Audit Quality and Accrual Persistence : Examining the impact of auditor size and audit fees

Abstract: Abstract This paper examines the connection between auditing and the persistency of reported accruals. Accruals are documented to be subjective by its nature thus running the risk of being aggressively reported by managers with the incentives of improving companies’ earnings. Consequently, accruals are less reliable and therefore problematic for investors to interpret. Investors rely on the independent auditor to detect material misstatements caused by such less reliable accruals. We extend to the evidence presented by Krishnan (2003) suggesting an association between audit quality (measured as Big 6 auditors) and accruals where Big 6 audited firms where shown to experience higher accrual persistency than Non Big 6 audited firms. We also extend to the findings presented by Zhao (2010) indicating that higher audit fees imply higher accrual persistence. This paper investigates if a definition of audit quality as both audit size and audit fee could yield even higher accrual persistence. In particular, this paper investigates whether companies that use Big 4 auditor firms and paying higher audit fees experience higher accrual persistence than companies that use Big 4 auditor firms and paying lower auditor fees. Our results suggest that audit fees do not affect the persistency in accruals for firms audited by Big 4. For firms audited by Non Big 4 however audit fees seem to affect the persistency in accruals where higher audit fees are documented to increase the persistence accruals.