«The Impact of IFRS Adoption on Audit Fees: Evidence from Jordan Khaled E. Abu Risheha and Mo'taz Amin Al-Saeeda,1 Al-Balqa' Applied University, Amman ...»
Accounting and Management Information Systems
Vol. 13, No. 3 pp. 520-536, 2014
The Impact of IFRS Adoption on Audit Fees:
Evidence from Jordan
Khaled E. Abu Risheha and Mo'taz Amin Al-Saeeda,1
Al-Balqa' Applied University, Amman – Jordan
Abstract: This study aims to provide evidence of the impact of International Financial
Reporting Standards (IFRS) adoption on audit fees in Jordan. Our study is based on
publicly available information obtained from a sample of annual reports from Jordanian industrial companies listed in Amman Stock Exchange (ASE). The final sample consists of data from a total of 1274 financial statements representing 91 listed companies during the period 1998 to 2011. Based on various previous studies; we develop an Ordinary least Squares (OLS) cross-sectional regression has indicated several variables that explain the level of audit fees: client size, operational complexity and various aspects of risks.
Furthermore; we develop a new variable which is the goodwill. The results indicate that the adoption of IFRS has significantly increased audit fees for Jordanian listed industrial companies in the IFRS-compliant period. Also, we find that the significantly positive coefficients on Intelligent and Expert Business (INTEXP) suggest that members of international accounting firms charge a higher level of audit fees than local Jordanian CPA firms. On the other hand, the significantly positive coefficients on ADOPT*INTEXP suggest that, in the initial years of IFRS adoption, international member firms charge higher incremental audit fees than local Jordanian CPA firms. Furthermore, we find that all control variables (goodwill, accounts receivable, and inventory, loss, firm size and total assets) have significant impact on audit fees. It is our understanding that the impacts of IFRS adoption on audit fees in Jordan have not been widely studied, and we empirically demonstrate that IFRS-related auditing expertise is an important determinant of the audit fees. We recommend that the local Jordanian audit firms should capture potential advantage of being affiliated with international audit firms Keywords: IFRS, audit fees, goodwill, Amman Stock Exchange, Jordanian Industrial Companies.
JEL codes: M41 1 Corresponding author: Motaz Amin Al Saeed, Al- Balqa' Applied University, Department of Accounting and AIS; tel. 00962-4639124; email: email@example.com The Impact of IFRS Adoption on Audit Fees: Evidence from Jordan
1. Introduction While many countries have adopted International Financial Reporting Standards (IFRS), Jordan has adopted IFRS for all entities and companies. This move to IFRS in the Jordanian Listed Industrial Companies may have increased additional risks for auditors which may have resulted in increased audit fees.
More than 100 countries around the world have already adopted International Financial Reporting Standards (IFRS) or are in the process of doing so (Ball, 2006;
Barth, 2008; Daske et al, 2008). Jordanian regulatory bodies in the 2005 stated that Jordanian listed companies were to adopt IFRS from 1 January 2005. For companies the adoption of new accounting standards is likely a huge step; under these new conditions the need for sufficient resources, training, dedication, communication and preparation by local authorities, managers and auditors is required. For auditors the complexity of the transition and a client’s potential insufficient preparations can result in risks in their audit assignment. Increased accounting regulation can, in turn, cause extra client risk and more time consuming work for the auditor. Logically, higher client risk and work will be associated with higher audit fees. Prior research supports this kind of conclusion (Hay et al., 2006).
The accounting profession and academic researchers have paid great attention to the Informational and other economic consequence of IFRS adoption. Proponents of IFRS claim that the IFRS adoption leads to greater and higher-quality disclosures.
The adoption of IFRS therefore increases the complexity of financial reporting environment in Jordan. The opportunity for management misreporting will be increased if financial statements preparers or auditors do not have sufficient expertise in IFRS. Furthermore, IFRSs require testing for goodwill impairment at least annually and write-down the goodwill against income if it is impaired.
Applying the impairment testing regime requires extensive professional judgment and discretion to be exercised by preparers, thereby introducing opportunities for managerial interpretation, judgment and bias, so we argued that this needs for more audit efforts and so will resulted in incremental audit fees.
As Ball (2009) indicates, auditor status, independence, training, and compensation are all important factors affecting the quality of financial reporting after the adopting IFRS. In this study, we investigate the impact of IFRS adoption on the Jordan audit market; in terms of charged audit fees.
We conduct our analysis by examining the impact of IFRS adoption on audit fees for Jordanian industrial companies listed in Amman Stock Exchange during (1998-2011). Our primary sample consists of Jordanian industrial companies listed in Amman Stock Exchanges during (1998 to 2011). Years from 1998 to 2004
represent the pre-IFRS-adoption period and years from 2005 to 2011 represent the post-IFRS-adoption period.
Our study contributes to the literature as follows. First, we empirically demonstrate that IFRS Adoption is an important driver of the audit fees; it is our understanding that the impacts of IFRS adoption on audit fees in Jordan have not been widely studied. In addition to that; many previous studies of audit fees ignored the changes in regulatory and disclosure environments. Taylor and Simon (1999), Griffin et al, (2009) and Schadewitz et al, (2009) found that differences and changes in regulatory and disclosure environments do affect audit fees. Up to our knowledge;
no studies exploring these changes and their impact on audit fees have been reported so far. We expect that evidence from Jordan will complement the existing international studies regarding the effects of international Financial Reporting standards adoption. Second, we empirically demonstrate that IFRS-related auditing expertise is an important determinant of the audit fees.
By affiliating with international accounting firms, more IFRS-related resources become accessible to auditing firms in Jordan. As a result, better audit service can be provided and higher audit premium can be charged. This finding also provides insight into the potential advantage of being affiliated with international accounting firms during the global convergence with IFRS.
This paper looks into the fees paid to statutory auditors associated with the companies who implement IFRS for their first time. This move increases client’s accounting and reporting complexity and the resources needed for preparing of the financial reporting. Prior research has shown that the increase in a client’s complexity and risk are associated with higher fees paid to statutory auditors (Hay et al, 2006). Although it is known that complexity and risk in general increases fees, it is mainly unknown how IFRS transition affects audit fees. Their metaanalysis shows that complexity of a client is positively associated with audit fees.
Since Simunic (1980), many studies have examined cross-sectional determinants of audit fees within a country. These studies find that audit fees are primarily determined by client size, potential legal liability or litigation risk, and audit task complexity (Simunic & Stein 1996; Craswell et al, 1995). To gain insights into the impact of IFRS on audit fee, we build an audit fee model, which is similar in spirit to the model of (Simunic, 1980, Hay et al, 2006, De George et al, 2008, Lin & Yen, 2009, and Vieru & Schadewitz, 2010).
The remainder of this paper is organized as follows. Section 2 reviews the previous literature and develops the hypotheses. Section 3 provides the research design.
Data selection and descriptive statistics of variables are presented in section 4.
Empirical results are reported in section 5. Section 6 concludes the study.
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2. Literature Review and Hypothesis Development From the auditor’s point of view the increase in accounting regulation, therefore, increases client related risk and potentially results in more time-consuming work for the auditor to collect evidence in support of the audit opinion (Arens et al, 1994). Prior research has shown that the increase in client’s complexity and risk is associated with higher audit fees paid to auditors and increased audit effort (Hay et al, 2006, Redmayne, 2005).
Hart et al, (2009) reported that audit fees in New Zealand increased by 48% in two years prior to adoption of IFRS in NZ and in the year of the adoption. In Cobbin’s (2002) survey of auditing literature the size variable is always reported as a significant and positive determinant of audit fees. Also, the complexity of the audit increases the need to spend time and conduct larger and deeper testing procedures and analyses. Taylor and Simon (1999) pointed out the importance of including macroeconomics variables in models explaining audit fee differences across countries.
For instance, Armstrong et al, (2010) examine European stock market reaction to 16 events associated with the adoption of IFRS. They document an incrementally positive reaction for European firms with low pre-adoption information quality and higher pre-adoption information asymmetry. Their finding suggests the market perceives that the adoption of IFRS improves the information transparency and earnings quality. Barth et al, (2008) find that firms applying International Accounting Standards (IAS) from 21 countries generally evidence less earnings management, more timely loss recognition, and more value relevance of accounting information; On the other hand, Daske (2006) investigates the cost of capital for German firms during the period from 1993 to 2002. He finds that the adoption of IAS or IFRS does not help to reduce the cost of capital. Naser and Nuseibeh, (2007) finds that the corporate size, status of the audit firm, industry type, degree of corporate complexity and risk are the main determinants of audit fees. However, variables such as corporate profitability, corporate accounting yearend (YEND) and time lag between YEND and the audit report date appeared to be insignificant determinants of audit fees.
Due to lack of clear accounting treatments to follow, Marden and Brackney (2009) suggest that accountants must spend more time and efforts on analyzing business transactions under IFRS in order to make the most appropriate judgments and to ensure adequate compliance. Accounting firms must also allow auditors to receive more professional education with respect to IFRS. In other words, in response to the implementation of new standards, accounting firms are expected to make more investment in resources that enhance audit quality. The incremental costs thus will be reflected in the increased audit fees. On the other hand, the principle-based
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accounting standards make accountants’ judgments vulnerable to challenge. The litigation risk facing accountants will be higher when their clients mismanage their business (Love & Eickemeyer, 2009). As Hey et al, (2006) suggest, one of the factors affecting audit fees is the litigation risk. To compensate the increased litigation risk, it is expected that higher audit premium will be charged by accounting firms. Lin and Yen (2009) results show that audit fees for listed companies in China significantly increased in the initial years of IFRS adoption.
The significant increase in audit fees supports the conjecture that accounting firms have to spend more costs and efforts on auditing IFRS-based financial statements for listed companies in China.
A small number of studies empirically examine the impact of IFRS on audit fees.
Griffin et al, (2008) analyze the association between overseas and New Zealand governance regulatory reforms, and audit and non-audit fees over 2002 to 2007.
Following U.S. Sarbanes-Oxley Act of 2002, a series of corporate governance regulatory reform has taken place in New Zealand. In the meantime, public listed companies are allowed to voluntarily adopt IFRS since 2005. Griffin et al, (2008) find that audit fees increase in New Zealand over 2002 to 2006. For companies voluntarily adopt IFRS, their audit fees increased both in the year prior to the IFRS adoption and in the first three years post to the IFRS adoption. Schadewitz and Vieru (2009) discuss the impact of 2005 IFRS adoption on audit fees and non-audit fees for 73 listed companies in Finland. They use the magnitude of IFRS adjustments on income before tax, net income, equity and total liabilities as the proxy of complexity of IFRS transition. Their results indicate a positive association between the complexity proxy and audit fees which suggest that higher audits fees were charged to compensate the increasing complexity of IFRS transition.
De George et al, (2008) analyze the effects of IFRS adoption on audit fees for 438 listed Australian companies. They find a positive and significant relation between fee increases and IFRS-exposure. They also find an increase in audit fees in the post-adoption period. Furthermore, they document that the increase is more substantial for smaller companies which contradicts the claims that smaller firms are less likely to be affected by the transition to IFRS. The general uncertainty surrounding IFRS adoption also contributes to the increased compliance costs faced by firms. Uncertainty in the financial reporting environment increases expost investor scrutiny over the relatively new IFRS financial statements, increasing the likelihood of costly shareholder litigation. To protect their reputation capital, auditors increase audit effort and/or client risk assessments (Clarkson, Ferguson, and Hall 2003) which are likely to result in increases in audit fees. Overall, we expect to observe increased audit fees associated with the adoption of IFRS attributable to increased audit effort, increased investment in audit resources, and an increased audit risk premium.