audit fee premium and auditor change - the effect of sarbanes-oxley act [review]

8/12/2019 Audit Fee Premium and Auditor Change - The Effect of Sarbanes-Oxley Act [Review]

1/3

INTERNATIONAL JOURNAL REVIEW

Kharisma Baptiswan

9B DIV Akuntansi Khusus, STAN, Tangerang Selatan

[email protected]

No Key points Details

1 Title Audit Fee Premium and Auditor Change: The Effect of Sarbanes-Oxley Act1

2 Research

question

How are the effects of Sarbanes-Oxley Act (SOX) implementation on both audit fee premium

and auditor change in the US audit market?

3 Motivation The purpose of this paper is to provide more comprehensive analysis of the effects of

Sarbanes-Oxley (SOX) Act on both audit fee premium and auditor change in the US audit

market.

4 Theory Audit fee is a fee for basic auditing procedures and audit fee premium (premium audit fee) is

incremental cost caused by sales-power by big auditing firms. Compliance of SOX has made

many companies, especially the small ones, to shift their audit activity to smaller auditor

firms. This changes results from an increase of premium audit fee related to additional tasks

that all firm must comply, e.g. deeper understanding and assessment of internal control

adequacy for financial reporting. The trend of these auditor changes was expected to result in

cheaper (less increase) audit cost and ultimately less burden audit fee for companies. But in

subsequent period after SOX compliance, studies suggest that both companies and auditors

have become more efficient in complying with SOX requirements (PricewaterhouseCoopers,2005; Ernst & Young, 2005).

5 Hypothesis 1. Audit fee premium expected to significantly increase after the enactment of the SOX in2002 especially for small accelerated filers,

2. Companies that changed from big audit firms to non-big audit firms have experiencedless increase in their audit fees after the SOX especially for small accelerated filers,

3. Compliance cost may decrease in the longer run as a result of streamlining the process,the need for less documentation, and the focus on key controls.

6 Methodology The audit fee premium model is employed to track the trend in audit fee premium between

2000 and 2006 for small accelerated filers2compared with large accelerated filers3and non-

1Sarbanes-Oxley Act of 2002 is an act to increase accountability and responsibility of US public companies sponsored after financialfraud of several highlighted US companies such as Enron and WorldCom.2Small accelerated filer is a public company that meets all of the following conditions as of the end of its fiscal year:

The company's public float was $75 million or more as of the last business day of its most recently completed second fiscal quarter. The company was subject to the reporting requirements of Section 13(a) or 15(d) of the Exchange Act for at least 12 calendar

months.

The company previously filed at least one annual report to stockholders under Section 13(a) or 15(d) of the Exchange Act. The company is not eligible to rely on the smaller reporting company requirements for its annual and quarterly reports.3Large accelerated filers is a public company that meets all of the following conditions as of the end of its fiscal year:

The company's public float of its common equity was $700 million or more as of the last business day of its most recently completedsecond fiscal quarter.

The company has been subject to the reporting requirements of Section 13(a) or 15(d) of the Exchange Act for at least 12 calendarmonths.


2/3

accelerated filers4and how the change in auditor affected such trend around the enactment of

SOX. Basic audit fee premium model that was used in this paper was as follows:

Fi = Xi + BIGi + i

Whereas formula speciffically design for this paper is as follows:

By analysing statistical trend, some evidences of effect of SOX implementation were found.

7 Sample object Data used in this research was taken from Audit Analytics5and Compustat6. Audit analytics

database was used to obtain data about audit and non-audit fees and auditor changes during

these years. Other financial data necessary to estimate other variables in both audit fee

premium and audit fee change models were obtained from Compustat7annual files for the

corresponding year. Objects are non-accelerated filers, accelerated filers (small) and large

accelerated filers.

8 Results 1. Audit fee for accelerated filers and larger accelerated filers are higher, especially at itssharpest rise in 2004 when SOX was enacted,

2. Growth rate of audit fee was higher in small accelerated filers than larger ones duringSOX implementation,

3. The audit fee premium has its sharpest increase in year 2004 and begin to dwindle in2006. This suggests that both companies and auditors are begin to learn efficiently toallocate its resources necessary for SOX compliance, e.g. streamline their internal control

documentation and testing processes,

4. Audit fee is significantly higher for clients with higher sales, larger clients, clientsreporting extraordinary items, clients reporting net loss, and those with foreign

operations, and significantly negatively related to clients profitability.

9 Implications 1. With the increasing demand of audit services in the US audit market during early yearsof SOX compliance, auditors had to significantly intensify their understanding of

companies internal control effectiveness and increase their audit fees to cover the cost of

increasing resources directed to their audit engagements especially those engagements

that involve smaller, more risky, or increasingly less profitable clients,

The company has previously filed at least one annual report to stockholders under Section 13(a) or 15(d) of the Exchange Act. The company is not eligible to rely on the smaller reporting company requirements for its annual and quarterly reports.4Non-accelerated filers is a public company that does not meet the requirements to be an accelerated filer or a large accelerated filer.5Audit Analytics is an innovative on-line public company intelligence service available from the Ives Group Inc, a leadingindependent research provider focused on the accounting, insurance, regulatory, legal and investment communities(http://www.auditanalytics.com/0000/, accesed in 13/05/2014).6Compustat is a database of financial, statistical and market information on active and inactive global companies throughout the world

and part of Division of S&P Capital IQ, which is a division of McGraw Hill Financial (https://www.capitaliq.com/home/what-we-offer/information-you-need/financials-valuation/compustat-financials.aspx, accesed in 13/05/2014).


3/3

2. As both clients and auditors develop their documentation and audit processes necessaryto comply with SOX, incur any setup and initial investment costs, and streamline their

processes, the audit fees and the audit fee premium is starting to wind down,

3. There is an increasing trend to switch from a big auditor to a non-big one and within thenon-big segment during the early years of SOX compliance.

10 Limitation The study limit the sample only to the data availability of the items necessary to conduct the

analysis and run the models above in both Audit Analytics and Compustat databases between

the years 2000-2006, thus its not future proof.

11 Future research The compliance costs of significant regulatory changes like SOX may be upfront loaded but

their benefits are long-term benefits in terms of higher quality of financial reporting and

better internal controls over financial reporting. When analyzing the effects of such regulatory

changes for future research, practitioners and researchers should factor these costs and

benefits over a sufficient time horizon.

12 Commentary Research was done nicely and it contained robust data about audit activity patterns (fee

growth and audit changes overview) in the US. All of hypothesis were proven by analysing

many trends regarding linkage between audit and its element and environment (SOX

enactment). Enactment of SOX in US is expected to increase audit quality by internal control

enhancement and stakeholders confidence in companies to which they invested their money.

Reviewer also thinks that this reserach also do not take into account any consideration

regarding clients and auditors effort to find loopholes in SOX enactment that could

significantly decrease compliance cost. This paper also lack of insight regarding cost and

benefit of SOX and both preferences of clients and auditors regarding SOX.Financial disaster happened in the US in 2008, have given us sound messages that checks and

balances expected by SOX were not functioning properly. That time shareholders were

grievely devastated. Deregulation, financial reengineering, short-term focused executives

bonuses and low ethical conduct of some corporation are things that should be reviewed.

Reviewer believes that auditing still has many to give to create trusts for and from

shareholders. Maybe further research could give us a better insight into what quality auditing

has for these matters.

audit fee premium and auditor change - the effect of sarbanes-oxley act [review]

Documents