The Effect Of Accrual Reliability On Audit Pricing

Abstract

This study investigates how accrual reliability is associated with audit fees. Since the enactment of the Sarbanes-Oxley Act of 2002, financial reporting has shifted toward a more principles-based accounting paradigm, along with an emphasis on fair value accounting by standard setters. As a result, auditors are exposed to more subjective accrual estimation processes, including accounting estimates. In the current financial reporting environment, external auditors are required to pay greater attention to accrual components that are largely based on accounting estimates to evaluate the reasonableness of accrual measurements. In this study, we find a negative association between the level of accrual reliability and audit fees. That is, the greater the potential litigation risk (due to accrual components based on more subjective or less reliable estimation processes), the more the audit work, and the higher the fees paid to external auditors.