Li Li Vuong 10000587
MSc Accounting and Control Supervisor: André Koet
Date: 30-08-2017 Word count: 13,168
UNIVERSITY OF AMSTERDAM
Audit fee renegotiations and the audit
senior’s decisions on audit effort
Abstract
The main audit output is the audit report stating the audit opinion that indicates whether or not the client’s financial statements are free of material misstatement. The impact of the audit
revenue model is examined on the audit effort of the audit senior in the development of the audit opinion. This is a two-part study. Part one investigates the engagement process of the audit firms through document analysis and interviews, this frames the study of the audit senior’s behaviour in part which is researched by conducting an experiment. Findings show that the audit revenue model leads to an audit contract that states a fixed audit fee with a possibility for fee
renegotiation after the finalization of the audit performance. The fee renegotiation allows the possibility that out-of-scope work is billed. Results do not show evidence that unsuccessful renegotiation of the additional fee leads to a higher tendency towards budget cutting in the planning of the audit or activities that diminishes the audit effort in the subsequent audit year. However, results show evidence that the tendency to under-report time significantly increases when out-of-scope work is not billed.
Table of contents
Abstract ______________________________________________________________________ i Table of contents ______________________________________________________________ 1 Introduction __________________________________________________________________ 3 Theoretical framework _________________________________________________________ 5
The purpose of auditing _____________________________________________________________ 5 The audit process ___________________________________________________________________ 6 Auditor’s effort ___________________________________________________________________ 10 Fixed fee and variable fee contracting _________________________________________________ 11 Dropping audit tariffs ______________________________________________________________ 13
Hypotheses development ______________________________________________________ 16 Literature review _____________________________________________________________ 17
Fee determination on fixed or variable-fee _____________________________________________ 17 Incentives of the auditor under fixed or variable-fee contracts _____________________________ 18 Fixed-fee contract with variable-fee element ___________________________________________ 19 Fee pressure on the auditor’s effort ___________________________________________________ 20 Conclusion of the literature review ___________________________________________________ 21
Field research ________________________________________________________________ 23
Hypotheses ______________________________________________________________________ 29 Population and participants _________________________________________________________ 31 Operationalization _________________________________________________________________ 32 Findings ____________________________________________________________________ 36 Additional analysis ___________________________________________________________ 38 Discussion ___________________________________________________________________ 39 References __________________________________________________________________ 43 Appendix A Analyses __________________________________________________________ 49
Introduction
The auditor has the responsibility to assess financial statements and create an audit report that indicates the audit opinion whether or not the financial statements are free of material misstatements. Material misstatements influences the decisions of the users. Users may suffer economic loss due to unreliable audit opinions. Audit firms are for-profit firms and need the public’s trust. The agglomeration of accounting scandals since the financial crisis has diminished the trust of the public in the auditor. This lead to measures that were taken to assure the independency of the auditor to regain public’s trust. Ronald Plasterk, minister of internal affairs and Roland van Vliet, parliament member, endorsed the mandatory decennial audit firm rotation policy and the policy that separates audit and advisory services. Furthermore, a 53 improvements plan is implemented, prepared by the Koninklijke Nederlandse Beroepsorganisatie van
Accountants (NBA) [Royal Dutch Professional Organization of Auditors].
However, these measures do not address the revenue model of the audit sector. Ada van der Veer, the chairman of the Monitoring Commissie Accountancy (MCA) [Monitoring Committee Audit], believes that the neglection of the revenue model leads to “[false assurance]” (Knoop & Piersma, 2016). MCA questions whether the current revenue model would lead to incentives that puts the commercial interest above the public interest. Budget pressure, according MCA, may lead to low audit quality (Knoop, 2016). The validity of these concerns is not researched, though the Independence Company (TIC, 2014a; TIC, 2014b) has attempted to gain a “quick and dirty” perspective of the chartered accountants. Their results may imply that the auditors themselves question the effects of the revenue model on the performance of the audit. They found that most of the external auditors think that the audit budget is too low, the available hours in the budget are insufficient due to high tariffs and audit failures are due to “lousy” audit performance (TIC, 2014b). Furthermore, the majority of chartered accountants, both in business and external, agrees that the audit culture is more focused on profit making than quality control (TIC, 2014a).
The distrust on the revenue model is based on opinions and little research are done on the audit revenue model and the audit performance. Therefore, this study focuses on answering the following research question: “What is the effect of the revenue model of the audit firm on the
audit effort of the audit senior?” The audit senior supervises the audit team and is in direct contact with the client. This research question is answered in two parts: a literature review and fieldwork.
In the theoretical framework, I describe the purpose of auditing, the audit process and the content of auditor’s effort. Here I summarize the audit process based on professional standards of Nadere Voorschriften Controle en overige standaarden (NV COS) [Detailed Regulations for Audit and Other Standards]. I furthermore explain differences between fixed-fee and variable-fee contracting. And at last I show the circumstances of the audit sector that may form external pressures on the audit senior, regarding the revenue of audit firms.
In the literature review I show what influences the fee determination. Then, I explain the effects of fixed-fee and variable-fee contracts on the behaviour of the auditor as described in the literature. Afterwards, I show how a combined-fee contract deals with deviations of the expected and real audit costs. At last, I show how different forces of pressure (e.g. budget pressure, fee pressure, partner pressure) has impact on the audit effort.
The second part of this study is the fieldwork. I assess how the audit revenue model of audit firms in the Netherlands complies with the audit process as described in the literature and NV COS. I furthermore examine how said audit revenue model influences the audit effort performed by the audit senior through an experiment. The assessment of the audit revenue model shows surprising results. Audit firms create contracts in which the fixed-fee is negotiable at the end of the audit engagement. This changed the scope of the latter part of this study. Here, a comparison is made between audit seniors behaviour depending on whether additional billing is done or not. This study ends with a discussion of the results.
Theoretical framework
This section introduces auditing and the auditor’s role in society and gives definitions that are related to the study in how the audit revenue model affect the audit effort.
The purpose of auditing
External auditors must be licensed as Register Accountants (RA) [Dutch equivalent of the Certified
Public accountant (CPA)] in order to express audit opinions on financial statements. This title is regulated by the state. Young professionals who want to become RA are required to work at least three years in the audit business for a licensed audit firm (NBA, 2017f). RA are registered by the NBA.
The RA perform the audit service to create the audit opinion. Auditing offers assurance on financial statements, the effectiveness of internal control and other information. In the audit process of the financial statement, the auditor obtains evidence to determine and report on the degree of correspondence between the information in the financial statement and established standards (Arens, 2013). In the Netherlands, the auditors determine whether the financial statements are in correspondence with NV COS, that is based on the International Financial Reporting Standards (IFRS).
The client creates and supplies the financial statement and the documents that form evidence for that what is stated in the financial statement. Each individual transaction is captured and recorded. The client uses internal controls to ensure that capturing and recording happens appropriately. These individual transactions are collected and summarized into various account
balances, which ultimately are summarized into the financial statement (Deegan & Ward, 2013).
Evidence is any information that helps the auditor to determine if the financial statement is in correspondence to the established standards (Arens, 2013).
The auditor designs audit procedures that collect the direct information of the account balances in the financial statement or audit procedures that test the direct information through
the collection of indirect information that proof that the account balances are fairly stated. To develop the audit opinion, the auditor collects a combination of evidence of each individual transaction, the internal controls and the account balances. However, the audit strategy relies on the auditor’s professional judgement (Deegan & Ward, 2013).
The professional judgement is the development of informed decisions based on relevant training, knowledge and experience, within the context provided by auditing, accounting and ethical standards (Deegan & Ward, 2013). The requirement is that auditors must be independent and competent. They must be competent to know which and the amount of evidence to gather. And they must be independent to prevent bias in the accumulation and evaluation of the evidence (Arens, 2013).
The main output of the audit is the audit report that indicates the findings of the audit. It shows the audit opinion stating to what degree the financial statement correspondents with the related standards and whether or not the client’s financial statements are free of material errors
or other misstatements (Arens, 2013). Material misstatement arises from Information risk, that is
the risk that information upon which business decisions are made are inaccurate. Inaccurate financial statements may cause information risk. Misstatements in the financial statements are material when this poses information risk (Arens, 2013; Deegan & Ward, 2013). Independent financial audits are provided to reduce the information risk.
The audit process
In order to express the audit opinion, the audit process goes through six phases: 1)
Engagement activities, 2) Planning, 3) Test of controls, 4) Substantive procedures, 5) Completion and 6) Reporting as described by Deegan & Ward (2013). These stages are not necessarily sequential, they are often iterative in nature (Deegan & Ward, 2013). The performance of these stages follows professional accounting standards, in the Netherlands the audit applies the NV COS. These standards are based on the International Financial Reporting Standards (IFRS) and are
published by the NBA in the Handleiding Regelgeving Accountancy 2017 (HRA) [Instruction manual of the audit regulations].
During the engagement activities, audit firms decide whether to accept or decline clients using COS 220 [Quality control for a control of financial statements]. COS 220.12 describes the conditions to the settlement of an engagement (NBA, 2017b). The audit firm assesses the
integrity of the client, the competence of the audit team to perform the audit, the ethical
compliance of the audit team (c.q. independency) and significant matters that may influence the
auditor-client relationship. This knowledge gathering is not in-depth, but must be sufficient to make an informed decision on the acceptance of the client (Deegan & Ward, 2013).
After the acceptance of the client, the engagement needs to be confirmed by a signed
engagement letter (Deegan & Ward, 2013). The engagement letters include terms on the
responsibilities of each contracting party, the assistance to be provided by the client, the timing of the engagement and the expected audit fees. This is described in COS 210 [Terms of conditions for the engagement matching] (NBA, 2017a).
Prior to the performance of the substantive procedures of the engagement, the auditor forms an audit strategy and plan. The content of the written planning is framed by COS 300 [Planning an audit on financial statements] (NBA, 2017c). The plan contains the scheduling of the team members on the audit. To make an informed decision on the planning, the auditor obtains sufficient knowledge of the entity to be able to identify the risk of material misstatement. This is substantialized in COS 315 [Identification and estimation of risks of material misstatement by gaining insight into the entity and its environment] (NBA, 2017d). Information on the nature of the entity, its environment and internal control is gathered and the risk of material misstatements is assessed. Information on the business of the client is needed to determine the client’s business
risk. This is the risk that the client fails to achieve its objectives. Client business risk may impair
the recorded accounts, which may affect the fair presentation in the financial statement (Arens, 2013). After the client business risk assessment, the auditor can apply the audit risk model to determine the extent of the audit evidence. Audit risk is the risk that the evidence gathered in the audit procedures do not lead to a reliable audit opinion (Arens, 2013).
The auditor uses the gathered information and applies professional judgement to set the
materiality level against which the information is assessed and the acceptable audit risk and inherent risk to develop the strategy and planning (Arens, 2013). The materiality and acceptable
risks are determined through the audit risk model. This model helps the auditor to decide how much and what types of evidence is needed to gather. The audit risk model is formulated as follows (Arens, 2013):
𝑃𝑃𝑃𝑃𝑃𝑃 =𝐼𝐼𝑃𝑃 × 𝐶𝐶𝑃𝑃𝐴𝐴𝐴𝐴𝑃𝑃
Where: PDR = planned detection risk
AAR = acceptable audit risk IR = inherent risk
CR = control risk
The planned detection risk is the risk that the evidence fails to detect misstatements
exceeding the tolerable misstatement. It is related to the other types of risk and helps the auditor to determine the amount of evidence that is needed. If the PDR is 0.05, it means that the auditor plans to gather evidence until the risk of misstatements exceeding tolerable misstatement is reduced to 5 percent (Arens, 2013).
The inherent risk is the risk of misstatements of an account before considering the internal controls of the audited company. It is directly related to evidence. If IR is higher, the PDR is lower which results into more planned evidence gathering. Commonly, the auditors assign more experienced staff and review completed audit tests more thoroughly (Arens, 2013).
The control risk is the risk that misstatements are timely prevented or detected by the client’s internal control. The combination of IR and CR is the risk of material misstatement. If CR is determined to be ineffective, the PDR is higher, leading to more evidence accumulation (Arens, 2013).
The acceptable audit risk is a measure of the degree of material misstatements that are accepted by the auditor after the completion of an audit. This exists because complete assurance of the audit is not economically practical. If the auditor decides to reduce the AAR, the PDR is reduced, that increases the planned evidence (Arens, 2013). The audit risk helps the auditor to determine the audit evidence needed to achieve an acceptable level of audit risk in the financial statement (Arens, 2013).
The audit planning is a written plan that shows a description, of among other things, the scope of the engagement, the nature, timing and extent of the planned audit procedures on the class of transactions, account balance and disclosure. This planning also shows what type of team members are booked on the engagement based on expertise and time (NBA, 2017c).
During the test of controls the auditor tests the internal control system of the client (Deegan & Ward, 2013). The purpose is to obtain evidence that the client’s internal control contributes to the auditor’s assessed control risk (Arens, 2013). During the performance of substantive procedures, the auditor gathers and obtains sufficient evidence to express the audit opinion (Deegan & Ward, 2013). Here the auditor obtains evidence to support the correctness of transactions (Arens, 2013).
In the completion phase, COS 220.17 states that the auditor determines whether sufficient and appropriate evidence is gathered to form the audit opinion. The auditor performs substantive testing to provide evidence that support the completeness and accuracy of the accounts and substantive testing relating to the client’s disclosed footnotes (Arens, 2013). All identified misstatements are accumulated, after which the auditor determines if this causes the financial statements to be materially misstated. The identified misstatements are communicated to the client in a timely matter, upon which the client receives the chance to correct these
misstatements (NBA, 2017b).
The last phase is to choose the appropriate audit opinion based on an evaluation of the audit evidence. This is written in the audit report, that is the output of the audit as described by COS 700 [Formation and reporting of the opinion on the financial statement] (NBA, 2017e). The type of report that is issued depends on the audit findings (Arens, 2013).
Auditor’s effort
The purpose of this study to give an indication of the auditor effort on the performance of the financial audit. Audit effort is examined because the audit input in the development of the audit opinion consists of human capital. There is an assumed competence of the auditor based on the general educational requirements and their licensing. The performance is done by audit tests. The quality of the audit, according to Francis (2011) is dependent of the actual competence of the auditor and the effort that the auditor makes to ensure the quality of the audit tests and the audit evidence that the audit tests gather. This section provides information on the audit effort.
Audit effort, here, is framed by the hours of work planned for the test of controls and substantive procedures and dysfunctional behaviour. The quality of audit services is defined to be “the market-assessed joint probability that a given auditor will both (a) discover a breach in the client’s accounting system, and (b) report the breach” (DeAngelo, 1981). With (a) depending on the technological capabilities, the audit procedures employed and the extent of sampling, and (b) depending on an auditor’s independence from a given client. By breach they mean the material misstatements. The goal of this study is to focus on (a). However, this study does not focus on the decisions made the audit strategy: the types and amount of evidence to accumulate. Instead it is focused on audit planning: the budgeted hours planned for each test of control or substantive procedure. And it focuses on the dysfunctional of the audit senior.
Dysfunctional behaviour affects the audit investment in the test of controls and substantive procedures. This study separates dysfunctional behaviour into reduced audit quality (RAQ)
activities and under-reporting of time. The identifiers of RAQ activities are roughly based on the research performed by Otley and Pierce (1996) who used the identifiers established by Kelley and Margheim (1987). Kelley and Margheim (1987) developed some types of dysfunctional
behaviour. Otley and Pierce (1996) examined the influence of a tight audit budget on RAQ activities, based on the types that are developed by Kelley and Margheim (1987). Audit inputs in this study is measured as the tendency to perform the audit service with RAQ activities.
This study contains five types of RAQ activities. First is not requesting more budget. Audit seniors should request more budget when the budget is not sufficient to assure the quality of the audit opinion. Second, the acceptance of weak client explanations. When questionable matters have come to the surface during the performance of audit procedures, the auditor may choose to accept weak and unfounded client explanations to reduce time put in the audit service. This reduces the reliability of the audit opinion. Third, prematurely signing off of an audit step as having been completed without carrying out the work or noting the omission. Signing-off each audit step is part of the auditor’s control system. When audit seniors sign off the audit procedure before it has been checked, the auditor’s control system will be undermined. Improperly
documenting the audit performance is a threat to the quality of the audit. Fourth, superficial
coaching of staff. The senior auditor manages and coaches the audit team, who performs the
audit. When the team is not well informed or trained in performing the procedures, the quality of the audit opinion is undermined. At last, the reduction of work on an audit step below acceptable
levels. Every audit procedure has characteristics that determine the actions needed to fulfil the
audit procedure. The required work done surrounding the actions within an audit procedure step might be reduced to save time, which also reduces the reliability of the audit opinion.
The under-reporting of time is also considered dysfunctional behaviour, because it leads to under-reported actual audit hours, which might affect the audit time budgeting and thus the audit planning for the next year. While this is not a direct threat to the quality of the audit, it might lead to unrealistic future budgets. The unrealistic future audit budgets might have the consequence that dysfunctional behaviour occurs in the next audit period that might threaten the quality of the audit opinion.
Fixed fee and variable fee contracting
The audit opinion does not only depend on the auditor’s effort. The other input is the co-operation with the client. Besides the auditor, the client has significant influence on both the cost
of the audit input and the quality of the audit opinion. Thus, the auditor’s efforts and the client’s effort are interdependent and interactive. The audit evidence acquisition is influenced by the client’s information processing, events and transactions, and co-operation (Palmrose, 1989). This subsection explains how audit contracts are strategically used through fixed-fee and/ or
variable-fee contracting.
Contracts function as a formal mechanism for management control (Anderson & Dekker, 2005). As a control measure contracting restricts the potential for opportunistic behaviour. Contracts are usually classified into two types: fixed-fee contracts and the variable-fee contract. For the fixed-fee contract, the auditor and the client agree on a fee prior to the audit. Whereas, for the variable-fee contract, the fee is determined when audit service obligations are satisfied and the measurement of the detailed procedures are done (Palmrose, 1989).
At audit contract negotiations, the information regarding potential evidence gathering is not identical between the auditor and the client. Auditors have more information on audit procedures than clients, and clients have more information on organization-specific factors such as the systems, the degree of cooperation, transactions and events. Choosing between the types of contracts therefore is strategical (Palmrose, 1989).
In general, the client bear task uncertainty risks under variable-fee contracts, because the total audit fees are determined at the finalization of the audit engagement and carries hourly charges of actual time devoted to the audit. In fixed-fee contracts, the auditor carries the consequences of deviations between the expected and actual time devoted to evidence
acquisition (Palmrose, 1989). Furthermore, fixed-fee contracts provide incentives for the auditor to diminish the costs of the engagement, because the auditor bear the exceeded costs (Palmrose, 1989). Research performed by Palmrose (1989) shows that fees are lower at fixed-fee contracts, but actual audit hours do not differ between fixed-fee or variable-fee contracts.
Dropping audit tariffs
The goal of this subsection is to describe the financial circumstances of the audit sector in order to draw a picture of other pressures that may influence the behaviour of the audit senior. Since the financial crisis in 2008, the audit firms suffered revenue shrinkage. Whilst taking 2010 as 100, the revenue has shrunk from 101.1 in 2009 to 96.3 on its lowest point in 2014, but increased to 103.7 in 2016 (CBS, 2017b). For the top 30 audit firms in the Netherlands this equals a loss of revenue of 6.7% comparing 2009 with 2014, but an increased revenue of 4.8%
comparing 2014 and 2015 (Maassen & Schutte, 2016).
The staggering loss in the year 2009 to 2014 of revenue led to price competition within the financial audits which decreased the tariffs. Based on the numbers of 2010 as 100, the tariffs for financial audits dropped from 104.3 in 2008 to 88.3 in 2016 (CBS, 2017a). While taking a look at the number of fulltime-equivalents (FTE) of the top 30 audit firms in the Netherlands, the FTE’s dropped by 13.1% comparing 2009 and 2014 and slightly increased by 1.5% comparing 2014 and 2015 (Maassen & Schutte, 2016). The revenue per FTE has increased with 7.4% comparing 2009 and 2015, and increased even further with 3.2% in 2015. Take a look at Chart 1 and two for an overview of the revenue, tariffs and FTE’s.
Chart 1
Revenue and tariffs
Derived from (CBS, 2017a; CBS, 2017b)
Chart 2
Revenue and FTE top 30 accounting firms
Derived from (Maassen & Schutte, 2016)
75 80 85 90 95 100 105 110 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Revenu Tarrifs 80 85 90 95 100 105 110 115 2009 2014 2015 Revenu FTE Revenu/FTE
The number of FTEs decreased faster than the revenue, leading to an increased revenue per FTE. It is asserted that the increase of revenue per FTE is due to increasing automation and the attention towards work efficiency (Maassen & Schutte, 2016). However, the tariff for the financial audit is continuously decreasing. The decreasing tariff is expected to lead to a decrease of revenue per hour. Note the paradox between the numbers. According to the prognosis performed by ABN Amro in 2015 (Huliselan, 2015) the reason is that the audit firms are heavily investing in work in other branches than the financial audit, such as advisory and legal services. Furthermore, the efficiency in audit services increased due to automation which has decreased the work volume. The prognosis on business services also shows that the advisory sector grew by 6.9% and legal services grew by 3.7% in 2015, while the audit sector’s development was only 2.5% (Buiting, 2017). However, in 2016 the audit sector grew by 6.3%, while the advisory grew by 5.1% and legal services by 2.8% (Buiting, 2017).
The largest barrier towards the growth in the audit, according to ABN Amro, is staff shortage (Buiting, 2017). The low number of staff and the high demand for financial audits suggests that individual auditors are putting more hours in the financial audit and are pressured to work over-time.
Hypotheses development
This study examines the effect of the audit fee and contract on the behaviour of the audit senior formulated in the question: “What is the effect of the revenue model of the audit firm on the audit effort of the audit senior?”
To summarize, this study investigates the effects of the contract type on the planning of the schedule of the audit expressed in hourly tariffs and planned audit hours, and the tendency towards dysfunctional behaviour such as RAQ activities and the under-reporting of time.
Three null hypotheses are tested in this study:
Hypothesis 1: Ceteris paribus, there is no difference in the scheduled audit budget in the between the fixed-fee and variable-fee contract.
Hypothesis 2: Ceteris paribus, there is no difference in the tendency towards the performance of reduced audit quality activities by the audit seniors between the fixed-fee and variable-fee contract.
Hypothesis 3: Ceteris paribus, there is no difference in the tendency towards the
under-reporting of actual audit time by the audit seniors between the fixed-fee and variable-fee contract.
The ceteris paribus conditions means that the predictions assume that the deviation between the expected and realized audit costs in the previous year are equal. It also assumes that the competence of the staff remains equal, and that there is no possibility for technological improvements that enhance the efficiency of the audit. Furthermore, the outcome of the audit risk model applied in both cases are equal, rendering an equal decision on the type and amount of evidence acquisition. At last, the hypotheses assume no staff shortage and hourly tariffs remain the same.
Literature review
This section attempts to answer the research question through a literature review. The unequal information of the client and auditor influences the incentives of the auditor.
Fee determination on fixed or variable-fee
The transactional risk of the unexpected costs that are placed at the auditor in fixed-fee contracts are mitigated in the audit fee pricing (Bell, Landsman, & Shackelford, 2001; Hogan & Wilkins, 2008). The set up in the audit process seems to help in the determination of the audit budget. Bell et al (2001) performed a research in the USA and found that a high client business risk increases the budgeted audit hours which translates into a higher fixed fee. Also, Hogan & Wilkins (2008) show that audit risk is mitigated, because the fixed-fee and thus the budgeted hours are higher when auditors find a higher control risk prior to the engagement. These researches suggest that auditors increase their audit effort in order to maintain an appropriate audit risk. These researches, however, assume that a higher fixed-fee results in higher audit effort. Moreover, these researches are directed towards the initial audit fee.
Other research shows that audit prices are ‘sticky’ (De Villiers, Hay, & Zhang, 2013). Audit fees do not (fully) adjust to changes in their determinants. The fixed-fee, usually, does not (fully) adjust after an engagement where the costs have been unexpectedly high (Ettredge, Bedard, & Johnstone, 2008). The audit budget of the next year reacts on the deviation of the actual audit costs and the realized audit costs. For each percentage of deviation in which the realized costs are lower than the expected costs, the audit budget decreases by 0.7 percent. When the deviation is in the opposite direction, each percentage of more audit costs leads to an audit budget increase of only 0.28 percent. This means that audit risk is not entirely mitigated in consecutive audit engagements in terms of planned investment in the audit budget. The determination of the fixed-fee is based on this audit budget. This means that the planned audit
effort is impaired when the actual audit costs exceeds the budgeted audit costs in the previous year.
Incentives of the auditor under fixed or variable-fee contracts
The results shown in previous academic literature on the effects of fixed or variable-fee contracts on the audit input seem ambiguous. The audit opinion seems to be a ready-made product. The amount and types of evidence gathering is determined during the determination of the audit strategy. In the planning phase, the expected costs are determined when staff
members are scheduled in the audit engagement. The auditor carries the unexpected costs in fixed-fee, while the client bears it in variable-fee contracting.
Research performed on contracting types in business services performed by Homburg & Stebel (2009) suggests that when the output is dependent on the co-operation between the contracting parties, fixed-fee contracting would prevent the service provider to behave opportunistically, because the service provider has the incentive to maintain a long-term
relationship with the client. Opportunistic behaviour does not pay off in long-term relationships, because of the possibility of the loss of trust from the client towards the service provider and thus the termination of the relationship. In my opinion, this is relevant to the audit sector, because audit relationships are usually long-term. Audit firms need to be rotated once in a decennium. Making it not likely that auditor’s efforts would show difference between fixed and variable-fee contracts, when the previous year’s audit lead to unexpected costs. If the auditor decides to diminish the audit effort in fixed-fee contracts, this may affect the trust of the client leading to the termination of the relationship. Research evidence also shows there is no
difference in actual audit input between the fixed-fee and variable-fee contract (Palmrose, 1989). This suggests that the implementation of fixed-fees does not impair the auditor’s effort in time invested in the engagement. In terms of this, the auditor would not behave opportunistically in fixed-fee contracts.
However, other Copley & Doucet (1993) state the opposite. They show that auditors have the incentive to perform lower audit effort and violate audit standards in fixed-fee contracts and long-term relations (Copley & Doucet, 1993). Their results suggest that setting a fixed-fee creates greater incentives for the auditor to minimize the costs of performance of audit engagements for higher profits.
Fixed-fee contract with variable-fee element
In the literature, another type of audit contracting arises that combines the fixed and variable fee contracts. A fee is determined beforehand and additional billing is negotiated after the finalization of the audit service. Fee renegotiations and incentives has been researched before in settings other than the audit contract. The possibility to renegotiate a contract weakens the management control function of both the client and the service provider in the initial contract (Christensen, Demski, & Frimor, 2002). The results may differ from the researches performed on fixed-fee or variable-fee contracting.
Hackenbrack & Hogan (2005) investigated the relationship between client retention and audit pricing. This research shows that auditors base client retention decisions on engagement
realization rates. The engagement realization rate is the ratio of the “actual fee billed” and the
“standard fee”. This standard fee is the product of the actual work in hours and the tariffs for each hour. This research on the combined audit contract shows that the discrepancy between the budgeted costs and the realized costs leads to frictions within the auditor-client relationship and are positively associated with the severance of the auditor-client relationship in a five-year window. This is because pricing pressure leads to the inability of firms to recover from the losses (Hackenbrack & Hogan, 2005). This also shows that this construction does not necessarily lead to fees billed that recover the work out of scope of the engagement.
Fee pressure on the auditor’s effort
The audit service planning, cost control, staff evaluation and staff scheduling is based on the audit budget (Houston, 1999). Pressures on the auditor may influence the decisions made by the audit senior on the planning and performance of the audit (Bierstaker & Wright, 2001; Houston, 1999; Margheim & Kelley, 2011; Margheim, Kelley, & Pattison, 2011). Researches performed in Australia and UK found that auditors have performed RAQ activities under time pressure (Coram, Ng, & Woodliff, 2003; Willett & Page, 1996). Willet and Page (1996) found that 60% of the participants suggested that budget pressure was a factor for RAQ activities. Coram, Ng and Woodliff (2003) questioned why RAQ activities occur, upon which the auditors have answered that time pressure is the greatest factor.
Margheim and Kelly (1992) shows that fee pressure results in reduced time budgets and therefore to lower audit quality. Fee pressure is closely related to budget pressure, and is a form of time pressure. Research shows that time pressure is positively related to the perceived stress of the auditor (Margheim, Kelley, & Pattison, 2011). This research investigates the impact of the time budget pressure and time deadline pressure on the subjective stress measure of the auditor, the organizational behaviour (eg. likelihood in dysfunctional behaviour) and cognitive problems of the auditor (e.g. likelihood of careless mistakes). Results show that both time budget pressure and time deadline pressure have significant effects of the auditor’s stress level, significant impact on dysfunctional behaviour of the auditor and time budget pressure have significant effect on the audit senior’s cognitive problems.
Moreover, Houston (1999) experimentally examined the joint effects of fee pressure and client risk on the audit senior’s planning judgements and decisions. Their research suggests that budgeted hours are reduced as a consequence of fee pressure, which is greater in
comparison with the effects of high audit risk. In the presence of a high client business risk, the presence of fee pressure lead to fewer budgeted hours than when there was no fee pressure.
Bierstaker and Wright (2001) also suggest that there is an impact of pressure to planned audit effort investment. They show that auditors reduce budgeted audit hours in response to fee pressure, partner pressure reduces planned tests and budgeted hours of more experienced staff
are reduced under a combination of both pressure forces (Bierstaker & Wright, 2001). However, this does not necessarily directly result in an impairment of audit quality since the staff
underreporting of audit time increases and the efficiency increases.
Dysfunctional behaviour is not only influenced by pressure. In a field survey performed in Sweden, Svanberg and Öhman (2013) found that punishment on dysfunctional behaviour leads to a decrease in RAQ activities, and obedience to the management leads to an increase in RAQ activities. It seems that the audit firm’s ethical culture and the management has great influence on dysfunctional behaviour. This is confirmed by Otley and Pierce (1996). Their research gathered evidence that audit seniors react functionally on partner pressure by working more hours,
charging more hours to clients, requesting and obtaining an increase in the time budget from superiors, and focusing on more relevant information.
Although most research show that time pressure might lead to reduced audit investment, surveys suggest that efficiency increases and under-reporting of audit time increases, such that the perceived audit effectiveness and therefore the current audit quality does not get impaired (Bierstaker & Wright, 2001). However, under-reporting of audit time is still considered
dysfunctional behaviour, because it leads to under-reported actual audit hours, which might affect the audit time budgeting and thus the audit planning for the next year. According to Ponemon (1992) the under-reporting of time is only related to peer pressure, however, Svanberg and Öhman (2013) state the under-reporting of time is only related to time pressure.
Conclusion of the literature review
The literature review suggests that there is no difference between the variable and fixed-fee contract in the work in hours invested in engagements. However, the amount of violations of standards are significantly higher in fixed-fee contracts. Furthermore, the stickiness of the audit pricing leads to audit prices that increase in a relatively slow rate when the engagement
in the fixed-fee contract, and that the fixed-fee contract may cause incentives other than actual cutting on hours to impair the quality of the audit.
Literature furthermore suggest that time budget pressure on the auditor leads to
dysfunctional behaviour. Except for partner pressure. It seems that the audit firms ethical culture diminishes the tendency towards dysfunctional behaviour of the audit senior instead. In fact, partner pressure leads to audit seniors behaving functionally.
Field research
In order to either confirm or debunk the findings of the literature review I conducted a field research. First, I performed an examination of the revenue model in order to understand what type of contracting is used in the audit service in the Netherlands. The revenue model is called the engagement process. I interviewed one audit manager, three audit seniors and one staff member to understand the engagement process of four of the audit firms: EY, PwC, Deloitte and BDO. I furthermore tested whether their explanation of the engagement process agrees with the provided documents by document analysis. Here I gathered the documents that are produced through an engagement process of one of the firms and judge the documents based on the requirements of NV COS.
Surprisingly, I found that audit contracting in the Netherlands is best described as a
combined contract, one in which the fixed-fee can be renegotiated at the finalization of the audit engagement. No longer a comparison can be made between the two types of contracts. Instead, I focus on the impact the variable-fee element in the fixed-fee contracts has on the audit effort. I will add to the literature by examining this construction of the audit fee contract instead of examining fixed fee versus variable fee.
I found that the engagement process of the audit firms consists of eight phases, considering pricing and budgeting from the moment a possible client is considered to the moment the audit fees are billed. The engagement process follows the standards of NV COS. Figure one gives a quick overview of the engagement process. It seems that the phases of the engagement process highly resemble the phases that are described in the audit process.
However, the difference is that the engagement process is the audit revenue model and focuses on the costs and billing of the engagement, rather than the performance of the audit itself.
The engagement process starts with client acceptance. The audit partner makes a
judgement to accept or decline a possible client based on an informal risk assessment. Here s/he makes a rough estimate of the risk of material misstatement based on COS 220.12 (NBA, 2017b), based on which s/he decides whether the audit service can be offered.
The second stage is formalizing the engagement by sending the engagement offer. Here the most important part is pricing the fixed audit fee. The price offer is based on a budget that the audit partner roughly estimates that is needed for the engagement based on the informal risk assessment. The budget is an estimation of the amount of work and the type of expertise that is needed to successfully perform the financial audit plus a safety margin. When calculating the fixed audit fee, the partner takes into account the tariffs of the type of staff. The tariff of an hour work is dependent on the expertise of the performer: the department, function title, hierarchy position and years of experience.
The tariffs are not fixed. According to my confidants, the form and magnitude of the audit fee depends on the type of business of the client, the capacity of the audit firm and the incentive of the partner. The fees tend to be lower in sectors where the audit pricing is more competitive. For example, audit fees for the healthcare sector, according to my confidants, are relatively low as compared to the financial sector. Furthermore, audit fees tend to be lower, when there is a case of overcapacity in the audit firm. Also, pricing may be influenced by the partner’s incentives based on the bonus s/he receives. When the engagement offer is calculated, it is send to the to be audited company. Stage three is the offer acceptance of the potential client.
If the potential audit client accepts the offer, stage four commences, the formal risk
assessment. This is an elaborate assessment of the independence of the auditor and the risk of
material misstatement that is congruent to COS 315 (NBA, 2017d) and COS 300 (NBA, 2017c). This is more detailed than the initial risk assessment done by the partner in stage one. The audit manager uses a checklist to assess the risks, the partner will decide whether to continue or discontinue an engagement based on the results of the checklist. This checklist exists of
questions related to the nature of the client’s business and industry environment, the scope of the engagement, the independency of the auditor and the competence of the audit team and financial considerations of the audit. It also considers engagement risks (e.g. third-party involvement, client financial viability and financial statement assurance such as the client’s internal control). There is a possibility that the audit firm pulls back the engagement offer despite that the client already accepted the offer.
If the partner decides to continue to perform the audit based on the formal risk assessment, the engagement letter is composed and send to the potential audit client. This embodies stage five of the engagement. The engagement letter is the audit contract. Here the responsibilities of both the auditor and the audit client are stated, such as a list of documents that is needed to be prepared by the client. Also, the scope of the engagement and the expected audit costs are stated. The engagement letter has the disclaimer that additional services and extra work out of scope of the agreement will be billed separately. This is the variable-fee element in the fixed-fee contract. The engagement letter is send and signed by the client. Note that the engagement letter as described by COS 210 (NBA, 2017a) is supplemented with the fee pricing, indicating the fixed-fee and the disclaimer indicating the variable-fee.
Stage six is the planning process of the audit engagement. Confidants state that for an existing engagement the senior auditor requests team members for performing the audit service, based on the review of last year’s budget and actual costs. The planning of the budgeted hours is also done by the audit senior. The gross margin and the estimated realization percentage of the tariffs need to be on an acceptable level. The estimated realization percentage is the percentage of the tariffs that is estimated to be billed. The goal is to realize a realization percentage of at least 35% of the tariffs. The audit firm does not bill the full tariffs, they give discounts on the tariffs for the engagement. The full tariffs give the audit firms room for negotiation of the audit fee. Discounts are usually given depending on price competition in the given sector of the engagement.
In the experience of my confidants, the planning and budgeting is based on an ‘ideal situation’, meaning that the planning is based on a situation without unexpected or out of scope work and a situation where the audit client hands in documents in time and with minimal divergence. In reality, the planning is usually not sufficient to perform the engagement, which leads to overtime and the occurrence of team members working on different tasks and on multiple financial audits at the same time. This explanation of my confidants shows that despite the safety margin, the fixed-fee and its budget is insufficient for the performance of the audit.
During the performance of the financial audit, all audit team members write the hours made in order to document to the realized hours placed in the engagement. There is a distinction
made between chargeable and non-chargeable hours, and the hours need to be ascribed to the specific tasks that are performed and to the right client code. This is the seventh stage of the engagement. The audit senior registers work out of scope of the engagement letter separately and ensures that the audit team members register the hours the right way. All expenses outside the scope of the engagement are notified to the audit client and the audit manager by the audit senior on a timely matter. Through timely communication the audit firm increases the verifiability of the efforts on the audit engagement. The audit manager has an oversight on the planned budget and the actual written hours. The documentation of audit hours and out of scope work is an attempt of the auditor to make a distinction between deficiencies made by the auditor or the client to justify possible additional billing when the audit is finalized.
When a deviation of the budget is noticed by the audit manager, s/he will mail the audit senior to attend them to the hours made. This often happens when the budget has been reached. The audit manager mainly attends the audit senior to work more efficiently, to focus only on material issues and not doing unnecessary work. It must be noted that the manager has trust in the legitimacy of the recorded audit hours by the team members and that the client has no oversight of the actual hours made. For this to work effectively, the audit staff and senior must record their hours truthfully and completely. The confidants cannot state with certainty that the audit team does this.
Billing is the last stage of the engagement process. Initially the fixed audit fee, as agreed
upon on the engagement letter, is billed to the audit client. When there have been deficiencies in the engagement, additional billing is considered. Deficiencies consist of work out of scope of the engagement as described in the engagement letter, these may be inefficiencies within the co-operation during the audit service or the emergence of signs of fraud. The hours dedicated to deficiencies are registered by the audit senior in the previous stage. The reasonableness to charge the costs to the client will be assessed by the audit manager and approved by the audit partner.
Additional billing is dependent on the magnitude of the extra work performed. If not billing the deficiencies still leads to a sufficient profit margin and realization percentage of the hourly tariffs, the partner often opts for not billing these expenses to maintain a positive relationship
with the client. When the audit partner is under the impression that additional billing may lead to a fracture of the auditor-client relationship, they may retain the transactional risk at the audit firm as stated by the confidants.
Furthermore, work out of scope that are not due to the failure of the client are not billed. Those concern work on more complex subjects, such as going concern, the change in accounting principles and laws, or failure in the administrative organization and the internal control. When additional billing is approved, the audit manager proceeds by negotiating the additional billing with the client. When the audit manager fails to come to an agreement with the client, the partner gets involved in the renegotiation. Only when both contracting parties agree to the additional billing, it may occur. Note, that the variable-fee element in the audit contract is a complex construction, since it is difficult to measure and to agree upon. The client still has the position to refuse paying an additional fee on top of the fixed-fee which was agreed upon upfront. The renegotiation of the audit fee is to replace the existing contractual relationship concerning the audit fees with unanimous consent. This complies with COS 210.14 and COS 210.16. COS 210.14 shows that changes in the engagement letter are allowed as long as it does not undermine the degree to which the gathered evidence can assure the reliability of the audit opinion. And COS 210.16 states that changes may only be made when there is unanimous
consent. In the next year, the engagement process starts again at either the engagement offer or the engagement letter.
For the purpose of the examination of the audit senior’s behaviour based on the audit contract, I make the assumption that the engagement offer remains equal to the prior year. My confidants state that in the subsequent year, the engagement offer generally remains equal to the prior year. This, unless the client undergoes changes that affects the scope of the
engagement. COS NV does not give guidance to the audit revenue model, the pricing of the audit. However, the audit process and the audit revenue model is interrelated.
Figure 1. Overview of the engagement process
Client requests bidding offers
Intital risk assessment: audit risk & client
business risk Accept engagement? End Rough estimation of budget Calculation of
fixed audit fee Sending engagement offer Engagement offer Client receives engagement offer Client accepts offer?
Formal risk assessment:
• Independence
• Audit risk
• Client Business Risk Continue? Engagement letter Sending engagement letter Client receives engagement letter Client accepts offer? Planning the engagement Audit budget Performance of engagement Registration of
hours work out of Separating
scope Realized hours Report:
Send to audit manager and client Assessment of deficiencies Bill deficiencies Renegotiation of billing Billing Set new fee? Feedback No No No No No Yes Yes Yes Yes Yes Client acceptance Formalizing engagement Offer acceptance Formal risk assessment
Engagement letter
Planning
Performance of the financial audit
Billing
Yes No
Hypotheses
In order to answer what the impact is of the audit revenue model on the audit effort of the audit seniors in the field, I had to change the research hypotheses. No comparison can be made between fixed-fee and variable-fee contracting. Instead, I focus on the influences of billing or not billing the out of scope work of the previous year on the senior. This may lead to differences in the expected budget tightness, feelings of stress and audit effort. Audit effort is measured through the budgeted hours planned by the audit senior, dysfunctional behaviour in the performance of the RAQ activities and under-reporting of hours.
Because the dysfunctional behaviour and reduced audit budgets are effected by stress, I first compared the perceived stress-level of the audit seniors between the two options. The choice to renegotiate the fee is up to the partner, the audit senior has little control over this decision. Moreover, the client may not agree with additional billing. In both cases out of scope work may not be billed. However, when additional costs are billed in the previous year the audit senior may expect the same to occur in the next year and vice-versa. Therefore, I formulate the following hypotheses:
Hypothesis 1: Ceteris paribus, the expected budget tightness by the audit senior is higher, when audit fee renegotiation of previous year’s engagement has not lead to an increase in audit fees.
Hypothesis 2: Ceteris paribus, the perceived stress by the audit senior prior to the
engagement performance is higher, when audit fee renegotiation of previous year’s engagement has not lead to an increase in audit fees.
In case of budget overrun in the previous year, the audit senior may be subject to more time pressure if the partner has decided not to bill the additional fees, while the fixed-fee remains equal to the previous year. Therefore, in this case, I expect that the audit senior is inclined to increase the budgeted costs (budgeted hours times tariffs) in a relatively lower rate
than when the audit fee renegotiation of previous year’s engagement has led to an increase in the audit fees billed. Based on this reasoning, the following prediction is made.
Hypothesis 3: Ceteris paribus, the budgeted costs in the audit plan will be relatively higher,
when audit fee renegotiation of previous year’s engagement has not lead to an increase in audit fees.
The fourth hypothesis focuses on dysfunctional behaviour that directly affect the audit investment of the engagement, this behaviour takes the form of RAQ activities. The combination of time pressure and job autonomy can give rise to conflict and dilemmas and create a great scope for dysfunctional behaviour among the audit seniors. The pressure is stronger since the audit senior him/herself is the one who plans the audit service.
Since the refusal by the client of the payment of the additional fee in the previous year is considered to give time pressure to the audit senior in the current year, I suggest that senior auditors are more likely to perform RAQ activities when this budget pressure is present. Based on this reasoning, the following prediction is made.
Hypothesis 4: Ceteris paribus, audit seniors are more likely to perform audit quality reducing
behaviour, when audit fee renegotiation of previous year’s engagement has not led to an increase in audit fees.
The fifth hypothesis examines the reporting of time. It leads to the following prediction. Hypothesis 5: Ceteris paribus, audit seniors are more likely to under-report time, when audit
fee renegotiation of previous year’s engagement has not led to an increase in audit fees.
Population and participants
The audit senior is the person who is supervising a team of auditors, is responsible for the planning and performance of the engagement and is in direct contact with the client. The audit senior is relatively autonomous in their audit performance due to the absence of on-the-job supervision. The position of the audit senior has been found to be the one where the auditor feels the most pressurized in the audit firm (Kelley & Seller, 1982).
The targeted population of audit seniors work at EY, Deloitte, KPMG, PwC and BDO. The big four firms are most mentioned in the media surrounding accounting scandals, and they are made responsible for the reputation of the auditors. The reason why I added BDO within the research population is the difficulty in finding respondents.
Function names for audit seniors differ at each audit firm. At EY s/he is called senior staff audit, at BDO s/he is called senior assistant accountant, at PwC the function is called senior associate audit, at KPMG supervisor audit and assurance, at last at Deloitte this function is named junior manager audit.
I used simple random sampling for the study. Stratified or cluster sampling would be better to have an overview of each audit firm. However, because of ethical considerations I decided to not include which audit firm the respondents work at in my study in order not to potentially harm the reputation of the audit firm. Moreover, through information of my confidants I learned that external auditors working at the big four firms are not likely to respond on surveys. In order to gain as many respondents as possible, I decided to contact everyone whom I was able to attain contact information.
Through my contacts at the respective firms, I have received lists of emails of 30 to 60 contacts for each audit firm. This small number does not represent the real number of audit seniors in the Netherlands. According to my contacts they made a printout of their companies’ system. Through LinkedIn, however, I found 978 audit seniors of which I managed to retrieve 856 email addresses. Because I performed the search for respondents in August, I have received 390 automatic replies of these senior auditors stating that they are on holiday during this period. This means that 466 emails have reached the auditors. Because of this low number, I additionally
recruited respondents through Facebook. In total, I contacted 608 senior auditors through Facebook messages. Table 1 shows the distribution of contact attempts among the five audit firms.
In total, I have received 57 responses, response rate is 6,7%. The reason for this low response rate is because the summer holidays and according to six respondents their colleagues usually ignore research requests and regard them as spam.
Tabel 1.
Distribution of population targeted
Audit firm Sent emails Holiday Emails Received Facebook
BDO 104 33 71 57 KPMG 109 80 29 105 PwC 283 80 203 199 EY 233 122 111 176 Deloitte 127 75 52 71 Total 856 390 466 608
Operationalization
This subsection operationalizes the research method. I conducted an experiment by using two surveys to examine the difference in audit effort investment by audit seniors as a result of billing out of scope work or not in the previous year. The independent variable here is billing additional fees or not. The surveys are randomly distributed among the respondents.
Respondents of Survey0 have received the case in which the out of scope work is billed, and respondents of Survey1 have received the case in which the out of scope work is not billed.The audit effort is measured in three ways. Hypothesis one focuses on the expected budget tightness, hypothesis two examines the amount of stress, hypothesis three investigates the planned audit
budget, hypothesis four looks at RAQ activities and hypothesis five is targeted at the underreporting of hours.
Expected budget tightness. The expected budget tightness is judged on a 5-point scale (1 =
Not likely/ strongly disagree to 5 = Very likely/ strongly agree). The t-test is used to analyse the
responses. Low expectations of insufficient budget receive mean ratings of lower than 2.5, neutral expectations receive mean ratings between 2.5 and 3.5, and high expectations receive mean ratings of higher than 3.5.
Stress. The amount of stress perceived prior to the engagement based on the reflections of previous year’s realization and the current year’s budget is judged on a 5-point scale. The results are analysed through t-testing. Low amount of stress receives mean ratings of lower than 2.5, neutral stress-level receives mean ratings between 2.5 and 3.5, and high perceived stress-level receive mean ratings higher than 3.5.
Planned audit budget deviation. The deviation of the planned audit budget and the audit budget of the previous year is measured through a task. This is roughly based on the studies done by Bierstaker and Wright (2001) and Houston (1999). In the experiment, I base the two cases on one of the existing engagements of one of the big four audit firms. The cases show the
respondents the fixed-fee and expected realization rate of the engagement, and the tariffs of the staff based on the years of experience. The numbers of these for audit year 2016 and 2015 remain the same. Furthermore, I show the planning made by the audit senior for audit year 2015 for eight audit procedures. The difference between the two cases lays within the independent variable of whether the audit firm has succeeded to bill the out of scope work for audit year 2015. In order to answer hypothesis one, I gave the respondents the task to make a planning for the eight audit procedures based on the respective case. There they will choose the number of hours to invest in a procedure and which staff type member to employ: intern, first year, second year or third year. The comparison would be made by a t-test for the total budgeted costs deviation.
RAQ activities. The identifiers of RAQ activities are roughly based on the research performed by Kelley and Margheim (1987) and Otley and Pierce (1996). Kelley and Margheim (1987) developed some types of dysfunctional behaviour. Otley and Pierce (1996) examined the
influence of a tight audit budget on RAQ activities, based on the types that are developed by Kelley and Margheim (1987). Audit inputs in this study is measured as the tendency to perform the audit service with RAQ activities.
This study contains five types of RAQ activities. First is not requesting more budget. Audit seniors should request more budget when the budget is not sufficient to assure the quality of the audit opinion. Second, the acceptance of weak client explanations. When questionable matters have come to the surface during the performance of audit procedures, the auditor may choose to accept weak and unfounded client explanations to reduce time put in the audit service. This reduces the reliability of the audit opinion. Third, prematurely signing off of an audit step as having been completed without carrying out the work or noting the omission. Signing-off each audit step is part of the auditor’s control system. When audit seniors sign off the audit procedure before it has been checked, the auditor’s control system will be undermined. Improperly
documenting the audit performance is a threat to the quality of the audit. Fourth, superficial
coaching of staff. The senior auditor manages and coaches the audit team, who performs the
audit. When the team is not well informed or trained in performing the procedures, the quality of the audit opinion is undermined. At last, the reduction of work on an audit step below acceptable
levels. Every audit procedure has characteristics that determine the actions needed to fulfil the
audit procedure. The required work done surrounding the actions within an audit procedure step might be reduced to save time, which also reduces the reliability of the audit opinion.
In the experiment, I use different wording of questions than Kelley and Margheim (1987). Question-wording may have an impact on the replies. I belief that questions such as “Would you reduce the work on an audit step below acceptable levels?” for hypothesis one is too direct. It is unlikely that individuals who do, would confirm this. Instead the question is for example as follows: “When the audit manager asks me to work more efficiently. I decide to rely more on the client’s internal control.”
Eight questions are asked in order to measure RAQ activities. RAQ activities are judged by a 5-point scale. Low tendency of RAQ behaviour receives mean ratings of lower than 2.5, neutral tendency receives mean ratings between 2.5 and 3.5, and high tendency receive mean ratings
higher than 3.5. Analysis happens through t-testing. The Cronbach’s alfa of these questions is 0.644, this shows that internal consistency is sufficiently reliable.
Under-reporting of actual time. The likeliness that audit seniors under-report time by working on personal time is judged on a 5-point scale and analysed by t-testing. Low tendency of under-reporting receives mean ratings of lower than 2.5, neutral tendency receives mean ratings between 2.5 and 3.5, and high tendency receive mean ratings higher than 3.5.
There are three control variables used in the experiment. One is the pressure by the audit manager which is just on a 5-point scale. Low pressure receives mean ratings of lower than 2.5, neutral pressure-level receives mean ratings between 2.5 and 3.5, and high pressure receives mean ratings higher than 3.5. Two are based on the competence of the audit senior. This is expressed in the years of experience in the audit of the respondent, and whether the respondent is certified as a Register Accountant (1 = no RA-title, 2 = RA-title). I use these control variables, because the respondents’ personal experience in the field may also influence their behaviour.
Findings
The analyses focus on whether the two cases presented to the respondents leads to significant different results. Survey0 has received 29 and survey1 has received 28 responses. Five responses are excluded, because the response was not complete. Sample size for survey0 is 27, for survey1 itis 25. The average number of years that the audit seniors have worked in the audit practice is five years (σ = 1.43) and 13% is has the RA-title. Table 2 shows the μ and σ of each variable dependent on each survey case. The findings of both Survey0 and Survey1 show that all respondents expect high budget tightness.
Also, both show that the respondents cut costs on the planned audit by on average 931 euros, equaling 18% of the original budget, while the out of scope work increased the costs by 23%. The perceived stress-level, however, is moderate. And the tendency to perform RAQ activities and the under-reporting of time is low.
Table 2
Means and Standard deviations
Hypothesis Survey μ σ
H1: Expected budget tightness 0 4.33 .62
1 4.12 .83
Total 4.23 .73
H2: Stress 0 2.93 1.14
1 3.16 1.03
Total 3.04 1.08
H3: Planned budget deviation 0 -936.30 906.75
1 -924.52 1760.54 Total -930.63 1370.32 H4: RAQ activities 0 1.98 .43 1 2.17 .50 Total 2.07 .47 H5: under-reporting of time 0 1.89 1.01 1 2.48 1.08 Total 2.17 1.08
However, the results do not show any significant correlation between the expected budget tightness, the stress-level, the planned budget deviation, tendency for RAQ activities and under-reporting of time with the billing of additional fee. But, the results do show a significant
relationship between obtaining the RA-title and the prospect on budget tightness, ρ = .281, p < .05. There is also a significant correlation between management pressure and the years of experience of the respondents in the audit sector, ρ = -.291, p < .05. Moreover, there is a strong correlation between the tendency of performing RAQ activities and the under-reporting of time, ρ = .473, p < 0.01. To view the all correlation results, see table 1 Correlations of hypotheses in appendix A Analyses.
The regression analysis in shown in appendix B Regression analysis of the hypotheses. The results show that not billing the additional fees significantly predict the under-reporting of time by the audit seniors, β = .289, p < .05.
