The effect of audit hours and firm characteristics on earnings quality

Abstract

The main purpose of this study is to examine the effect of audit hours and firm characteristics on earnings quality over the period 2014-2015 in Korea, where audit firms are required to disclose audit hours by personnel level in their audit reports. The audit hours are measured as both total hours and hours by accounting professional position level. In public accounting firms, professional positions can be categorized as engagement quality reviewers, partners, registered certified public accountants (CPAs), apprentice CPAs and information technology (IT) experts. The proxy of earnings quality is discretionary accruals (DA) estimated using the modified Jones model. To test our hypothesis, we specify a stochastic frontier function in which output is DA and inputs are audit hours and firm characteristics. The results are summarised as follows. First, we verify that lower DA (i.e., higher earnings quality) is positively related to high total audit hours and audit hours incurred by each of engagement quality reviewers, partners, CPAs and IT experts. Second, the magnitude of scale economies in the stochastic frontier is less than one, signifying that there are decreasing returns to scale in audit activity. Our analysis reveals that total hours as well as audit hours by engagement quality reviewers, partners, CPAs and IT experts have positive relations with earnings quality. The empirical results are consistent with firms reporting high quality earnings when audit efforts are high. © Serials Publications Pvt. Ltd.