Audit Pricing of Accounting Errors

The principal role of accruals in accounting is to improve the measurement accuracy of the economic performance by eliminating the timing errors of operating cash flows. At the same time, random and deliberate errors in the estimations of accruals from cash flows reduce the accuracy of economic performance measurement. This study investigates the association between audit fees and the accounting error component of accruals. The study uses a sample including 656 observations from 107 unique firms listed on the Tehran Stock Exchange from 2014 to 2020. Multivariate regression models are used to investigate the effect of the standard deviation of the accounting error component of accruals on audit fees. In addition, the research addresses the endogeneity of accounting errors and audit fees using simultaneous equations and dynamic panel models. The standard deviation of the accounting error component of accruals is estimated using Nikolaev’s (2018) model. This model explicitly introduces the true economic performance and helps better separate the accounting error component of accruals and the performance component of accruals. This study reports robust evidence that the standard deviation of the accounting error component of accruals has a positive association with the audit fee. Research evidence also shows that the accounting error component of accruals affects audit fees at a higher rate than the other component. The results suggest that the accounting errors component of accruals influences audit pricing by motivating bribery, changing the demand and supply factors of audit services, and increasing the auditor risk premium.