases with a higher level of conservatism in the initial period. Further, auditors lower the audit quality as a response to conservative accounting. Therefore, a large low-balling discount is correlated with low audit quality in the first period, but does not cause it. The driving force is accounting conservatism.