The Relationship between Principles-Based Accounting Rules and Audit Fees
Abstract
This paper examines the relations between principles-based accounting standards and audit fees. Our empirical evidence suggests auditors charge a lower fee when firms’ standards are more principles based. Our result is consistent with the notion that principles-based accounting standards improve earnings quality and reduce auditor’s risk-related premium. Further analyses indicate this fee saving is more pronounced for firms with stronger corporate governance and firms in post-SOX era. The results add to the growing body of literature examining cost/benefit of principles-based accounting standards, as well as to the literature of the determinants of audit fees.
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References
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Ahmed, A. S., Neel, M., & Wang, D. (2013). Does mandatory adoption of IFRS improve accounting quality? Preliminary evidence. Contemporary Accounting Research, 30(4), 1344-1372.
Agoglia, C. P., Doupnik, T. S., & Tsakumis, G. T. (2011). Principles-based versus rules-based accounting standards: The influence of standard precision and audit committee strength on financial reporting decisions. The Accounting Review, 86(3), 747-767.
Ashbaugh, H., LaFond, R., & Mayhew, B. (2003). Do nonaudit services compromise auditor independence? Further evidence. The Accounting Review, 78(3), 611-639.
Badertscher, B., Jorgensen, B., Katz, S., & Kinney, W. (2014). Public equity and audit pricing in the United States. Journal of Accounting Research, 52(2), 303-339.
Balsam, S., Krishnan, J., & Yang, J. S. (2003). Auditor industry specialization and earning quality. Auditing: A Journal of Practice and Theory, 22(2), 71-79.
Barth, M. E., Landsman, W. R., & Lang, M. H. (2008). International accounting standards and accounting quality. Journal of Accounting Research, 46(3), 467-498.
Brochet, F., Jagolinzer, A. D., & Riedl, E. J. (2013). Mandatory IFRS adoption and financial statement comparability. Contemporary Accounting Research, 30(4), 1373-1400.
Byard, D., Li, Y., & Yu, Y. (2011). The effect of mandatory IFRS adoption on financial analysts’ information environment. Journal of Accounting Research, 49(1), 69-96.
Chan, A. L., Hsu, A. W., & Lee, E. (2013). Does mandatory IFRS adoption affect the credit ratings of foreign firms cross-listed in the US? Accounting Horizons, 27(3), 491-510.
Chang, H., Cheng, C. S. A., & Reichelt, K. J. (2010). Market reaction to auditor switching from Big 4 to third-tier small accounting firms. Auditing: A Journal of Practice and Theory, 29(2), 83-114.
Chang, H., Chen, J., Chen, H., & Kim, S. (2014). The effect of supply chain knowledge spillovers on audit pricing. Journal of Management Accounting Research, 26(1), 83-100.
Chung, H. H., Wynn, J. P., & Yi, H. (2013). Litigation risk, accounting quality, and investment efficiency. Advances in Accounting, 29(2), 180-185.
Cohen, D. A., Dey, A., & Lys, T. Z. (2008). Real and accrual-based earnings management in the pre- and post-Sarbanes-Oxley periods. The Accounting Review, 83(3), 757-787.
Cornell, R., Magro, A., & Warne, R. (2017). Understanding investors’ propensity to litigate: The role of perceived reporting flexibility and assessed management responsibility for harmful events. Journal of Applied Accounting Research, 18(3), 317-340.
Craswell, A., Francis, J., & Taylor, S. (1995). Audit brand name reputations and industry specializations. Journal of Accounting and Economics, 20, 297-322.
DeFond, M., & Lennox, C. (2011). The effect of SOX on small auditor exits and audit quality. Journal of Accounting and Economics, 52, 21-40.
De George, E., Ferguson, C., & Spear, N. (2013). How much does IFRS cost? IFRS adoption and audit fees. The Accounting Review, 88(2), 429-462.
Deloitte. (2008). 2008 IFRS Survey: Where Are We Today? New York, NY: Deloitte & Touche LLP.
Donelson, D. C., McInnis, J. M., & Mergenthaler, R. D. (2012). Rules-based accounting standards and litigation. The Accounting Review, 87(4), 1247-1279.
Donelson, D. C., McInnis, J. M., & Mergenthaler, R. D. (2016). Explaining rules-based characteristics in U.S. GAAP: Theories and evidence. Journal of Accounting Research, 54(3), 827-861.
Folsom, D., Hribar, P., Mergenthaler, R. D., & Peterson, K. (2016). Principles-based standards and earnings attributes. Management Science, 63(8), 2592-2615.
Gimbar, C., Hansen, B., & Ozlanski, M. E. (2016). The effect of critical audit matter paragraphs and accounting standard precision on auditor liability. The Accounting Review, 91(6), 1629-1646.
Gotti, G., Han, S., Higgs, J., & Kang, T. (2010). Managerial stock ownership, analyst coverage and audit fee. Working paper.
Grenier, J., Pomeroy, B., & Stern, M. (2015). The effects of accounting standard precision, auditor task expertise, and judgment frameworks on audit firm litigation exposure. Contemporary Accounting Research, 32(1), 336-357.
Hay, D. (2013). Further evidence from meta-analysis of audit fee research. International Journal of Auditing, 17, 162-176.
Hay, D. C., Knechel, W. R., & Wong, N. (2006). Audit fees: A meta-analysis of the effect of supply and demand attributes. Contemporary Accounting Research, 23, 141-191.
Herz, R. (2003). A year of challenge and change for the FASB. Accounting Horizons, 17, 247-255.
Hribar, P., Kravet, T., & Wilson, R. (2014). A new measure of accounting quality. Review of Accounting Studies, 19(1), 506-538.
Hogan, C. E., & Wilkins, M. S. (2008). Evidence on the audit risk model: Do auditors increase audit fees in the presence of internal control deficiencies? Contemporary Accounting Research, 25(1), 105-126.
Houston, R., Peters, M., & Pratt, J. (1999). The audit risk model, business risk and audit-planning decisions. The Accounting Review, 74(3), 281-298.
Houston, R., Peters, M., & Pratt, J. (2005). Nonlitigation risk and pricing audit services. Auditing: A Journal of Practice & Theory, 24(1), 37-53.
Hua, S., Liu, Z., Sun, X. C., & Yu, J. (2016). Auditor bargaining power and audit fee lowballing. Advances in Business Research, 7, 81-89.
Jamal, K., & Tan, H. (2010). Joint effects of principles-based versus rules-based standards and auditor type in constraining financial managers’ aggressive reporting. The Accounting Review, 85(4), 1325-1346.
Jamal, K., Colson, R. H., Bloomfield, R. J., Christensen, T. E., Moehrle, S. R., & Ohlson, J. (2010). A research-based perspective on SEC’s proposed rule on roadmap for potential use of financial statements prepared in accordance with International Financial Reporting Standards (IFRS) by U.S. issuers. Accounting Horizons, 24(1), 139-147.
Kadous, K., & Mercer, M. (2016). Are juries more likely to second-guess auditors under imprecise accounting standards? Auditing: A Journal of Practice & Theory, 35(1), 101-117.
Ke, B., Petroni, K., & Safieddine, A. (1999). Ownership concentration and sensitivity of executive pay to accounting performance measures: Evidence from publicly and privately-owned insurance companies. Journal of Accounting and Economics, 28, 185-209.
Kim, J., Liu, X., & Zheng, L. (2012). The impact of mandatory IFRS adoption on audit fees: Theory and evidence. The Accounting Review, 87(6), 2061-2094.
Kothari, S. P., Leone, A. J., & Wasley, C. E. (2005). Performance matched discretionary accrual measures. Journal of Accounting and Economics, 39, 163-197.
KPMG. (2007). International Financial Reporting Standards: The Quest for a Global Language. London, U.K.: KPMG LLP.
Krishnan, G. V., Sun, L., Wang, Q., & Yang, R. (2013). Client risk management: A pecking order analysis of auditor response to upward earnings management risk. Auditing: A Journal of Practice & Theory, 32(2), 147-169.
Lobo, G. J., & Zhao, Y. (2013). Relation between audit effort and financial report misstatements: Evidence from quarterly and annual restatements. The Accounting Review, 88(4), 1385-1412.
Mergenthaler, R. D. (2011). Principles-based versus rule-based standards and accounting irregularities. Working paper, University of Iowa, Iowa City.
Palmrose, Z. (1986). Audit fees and audit size: Further evidence. Journal of Accounting Research, 24(1), 97-110.
Raghunandan, K., & Rama, D. V. (2006). SOX Section 404 material weakness disclosures and audit fees. Auditing: A Journal of Practice and Theory, 25, 99-114.
Ramalingegowda, S., & Yu, Y. (2012). Institutional ownership and conservatism. Journal of Accounting and Economics, 53, 98-114.
Reichelt, K. J., & Wang, D. (2010). National and office specific measures of auditor industry expertise and effects on audit quality. Journal of Accounting Research, 48(3), 647-686.
Salman, F., & Carson, E. (2009). The impact of the Sarbanes-Oxley Act on the audit fees of Australian listed firms. The International Journal of Auditing, 13, 127-140.
Schipper, K. (2003). Principles-based accounting standards. Accounting Horizons, 17, 61-72.
Securities and Exchange Commission (SEC). (2013). Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. Issuers: Final Staff Report. Tersedia di https://www.sec.gov/spotlight/globalaccountingstandards/ifrs-work-plan-final-report.pdf.
Seetharaman, A., Gul, F., & Lynn, S. (2002). Litigation risk and audit fees: Evidence from UK firms cross-listed on US markets. Journal of Accounting and Economics, 33, 91-115.
Simunic, D. (1980). The pricing of audit services: Theory and evidence. Journal of Accounting Research, 18(1), 161-190.
Simunic, D., & Stein, M. (1996). The impact of litigation risk on audit pricing: A review of the economics and the evidence. Auditing: A Journal of Practice & Theory, 15, 119-134.
Skinner, D. J., & Srinivasan, S. (2012). Audit quality and auditor reputation: Evidence from Japan. The Accounting Review, 87(5), 1737-1765.
Venkataraman, R., Webber, J., & Willenborg, M. (2008). Litigation risk, audit quality, and audit fees: Evidence from initial public offerings. The Accounting Review, 83(5), 1315-1345.
Vermeer, T. E., Raghunandan, K., & Forgione, D. A. (2009). Audit fees at U.S. non-profit organizations. Auditing: A Journal of Practice & Theory, 28(2), 289-303.
Whisenant, S., Sankaraguruswamy, S., & Raghunandan, K. (2003). Evidence on the joint determinations of audit and non-audit fees. Journal of Accounting Research, 41(4), 721-744.
Xie, B., Davidson, W., & DaDalt, P. J. (2003). Earnings management and corporate governance: The role of the board and the audit committee. Journal of Corporate Finance, 9(3), 295-316.
Ahmed, A. S., Neel, M., & Wang, D. (2013). Does mandatory adoption of IFRS improve accounting quality? Preliminary evidence. Contemporary Accounting Research, 30(4), 1344-1372.
Agoglia, C. P., Doupnik, T. S., & Tsakumis, G. T. (2011). Principles-based versus rules-based accounting standards: The influence of standard precision and audit committee strength on financial reporting decisions. The Accounting Review, 86(3), 747-767.
Ashbaugh, H., LaFond, R., & Mayhew, B. (2003). Do nonaudit services compromise auditor independence? Further evidence. The Accounting Review, 78(3), 611-639.
Badertscher, B., Jorgensen, B., Katz, S., & Kinney, W. (2014). Public equity and audit pricing in the United States. Journal of Accounting Research, 52(2), 303-339.
Balsam, S., Krishnan, J., & Yang, J. S. (2003). Auditor industry specialization and earning quality. Auditing: A Journal of Practice and Theory, 22(2), 71-79.
Barth, M. E., Landsman, W. R., & Lang, M. H. (2008). International accounting standards and accounting quality. Journal of Accounting Research, 46(3), 467-498.
Brochet, F., Jagolinzer, A. D., & Riedl, E. J. (2013). Mandatory IFRS adoption and financial statement comparability. Contemporary Accounting Research, 30(4), 1373-1400.
Byard, D., Li, Y., & Yu, Y. (2011). The effect of mandatory IFRS adoption on financial analysts’ information environment. Journal of Accounting Research, 49(1), 69-96.
Chan, A. L., Hsu, A. W., & Lee, E. (2013). Does mandatory IFRS adoption affect the credit ratings of foreign firms cross-listed in the US? Accounting Horizons, 27(3), 491-510.
Chang, H., Cheng, C. S. A., & Reichelt, K. J. (2010). Market reaction to auditor switching from Big 4 to third-tier small accounting firms. Auditing: A Journal of Practice and Theory, 29(2), 83-114.
Chang, H., Chen, J., Chen, H., & Kim, S. (2014). The effect of supply chain knowledge spillovers on audit pricing. Journal of Management Accounting Research, 26(1), 83-100.
Chung, H. H., Wynn, J. P., & Yi, H. (2013). Litigation risk, accounting quality, and investment efficiency. Advances in Accounting, 29(2), 180-185.
Cohen, D. A., Dey, A., & Lys, T. Z. (2008). Real and accrual-based earnings management in the pre- and post-Sarbanes-Oxley periods. The Accounting Review, 83(3), 757-787.
Cornell, R., Magro, A., & Warne, R. (2017). Understanding investors’ propensity to litigate: The role of perceived reporting flexibility and assessed management responsibility for harmful events. Journal of Applied Accounting Research, 18(3), 317-340.
Craswell, A., Francis, J., & Taylor, S. (1995). Audit brand name reputations and industry specializations. Journal of Accounting and Economics, 20, 297-322.
DeFond, M., & Lennox, C. (2011). The effect of SOX on small auditor exits and audit quality. Journal of Accounting and Economics, 52, 21-40.
De George, E., Ferguson, C., & Spear, N. (2013). How much does IFRS cost? IFRS adoption and audit fees. The Accounting Review, 88(2), 429-462.
Deloitte. (2008). 2008 IFRS Survey: Where Are We Today? New York, NY: Deloitte & Touche LLP.
Donelson, D. C., McInnis, J. M., & Mergenthaler, R. D. (2012). Rules-based accounting standards and litigation. The Accounting Review, 87(4), 1247-1279.
Donelson, D. C., McInnis, J. M., & Mergenthaler, R. D. (2016). Explaining rules-based characteristics in U.S. GAAP: Theories and evidence. Journal of Accounting Research, 54(3), 827-861.
Folsom, D., Hribar, P., Mergenthaler, R. D., & Peterson, K. (2016). Principles-based standards and earnings attributes. Management Science, 63(8), 2592-2615.
Gimbar, C., Hansen, B., & Ozlanski, M. E. (2016). The effect of critical audit matter paragraphs and accounting standard precision on auditor liability. The Accounting Review, 91(6), 1629-1646.
Gotti, G., Han, S., Higgs, J., & Kang, T. (2010). Managerial stock ownership, analyst coverage and audit fee. Working paper.
Grenier, J., Pomeroy, B., & Stern, M. (2015). The effects of accounting standard precision, auditor task expertise, and judgment frameworks on audit firm litigation exposure. Contemporary Accounting Research, 32(1), 336-357.
Hay, D. (2013). Further evidence from meta-analysis of audit fee research. International Journal of Auditing, 17, 162-176.
Hay, D. C., Knechel, W. R., & Wong, N. (2006). Audit fees: A meta-analysis of the effect of supply and demand attributes. Contemporary Accounting Research, 23, 141-191.
Herz, R. (2003). A year of challenge and change for the FASB. Accounting Horizons, 17, 247-255.
Hribar, P., Kravet, T., & Wilson, R. (2014). A new measure of accounting quality. Review of Accounting Studies, 19(1), 506-538.
Hogan, C. E., & Wilkins, M. S. (2008). Evidence on the audit risk model: Do auditors increase audit fees in the presence of internal control deficiencies? Contemporary Accounting Research, 25(1), 105-126.
Houston, R., Peters, M., & Pratt, J. (1999). The audit risk model, business risk and audit-planning decisions. The Accounting Review, 74(3), 281-298.
Houston, R., Peters, M., & Pratt, J. (2005). Nonlitigation risk and pricing audit services. Auditing: A Journal of Practice & Theory, 24(1), 37-53.
Hua, S., Liu, Z., Sun, X. C., & Yu, J. (2016). Auditor bargaining power and audit fee lowballing. Advances in Business Research, 7, 81-89.
Jamal, K., & Tan, H. (2010). Joint effects of principles-based versus rules-based standards and auditor type in constraining financial managers’ aggressive reporting. The Accounting Review, 85(4), 1325-1346.
Jamal, K., Colson, R. H., Bloomfield, R. J., Christensen, T. E., Moehrle, S. R., & Ohlson, J. (2010). A research-based perspective on SEC’s proposed rule on roadmap for potential use of financial statements prepared in accordance with International Financial Reporting Standards (IFRS) by U.S. issuers. Accounting Horizons, 24(1), 139-147.
Kadous, K., & Mercer, M. (2016). Are juries more likely to second-guess auditors under imprecise accounting standards? Auditing: A Journal of Practice & Theory, 35(1), 101-117.
Ke, B., Petroni, K., & Safieddine, A. (1999). Ownership concentration and sensitivity of executive pay to accounting performance measures: Evidence from publicly and privately-owned insurance companies. Journal of Accounting and Economics, 28, 185-209.
Kim, J., Liu, X., & Zheng, L. (2012). The impact of mandatory IFRS adoption on audit fees: Theory and evidence. The Accounting Review, 87(6), 2061-2094.
Kothari, S. P., Leone, A. J., & Wasley, C. E. (2005). Performance matched discretionary accrual measures. Journal of Accounting and Economics, 39, 163-197.
KPMG. (2007). International Financial Reporting Standards: The Quest for a Global Language. London, U.K.: KPMG LLP.
Krishnan, G. V., Sun, L., Wang, Q., & Yang, R. (2013). Client risk management: A pecking order analysis of auditor response to upward earnings management risk. Auditing: A Journal of Practice & Theory, 32(2), 147-169.
Lobo, G. J., & Zhao, Y. (2013). Relation between audit effort and financial report misstatements: Evidence from quarterly and annual restatements. The Accounting Review, 88(4), 1385-1412.
Mergenthaler, R. D. (2011). Principles-based versus rule-based standards and accounting irregularities. Working paper, University of Iowa, Iowa City.
Palmrose, Z. (1986). Audit fees and audit size: Further evidence. Journal of Accounting Research, 24(1), 97-110.
Raghunandan, K., & Rama, D. V. (2006). SOX Section 404 material weakness disclosures and audit fees. Auditing: A Journal of Practice and Theory, 25, 99-114.
Ramalingegowda, S., & Yu, Y. (2012). Institutional ownership and conservatism. Journal of Accounting and Economics, 53, 98-114.
Reichelt, K. J., & Wang, D. (2010). National and office specific measures of auditor industry expertise and effects on audit quality. Journal of Accounting Research, 48(3), 647-686.
Salman, F., & Carson, E. (2009). The impact of the Sarbanes-Oxley Act on the audit fees of Australian listed firms. The International Journal of Auditing, 13, 127-140.
Schipper, K. (2003). Principles-based accounting standards. Accounting Horizons, 17, 61-72.
Securities and Exchange Commission (SEC). (2013). Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. Issuers: Final Staff Report. Tersedia di https://www.sec.gov/spotlight/globalaccountingstandards/ifrs-work-plan-final-report.pdf.
Seetharaman, A., Gul, F., & Lynn, S. (2002). Litigation risk and audit fees: Evidence from UK firms cross-listed on US markets. Journal of Accounting and Economics, 33, 91-115.
Simunic, D. (1980). The pricing of audit services: Theory and evidence. Journal of Accounting Research, 18(1), 161-190.
Simunic, D., & Stein, M. (1996). The impact of litigation risk on audit pricing: A review of the economics and the evidence. Auditing: A Journal of Practice & Theory, 15, 119-134.
Skinner, D. J., & Srinivasan, S. (2012). Audit quality and auditor reputation: Evidence from Japan. The Accounting Review, 87(5), 1737-1765.
Venkataraman, R., Webber, J., & Willenborg, M. (2008). Litigation risk, audit quality, and audit fees: Evidence from initial public offerings. The Accounting Review, 83(5), 1315-1345.
Vermeer, T. E., Raghunandan, K., & Forgione, D. A. (2009). Audit fees at U.S. non-profit organizations. Auditing: A Journal of Practice & Theory, 28(2), 289-303.
Whisenant, S., Sankaraguruswamy, S., & Raghunandan, K. (2003). Evidence on the joint determinations of audit and non-audit fees. Journal of Accounting Research, 41(4), 721-744.
Xie, B., Davidson, W., & DaDalt, P. J. (2003). Earnings management and corporate governance: The role of the board and the audit committee. Journal of Corporate Finance, 9(3), 295-316.
Published
2025-05-07
How to Cite
DRUM, Dawna; LIU, Zenghui; WAN, Huishan.
The Relationship between Principles-Based Accounting Rules and Audit Fees.
Journal of Accounting, Business and Management (JABM), [S.l.], v. 32, n. 1, p. 1-26, may 2025.
ISSN 2622-2167.
Available at: <https://journal.stie-mce.ac.id/index.php/jabminternational/article/view/1000>. Date accessed: 08 may 2025.
doi: https://doi.org/10.31966/jabminternational.v32i1.1000.
Section
Articles
