Initial Evidence on the Association between Nonaudit Fees and Restated Financial Statements
Journal article by K. Raghunandan, William J. Read, J. Scott Whisenant; Accounting Horizons, Vol. 17, 2003
Journal Article Excerpt
Initial Evidence on the Association between Nonaudit Fees and Restated Financial Statements. by K. Raghunandan , William J. Read , J. Scott Whisenant SYNOPSIS. An increasing number of firms have restated previously issued financial statements in recent years. Legislators, regulators, and others speculate that restatements are associated with fees received by auditors for nonaudit services (nonaudit fees). The current study provides empirical evidence on the association between firms that restate financial statements and the nonaudit service fees received by incumbent auditors during reporting periods that required restatement. We identify a sample of 110 firms that restated financial statements previously filed with the SEC for fiscal years 2000 or 2001, and provided relevant audit and nonaudit fee data. The SEC requires firms to disclose these fee data beginning in proxy statements filed on or after February 5, 2001. We compare the fees paid by the restatement sample with fee data for 3,481 firms that filed proxies with the SEC from February 5, 2001 to August 31, 2001 and develop benchmarks for expected nonaudit fees, fee ratio, and total fees. Using these benchmarks, we calculate the unexpected values for these measures and investigate whether restatement firms differ from the control firms. Our findings of no significant differences between the restatement and control samples for unexpected nonaudit fees, fee ratios, and total fees do not support concerns that either nonaudit fees or total fees inappropriately influence the audit and lead to restatements. INTRODUCTION In recent years, an increasing number of firms have restated their financial statements to bring them into conformity with GAAP (Moriarty and Livingston 2001). While serving as Chief Accountant of the SEC, Lynn Turner said that the SEC regards restatements to be audit failures (Turner 1999). Consistent with this position, Palmrose and Scholz (2000) find that auditor litigation is significantly associated with restatements involving core or recurring earnings. Legislators and others suggest that a relationship exists between the growing number of restatements and the increasing reliance of audit firms on fees from nonaudit services (U.S. House of Representatives 2002; U.S. Senate 2002). Turner also noted that "accounting firms have become too dependent on nonaudit fees and are unwilling to risk those revenues by challenging corporate managers who stretch accounting rules" (Berenson 200l). In response to concerns that the supply of nonaudit services to audit clients can inappropriately influence audit judgments, in 2000 the SEC attempted to restrict the supply of nonaudit services by auditors to their SEC audit clients. More recently, in July 2002 Congress enacted legislation prohibiting auditors from supplying specific types of nonaudit services (Sarbanes-Oxley Act 2002). After the enactment of the Sarbanes-Oxley Act, the SEC has issued detailed rules related to the prohibition and disclosure of nonaudit fees (SEC 2003). Specifically, the SEC (2003) prohibited registrants from purchasing financial information systems design and implementation services or internal audit outsourcing from the incumbent auditor. However, registrants may still purchase many types of nonaudit services from the incumbent auditor including tax compliance and consulting, employee plan audits, consulting on accounting matters, merger and acquisition consulting, and consulting on new debt and equity issues. Thus, recent actions of legislators and the SEC indicate concerns that nonaudit services provided by incumbent auditors can inappropriately influence audit judgments, make auditors less likely to enforce GAAP, and result in subsequent restatements. This study provides empirical evidence about a possible association between firms that restate financial statements and the fees paid to their incumbent auditors. BACKGROUND AND RESEARCH QUESTION The SEC contends that providing nonaudit services to audit clients " ... creates economic incentives that may inappropriately influence the audit" (SEC 2000b). This concern is based on the premise that nonaudit services increase the economic dependency of auditors on their clients. Others counter the SEC's concern by suggesting that market-based incentives help to ensure audit quality. For example, Benston (1975) and Watts and Zimmerman (1986) suggest that auditor concern for professional reputation is an incentive for maintaining audit quality. In addition, the risk of litigation arising from class action suits by investors alleging injury provides an incentive for auditors to act independently.Some recent studies examine whether there is an association between nonaudit fees and financial-reporting quality. In general, these studies use estimates of discretionary accruals, which are believed to signal earnings management, as a proxy for financial-reporting quality. Frankel et al. (2002) find that firms with greater ratios of nonaudit fees to total fees are more likely to just meet or beat analysts' forecasts and to report larger discretionary accruals. Although their results ... |
End of free preview...
To continue reading this publication, you must have a Questia Subscription.
Try Us Today! Click Here
Questia provides the world's largest online library of scholarly books and journal articles, with integrated footnote and bibliography tools, highlighting, note taking and book marking. With a Questia subscription, you'll have access to the full text of more than 67,000 books and 1.5 million articles.
Already a subscriber? Login:
Sponsored Links
Free Newsletter
Get helpful how-to's, writing tips, search strategies, quizzes & more!
Search the Library
