The Effect Of Firm's Debt Risk And Earnings Management On Audit Fee

Based on the Simunic's audit fee's determination model, this paper did an empirical study on the effect of firm's liquidity risk and earnings management on audit fee in Chinese securities market. This paper is excepted to deepen the understanding of the issues on audit fee's determinants in China's capital market and makes efforts to improve the CPA audit system. This paper consists of seven parts:Introduction: This chapter introduced the background of selected topics, significance of selected topics and the framework of the paper.Background of the selected topics: with the development of China's capital market, the information disclosure of listed companies have received increasing attention. In order to attract investment and maintain price stability, listed companies need clear audit opinion made by CPA to assure the reliability of the financial reports. At the same time, CPA obtain necessary capital to maintain development through audit fee. The needs of high-quality audit services in capital market promote the development of China's auditing market. However audit service is different from the general services or products because it has quasi-public good attributes. The buyer and consumer of audit service is not the same so the determination of audit fee is more complex than general goods. As a component of CPA audit system, appropriate audit fee guarantees reasonable audit quality. Therefore, whether audit fee is reasonable, and whether it reflects the risks of audits and audit quality is a topic worthy of study. Significance of the selected topics: the theoretical significance is that examine the reliability and credibility of related audit fee research and expand new perspective for audit fee research as well as deepen understanding of the determination factors of audit fee in our country. Practical significance: through the study of determination factors of audit, it is helpful to strengthen understanding of audit services for participants in capital market and also useful for regulation segment to assess the quality of auditing.Chapter 1: Literature review. This part first did review of related foreign research on audit fee literature and introduced Simunic (1980). Then reviewed related research on audit fee in our country. It is noted that the researches on audit fee are first focus on the general impact factors and then gradually focus on specific factors.Chapter 2: the significance of the audit fee and its determinants. Based on agency theory and related literature, this chapter first made a clarification on the significance of the audit fee that is appropriate audit fee guarantee the quality of auditing to some extent. Then I analyzed how audit fee impacted on the quality of the audit that is the audit fee determines the input resource by CPA thus determines the quality of auditing. At last this chapter summarized the determinants of audit fee. Audit fee consists of inherent costs, expected profits and compensation for risks. The determinants of audit found by previous research include firm size, number of controlling subsidiaries, accounts receivable, inventory, regional differences, risk factors, etc.Chapter 3: theoretical analysis and the assumptions. This chapter first did a theoretical analysis for the effect of firm's liquidity risk on audit fee. The higher the debt risks, the higher audit fee will be determined by rational CPA to compensate for more audit procedures and expected losses correspondingly, and vice versa. Based on the theoretical analysis, this paper made H1: audit fee is positively related to firm's liquidity and H2: audit fee is positively related to firm's long-term debt risk. Then chapter describes the concept of earnings management, forms of earnings management and related empirical research. Earnings management is the choice by a manager of accounting policies so as to achieve some specific objective. I argue that earnings management is a neutral concept since appropriate earnings management can improve the relevance of the accounting information while its abuse damages the reliability of accounting information. This paper is focus on the effect of abuse earnings management on audit fee. Earnings management reflects inherent risk and control risk in firm's operating activities. Rational CPA will take the earnings management factor in to account when determining audit fee. Based on the theoretical analysis, I made H3: audit fee is positively related to earnings management.Chapter 4: Positive test design. Based on Simunic model, this chapter established a multiple linear regression model to test H1 and H2. In order to find better proxy for earnings management, I chose underline item and disposable accruals which can be calculated by using modified Jones model as the proxy variable. With variable design, I established regression model to test H3. After screening, this paper select financial data of A-share listed companies in China's Shanghai and Shenzhen stock markets as sample data.Chapter 5: The empirical study results and analysis. Empirical study results show that audit fee is positively correlated with short-term debt risk significantly while no such relationship was found between audit fee and long-term debt risk. It can be argued that CPA audit identified liquidity risk in the determination of audit fee but has"short-sighted"effect because they did not consider long-term debt risk of the auditee, which may damage the quality of auditing services. Regression results also show that audit fee is positively correlated with earnings management significantly. It can be argued that CPA considered earnings management with due care in the determination of audit fee, which is beneficial to assure the quality of financial information made by listed companies.Conclusion: This chapter summarized main conclusions of this paper. My empirical research findings are consistent with previous research in that the firm size is the most influential factor to audit fee. As to debt risk and earnings management, it can be argued that CPA take these factors into account when determining audit fee. But CPA firm still need to improve their awareness of risk factors. Relaxing the restrictions, audit fee can get a reasonable level under the force of market economy.