The Impacts of Mandated Audit Communication on Audit Hour, Audit Fee and Firm’s Earnings Management

Abstract

[Purpose] After some large accounting scandals happened, it is required for regulatory authorities to strengthen the role of firm’s internal monitoring system to prevent accounting fraud. In this regard, the External Auditing Act was amended in May 2014 to encourage audit committee or board of directors of audited firm and external auditors to discuss the timing and method of external audit and to exchange related information. Thus, this paper analyzes the effects of mandated communication between external auditors and audit committee or board of directors on audit hour, audit fee and firm’s earnings management. [Methodology] The data of non－financial Korean firms between 2014 and 2016 is used to analyze how the communication between external auditors and audit committee or board of directors of the audited firm affects audit hour, audit fee, and firm’s earnings management after the enactment of the External Auditing Act. [Findings] We find that as the communication between the external auditor and audit committee or board of directors become more active, audit hour and audit fees increase, and the firm’s earnings management decrease. This result implies that the communication between external auditor and audit committee or board of directors of audited firm contributes to enhancing the audit quality by increasing the audit hour and audit fees. However, this results is applicable for firms that are audited by non－big4 auditors. [Implications] Therefore, this study suggests the mandated audit communication as an indicator for the independence of audit committee or board of directors and provides useful guidelines for the regulatory authorities.