Auditing standards and audit effort: evidence from related party transactions

Abstract

Purpose This paper aims to examine how audit report lags and audit fees increased for firms that engage in related party transactions (RPTs) around the introduction of Auditing Standard No. 18 (AS18). AS18, which was introduced in 2014, requires following a risk-based approach and additional audit procedures in auditing RPTs and is expected to eliminate the pre-existing inadequate audit effort in auditing RPTs documented earlier by the Public Company Accounting Oversight Board. Design/methodology/approach Using eight years of hand-collected RPT data from annual proxy statements (form DEF 14A) from the SEC EDGAR database for a sample based on S&P 1,500 firms, this paper examines the effect of AS18 on audit effort using two measures, audit fees and audit report lags. The paper conducts the analysis using both unmatched samples and entropy-balanced regression models. Findings This paper finds that audit report lags and audit fees do not significantly increase after AS18 for RPT firms in general. However, when this paper classifies RPTs into Business RPTs and Non-Business RPTs and finds that compared to non-RPT firms, Business RPT firms experience a significant increase in their audit report lags and audit fees after AS18. On the other hand, no such association is observed when comparing non-Business RPT firms with non-RPT firms. In addition, this paper shows that this significant association is only observable in firms with weaker corporate governance mechanisms. Practical implications The findings shed light on the role of auditing standards in enhancing audit effort over risky transactions and the role of corporate governance in moderating the relationship between auditing standards and audit effort. Originality/value This study is the first, up to the best of the authors’ knowledge, that examines whether the additional required procedures associated with AS18 will result in a significant increase in audit effort after AS18 or not.