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Asian Review of Accounting

The effects of IFRS experience on audit fees for listed companies in China
Hsiao-Lun Lin Ai-Ru Yen
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To cite this document:
Hsiao-Lun Lin Ai-Ru Yen , (2016),"The effects of IFRS experience on audit fees for listed companies
in China", Asian Review of Accounting, Vol. 24 Iss 1 pp. 43 - 68
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Li-Chun Kuo, Chan-Jane Lin, Hsiao-Lun Lin, (2016),"Auditor switch decisions under forced
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The effects of IFRS experience Effects of


IFRS
on audit fees for listed experience on
audit fees
companies in China
Hsiao-Lun Lin 43
Department of Accountancy, Received 27 February 2014
National Taipei University, New Taipei City, Taiwan, and Revised 23 July 2014
Accepted 17 September 2014
Ai-Ru Yen
Accounting, Business Law, and Finance,
Northeastern Illinois University, Chicago, Illinois, USA
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Abstract
Purpose The purpose of this paper is to examine whether and how auditors and audit clients
IFRS-related experience alters auditors pricing decisions in the initial years of IFRS adoption in China.
Design/methodology/approach The authors conduct the analysis by examining audit fees from
4,129 sample observations that issued A-shares in the Shanghai and Shenzhen stock exchanges
from 2005 to 2008. The authors empirically test the association between audit premiums and auditors
and auditees IFRS experience.
Findings The authors find that auditors with IFRS experience charged significantly higher audit
premiums in the initial years of IFRS adoption. The authors also find that audit clients with IFRS
experience paid significantly lower incremental fees. The authors further find that the increased fees
charged by audit firms with IFRS experience are independent of the degree of changes in the financial
reporting complexity of their clients. In contrast, audit clients with IFRS experience paid lower
incremental fees only when they underwent a high degree of changes in financial reporting complexity.
Originality/value First, it is the understanding that this study is the first to provide evidence on the
effect of audit clients experience on audit fees. Second, the measure of auditors expertise is
independent of audit clients decisions and is a less noisy measure. Third, the findings complement the
existing evidence from other countries regarding the effects of IFRS convergence on audit fees. Finally,
this study empirically tests the effects of changes in financial reporting complexity on audit fees.
Keywords Convergence, IFRS, Audit fees
Paper type Research paper

1. Introduction
The introduction of a single set of global accounting standards has received much attention
from both academics and practitioners. One stream of literature examines the effects of the
adoption of the International Financial Reporting Standards (IFRS hereafter) on audit fees
in various countries (e.g. DeGeorge et al., 2013; Griffin et al., 2009; Kim et al., 2011).
These studies generally document an increase in audit fees in the initial years of IFRS
adoption. The need for more judgment under the principle-based standards, which implies
more time and efforts from auditors (DeGeorge et al., 2013; Marden and Brackney, 2009),
has been considered the main reason for the increasing audit fees. As anecdotal evidence
suggests that experience directly affects auditors judgment, this study attempts to

This study was funded by the grant from the National Science Council in Taiwan (No. 99-2410-H- Asian Review of Accounting
Vol. 24 No. 1, 2016
009-002). The authors greatly appreciate the helpful comments and suggestions from workshop pp. 43-68
participants at the 2010 the Illinois International Accounting Symposium and the 2010 American Emerald Group Publishing Limited
1321-7348
Accounting Association annual meeting. DOI 10.1108/ARA-02-2014-0028
ARA examine whether and how auditors and audit clients IFRS-related experience alters
24,1 auditors pricing decisions in the initial years of IFRS adoption in China. We focus on the
effect of IFRS experience in the initial years of Chinese IFRS adoption for the following two
reasons. First, Chinas audit market consists of a mix of domestic accounting firms and
international affiliated accounting firms. Given that IFRS was adopted by other countries
prior to Chinas adoption in 2007, international accounting firms, such as the Big 4
44 (i.e. Deloitte, Ernst and Young, KPMG, and PricewaterhouseCoopers), have more
opportunities to audit IFRS-based financial statements than their domestic counterparts.
The various degrees of exposure to IFRS among audit firms likely affected audit quality
when IFRS were initially adopted, which in turn affected audit fees. Second, the extent of
exposure to IFRS prior to Chinas adoption of IFRS among public companies also differs.
Prior to 2007, companies listed in certain overseas stock exchanges were already required
to prepare their financial statements in accordance with international accounting
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standards. This requirement implies a difference in the degree of understanding of IFRS


between those issuing A-shares only and those issuing shares in overseas markets that
require IFRS reporting in addition to A-shares. Given that accounting errors or
misstatements are more likely to occur when financial statement preparers are unfamiliar
with the new standards, the assessed audit risk is likely to be higher for clients with limited
IFRS experience. Audit firms hence may charge different fees based on the assessed audit
risk. The different degrees of IFRS experience among audit firms and audit clients in
Chinas audit market thus provide an interesting setting to examine the change in audit
fees following the adoption of IFRS.
We conduct our analysis by examining audit fees from 4,129 sample observations
that issued A-shares in the Shanghai and Shenzhen stock exchanges from 2005 to 2008.
We measure auditors experience based on whether they are from joint ventures of
Big 4 accounting firms in China, and we measure audit clients experience based on
whether, in addition to A-shares, listed firms also issue shares in stock exchanges that
require IFRS reporting before 2007[1]. Our results suggest that Big 4 joint ventures
charged a significantly positive increased audit premium in the initial years of IFRS
adoption. This result suggests that accounting firms with IFRS experience were able to
charge higher audit premiums than their counterparts, which is consistent with the
reputation theory that auditors charge higher premiums for their established
reputation. We also find that audit clients with IFRS experience paid lower incremental
audit fees during the initial years of IFRS adoption. This result suggests that audit
firms tended to give price discounts to clients who possessed experience in preparing
IFRS-based financial statements prior to 2007.
We further consider the effect of the degree of change in financial reporting
complexity brought about by the adoption of IFRS. We find that the positive
association between audit fees and auditors IFRS experience holds regardless of the
degree of change in financial reporting complexity. We also find that experienced
clients receive fee discounts only when the degree of change in financial reporting
complexity is high. No significant impact of audit clients IFRS experience on audit
fees is found when the degree of changes in complexity is low. This result is consistent
with the expectation that the demand for professional judgment is lower when
the degree of changes in financial reporting complexity is low. Thus, auditors did not
give a significant fee discount even though their clients had IFRS-related experience
before 2007. Finally, in addition to the above results, we also consider the effect
of non-Big 4 auditors IFRS experience in a robustness test. The results suggest that
non-Big 4 auditors with IFRS experience also charged increased audit fees in the first
year of IFRS adoption; however, the increased fees were not as significant as what Effects of
Big 4 joint ventures charged. IFRS
Our study contributes to the literature as follows. First, our findings add to the
understanding of the effects of experience on audit fees. In particular, unlike previous
experience on
studies that focus solely on the effect of auditors experience, we consider the effect of audit fees
audit clients experience on audit fees. We show that auditors IFRS experience is
positively associated with audit premiums but that audit clients IFRS experience 45
is negatively associated with audit premiums. These results suggest that auditors charge
a reputation premium for their experience and give fee discounts to their experienced
clients. It is our understanding that this study is the first to provide evidence on the effect
of audit clients experience on audit fees. Second, previous studies measure auditor
industry expertise based on the market share of audit firms within a certain industry.
The within-industry market share, however, is affected when audit clients switch
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auditors and could be a noisy measure for auditors expertise in industry (Minutti-Meza,
2013). Our measure of auditors expertise is based on their prior IFRS-related experience
and thus is independent of audit clients decisions. Third, many emerging markets, such
as India, Korea, Singapore, Malaysia, and Taiwan, are in the process of adopting IFRS or
IFRS equivalents, and it is our understanding that the effects of IFRS convergence on
audit fees in emerging capital markets have not been widely studied[2]. China is one of
the largest emerging capital markets in the world, and it has had a significant influence
on the world economy in recent years. We expect that evidence from China will
complement the existing international studies regarding the effects of international
accounting standards convergence on auditors pricing decisions. Finally, the changes in
financial reporting complexity following the international accounting convergence have
not been measured and examined widely in previous literature. We empirically measure
the changes in financial reporting complexity and consider its effect on the association
between IFRS experience and audit fees. The measures we provide may be further
refined and applied to examine Chinese IFRS-related issues in future studies.
The remainder of this paper is organized as follows. Section 2 provides the
background of this study, reviews the previous literature, and develops the hypotheses.
Section 3 presents the research method. The data selection and descriptive statistics of
variables are presented in Section 4. Empirical results are reported in Section 5.
Section 6 concludes the study.

2. Background, literature review, and hypothesis development


2.1 Background
More than 100 countries around the world have either adopted or committed to adopt IFRS
(Barth, 2008; Daske et al., 2008). The adoption of IFRS has caused unprecedented effects on
the global capital market. In November 2005, the China Accounting Standards Committee
signed a joint statement with the International Accounting Standards Board with respect
to the status of substantial convergence between Chinese accounting standards and IFRS.
As mentioned in the Joint Statement of the Secretary-General of China Accounting
Standards Committee and the Chairman of the International Accounting Standard
Boards, China stated that convergence with IFRS is one of the fundamental goals of their
standard-setting program. In February 2006, the Ministry of Finance of China formally
announced the issuance of the amended Accounting Standards for Business Enterprises
(including one basic standard and 38 specific standards) that took effect for the 2007
financial reports of listed companies in China. The new standards, with a few exceptions,
are substantially in line with IFRS. Unlisted companies are also encouraged to use the new
ARA accounting standards. The Ministry of Finance further mandated the implementation of
24,1 the new standards for all non-listed state-owned companies by the end of 2008.
The requirement to use IFRS-equivalent accounting standards is expected to extend to all
enterprises in China in the near future. In this study, the amended Accounting Standards
for Business Enterprises are referred to as the Chinese IFRS.
Chinese IFRS not only expanded the disclosure requirement but also made
46 fundamental changes to the original Chinese Generally Accepted Accounting Principles
(Chinese GAAP hereafter). One major change is the increasing use of fair value
measurement basis. For instance, listed companies are required to apply fair value
measurement on share-based payment transactions for employee services, goodwill,
derivatives, investment properties, non-monetary transactions, and financial assets and
liabilities. Another major change involves the presentation of financial statements.
Several accounts were replaced or revoked. For example, short-term investment,
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long-term investment, and long-term debt investment accounts were no longer used
after the adoption of the Chinese IFRS. The corresponding financial assets are reported
using the trading securities, long-term equity investment, available-for-sale
securities, and held-to-maturity securities accounts. Moreover, restrictions have been
placed on several accounting treatments. For instance, the Last In, First Out inventory
cost flow assumption, reversals of impairment loss on fixed assets and intangibles,
and amortization of goodwill are all prohibited under the new standards. Other rules,
such as those stating that development costs should be capitalized when certain criteria
are met, minority interest should be included within equity, investment property should
be separated from intangible assets, and negative goodwill should be recorded as a gain,
also have significant effects on financial reporting practices.
Most of the Chinese IFRS are in line with IFRS, with a few exceptions[3]. The major
differences are related to the flexibility of selecting accounting methods to account for
certain transactions. For instance, IFRS allow both the equity method and
proportionate consolidation to account for jointly controlled entities, but the Chinese
IFRS allow only the former. IFRS prohibit only the reversal of impairment of goodwill,
but the Chinese IFRS prohibit the reversal of all impairment losses. IFRS allow a
revaluation model for the measurement of fixed assets and intangibles, but the Chinese
IFRS allow only the cost model. Generally, IFRS give more flexibility on accounting for
certain transactions than the Chinese IFRS. Other than these differences, the Chinese
IFRS are fundamentally in line with IFRS.
Prior to the adoption of Chinese IFRS, Chinese accounting standards were more like
rule-based standards, providing a list of detailed rules that must be followed when
preparing financial statements. Compared with rule-based standards, IFRS are generally
principle-based standards, and only a simple set of principles are set out to ensure good
reporting. Due to the lack of detailed guidance on specific transactions, it often requires
more time and professional judgment from accountants to assess proper accounting
treatments for corporate transactions. Management misreporting becomes more likely if
financial statement preparers or auditors do not have sufficient expertise in IFRS.
Moreover, previous studies (e.g. He et al., 2012) indicate an increase in earnings management
after the adoption of IFRS in China. The adoption of the Chinese IFRS therefore increases
both the complexity of the financial reporting environment and the audit risk in China.

2.2 Literature review


The convergence toward principle-based international accounting standards also has
far-reaching effects on the audit market. One immediate effect is the large increase in
the costs of auditing principle-based financial statements. Due to a lack of clear Effects of
accounting guidelines under the principle-based accounting standards, accountants IFRS
must put forth a considerable amount of time and effort to analyze business
transactions to make the most appropriate judgments and to ensure adequate
experience on
compliance (Marden and Brackney, 2009). An increase in audit hours due to a lack of audit fees
experience in auditing principle-based financial statements is also likely to occur. In an
effort to enhance audit quality, IFRS-related education and training need to be provided 47
on a regular basis. Both audit procedures and information systems may also need to be
modified to accommodate the new accounting standards. More investments by audit
firms become imperative.
As the global convergence of accounting standards accelerates, how audit firms in
different jurisdictions respond to the increasing audit cost becomes an interesting topic.
A small number of international studies empirically examine the impact of IFRS
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convergence on audit fees. For instance, Griffin et al. (2009) analyze the association
between overseas and New Zealand governance regulatory reforms and New Zealand
companies audit and non-audit fees from 2002 to 2007. Following the US Sarbanes-Oxley
Act of 2002, corporate governance regulatory reform has taken place in New Zealand.
In the meantime, public listed companies have been allowed to adopt IFRS equivalents
voluntarily since 2005. Griffin et al. (2009) find that audit fees for voluntary IFRS adopters
in New Zealand were higher than those for non-IFRS-adopters from 2002 to 2006.
For those that voluntarily adopt IFRS, their audit fees increased both in the year prior to
the IFRS adoption and in the first three years after the IFRS adoption. DeGeorge et al.
(2013) analyze the effects of IFRS adoption on audit fees for 438 listed Australian
companies. They find an increase in audit fees in the post-adoption period. Furthermore,
they document that the increase is more substantial for smaller companies, which
contradicts the claims that smaller firms are less likely to be affected by the transition to
IFRS. More recently, Kim et al. (2012) compare the changes in audit fees between IFRS
adopter firms from EU countries with non-IFRS-adopter firms from non-EU Organization
for Economic Cooperation and Development (OECD) countries in which IFRS have not
been mandated up to 2008 (such as the USA and Japan). They document a significant
increase in audit fees for the IFRS adopter firms compared to non-IFRS-adopter firms.
They also examine the impact of changes in audit complexity and financial reporting
quality on audit premiums. Their results show that the IFRS-related audit premium
increases with the increase in audit complexity and decreases with the improvement in
financial reporting quality brought about by IFRS adoption.

2.3 Hypothesis development


DeGeorge et al. (2013) indicate that auditors will exert additional effort to become
knowledgeable about the new standards so they can assess whether these standards
have been appropriately implemented. Auditors are likely to seek to recover the cost of
this increased effort through increases in audit fees in the year of IFRS adoption.
Findings from prior studies (Griffin et al., 2009; Kim et al., 2012) support this viewpoint.
In this study, we extend the above literature by investigating factors that altered
auditors pricing decisions in the initial years of IFRS adoption in China. Specifically,
we focus on examining the effect of IFRS experience on audit fees.
Prior studies have not yet provided evidence on the association between auditors
IFRS experience and audit fees. To gain some initial understanding of the potential
effect of auditors IFRS experience on audit fees, we refer to the literature on auditor
industry expertise. Auditor industry expertise stems from auditors experience and
ARA knowledge, and its effect on audit fees has been explored widely in the previous
24,1 literature. Empirical studies have provided confounding evidence regarding the effect
of auditor industry expertise. For instance, Palmrose (1986) and Ferguson and
Stokes (2002) do not find that significant audit premiums were charged by auditors
with industry expertise. Meanwhile, a great number of studies (e.g. Craswell et al.,
1995; Ferguson et al. 2003; Casterella et al., 2004) document that auditor industry
48 expertise is positively associated with audit premiums under various considerations.
The confounding evidence from previous studies is consistent with Ettredge and
Greenberg (1990), who suggest that industry expertise could have two possible
conflicting effects on audit fees. On the one hand, it enables auditors to complete audit
task more efficiently, which implies lower audit fees in a competitive setting.
On the other hand, industry expertise may be associated with a positive reputation
effect. Managers may be willing to pay higher audit premiums with the expectation
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of better-quality auditing. IFRS-related experience is similar to industry expertise.


With IFRS experience, audit cost may be reduced when experienced auditors
audit IFRS-based financial statements[4]. In the meantime, experienced audit firms
may be able to charge higher audit premiums when audit quality is improved by
their experience.
We predict that IFRS experience will have a positive impact on audit fees in the
initial years of IFRS adoption for two reasons. First, IFRS require more professional
judgments than the Chinese GAAP, which implies higher audit risk. The audit risk is
client-specific and cannot be reduced by auditors even if they have prior IFRS-related
experience. It is likely that experienced audit firms that are more sensitive to audit risk,
such as Big 4 (Rama and Read, 2006), still exert significant effort to prepare for the new
standards. This implies that a higher audit fee to compensate extra cost is necessary.
Second, it is likely that the IFRS experience auditors have will enhance their reputation
when the new standards were initially adopted. As mentioned earlier, auditors are able
to charge higher audit premium for their industry expertise. Similarly, auditors with
IFRS-related experience may be able to charge higher audit fees. This is especially true
when IFRS were initially implemented in China. Specifically, the transition period to the
adoption of new standards is only one year in China[5]. Because both listed companies
and audit firms did not have much time to comprehend the new standards, the demand
for IFRS-related experience was high. In the meantime, the competition in the audit
market is low as most Chinese audit firms did not have prior experience in auditing
IFRS-based financial statements prior to 2007[6]. The economic environment implies
that it is more likely for experienced audit firms to raise audit fees rather than to lower
the fees. The above two reasons suggest a positive association between auditors IFRS
experience and audit fees in the initial years:
H1. Auditors IFRS experience is positively associated with audit fees in the initial
years of IFRS adoption.
Previous studies also have not provided evidence on the relationship between audit
clients IFRS experience and audit fees. We posit that having experience in preparing
IFRS-based financial statements before the adoption of the Chinese IFRS likely enhance
audit clients bargaining power when they negotiate audit fees with audit firms. Prior to
an audit, it is audit clients responsibility to prepare financial statements in accordance
with the applicable accounting standards. As several major changes have been made to
the Chinese accounting standards (see the discussion in the background section), the
level of financial reporting complexity has been increased significantly. The one year of
transition period further adds challenges for both auditors and audit clients to prepare Effects of
themselves for the new rule. Under such a circumstance, auditors tend to have a IFRS
perception of better financial reporting quality from clients with IFRS experience.
Moreover, it is also relatively easier for auditors to communicate accounting issues
experience on
with experienced clients and thereby improve audit efficiency. Both the perception of audit fees
better-quality financial reporting and more efficient auditing are expected to provide
bargaining power to clients with IFRS experience in the initial years of IFRS adoption. 49
A negative association between audit clients IFRS experience and audit fees is
expected. We state the following hypothesis:

H2. Audit clients IFRS experience is negatively associated with audit fees in the
initial years of IFRS adoption.
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One factor that could affect the association between IFRS experience and audit fees is
the cross-sectional differences in the degree of financial reporting complexity. Though
several fundamental changes have been made to the Chinese accounting standards, the
extent to which financial reporting complexity is affected varies across listed
companies. For instance, listed companies are required to classify their marketable
securities investments into different portfolios and restate their investments based on
fair value. Such a rule will not have a significant impact on a company unless it has a
highly diversified investment portfolio. Likewise, listed companies are required to
capitalize their development cost under the Chinese IFRS. This change will not affect
companies that do not have any development cost. It is expected that the importance of
IFRS experience will increase as the degree of financial reporting complexity increases.
Accordingly, IFRS experience may affect auditors pricing decisions more significantly
when audit clients encounter a large change in their financial reporting complexity
than when they face only a small change. This leads to the following hypothesis:

H3a. Auditors IFRS experience affects audit fees more significantly when the
degree of change in the financial reporting complexity of their clients is high
than when it is low.
H3b. Audit clients IFRS experience affects audit fees more significantly when the
degree of change in their financial reporting complexity is high than when it
is low.

3. Research method
3.1 Measure of IFRS experience
Because it is impractical to measure experience at the individual level, we measure both
auditors and audit clients IFRS experience at the firm level. We measure auditors
IFRS experience based on whether an audit firm provides auditors with sufficient
IFRS-related training support or resources and whether it had experience
auditing IFRS-based financial statements before 2007[7]. Prior to Chinas adoption of
IFRS, several countries had already used IFRS for years. Compared to local Chinese
accounting firms, accounting firms that operate internationally are likely to have had
experience auditing IFRS-based financial statements before 2007. Among the
accounting firms in China, joint ventures of Big 4 are considered those with
the most experience in IFRS. Several joint ventures with Big 4 international accounting
firms have formed since the early 1990s in China. These Big 4 joint ventures were
ARA mostly owned by Hong Kong accounting firms. Because companies in Hong Kong were
24,1 required to prepare financial statements in accordance with IFRS before 2007, foreign
partners and auditors from these joint ventures are expected to have had experience
auditing IFRS-based financial statements prior to 2007. Moreover, through
standardized staff training and knowledge-sharing practices, auditors from these
Big 4 joint ventures tend to have more access to IFRS-related resources and support in
50 the initial years of IFRS adoption. This enables Big 4 auditors to provide more reliable
assurance regarding IFRS compliance. Additionally, Big 4 audit firms have put
significant effort into the convergence of accounting principles for years, and their
expertise in the area of international accounting is well recognized in the Chinese audit
market. Based on the above reasons, we consider auditors from Big 4 joint ventures
auditors with IFRS experience.
We measure audit clients IFRS experience based on whether, in addition to A-shares,
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listed companies also issue shares in a stock exchange that requires IFRS-based financial
reporting. Specifically, a portion of listed companies that issue A-shares also issue shares in
the Hong Kong Stock Exchange, the London Stock Exchange, or the New York Stock
Exchange[8]. Before Chinas official adoption of the Chinese IFRS, these stock exchanges
already require companies to prepare their financial statements in accordance with IFRS[9].
Consequently, companies that issue shares in these stock markets, compared to those only
issue A-shares, should have had experience in preparing IFRS-based financial statements
prior to 2007[10]. Hence, we identify whether companies issue shares in a stock exchange
that requires IFRS reporting to proxy for audit clients IFRS experience.

3.2 Complexity of financial reporting


Given the difficulty of quantifying the differences between different accounting
principles, only a limited number of studies have empirically measured the degree of
changes in financial reporting complexity under the adoption of new accounting
standards. Ding et al. (2007) developed scores that measure the absence of and
divergence between international accounting standards and the local GAAP in
different countries. Kim et al. (2011), for example, adopt the scores in examining
the difference of the effects of change in audit complexity on audit fees between
IFRS-adopter firms in EU countries and non-IFRS-adopter firms in OECD countries.
The measure developed by Ding et al. (2007), however, is not a firm-specific measure,
and it cannot be directly used to compare the changes in financial reporting complexity
between different companies in the same country.
To see how the degree of change in the complexity of financial reporting affects the
association between IFRS experience and audit fees, a firm-level measure that captures
the changes in financial reporting complexity for each firm is needed. According to
Accounting Standards for Business Enterprises No. 38, First-time Adoption of
Accounting Standards for Business Enterprises, the first annual financial statements
shall include at least one year of comparative information prepared under the Chinese
IFRS after the standards effective date. Under this requirement, listed companies must
restate their 2006 financial statements in accordance with the Chinese IFRS and issue the
restated 2006 financial statements with their 2007 financial statements[11]. By comparing
the balances of accounts on the two sets of 2006 financial statements, we are able to
measure empirically the effect of Chinese IFRS adoption on financial reporting complexity.
We measure the degree of changes in financial reporting complexity by considering
the number of the affected balance sheet and income statement accounts separately.
On a companys balance sheet, we count the number of asset and liability accounts that
require IFRS-related adjustments to measure the change of financial reporting Effects of
complexity on the balance sheet (COUNT_BS)[12]. Because the revaluation of assets IFRS
and liabilities implies a revaluation of the stockholders equity, to avoid
double-counting the effect of IFRS adjustments on a balance sheet, we do not
experience on
include the number of equity accounts that are affected. On a companys income audit fees
statement, we count the number of revenue and expense accounts that were restated.
The total number of affected income statement accounts is used to measure the change 51
in the financial reporting complexity of the income statement (COUNT_IS)[13].
A company is classified as having a low (high) degree of changes in the complexity of
balance sheet and income statement when COUNT_BS and COUNT_IS are below
(above) the median, respectively[14]. By counting the number of balance sheet and
income statement accounts affected, we are able to measure the overall impact of
adopting the Chinese IFRS on the presentation and the valuation of assets, liabilities,
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revenues, and expenses.

3.3 Empirical model


To investigate how IFRS experience affected audit fees in the initial years of the
Chinese IFRS adoption, we follow prior studies (Simunic, 1980; Palmrose, 1986; Wang
et al., 2008) and develop an ordinary least square cross-sectional regression model in
Equation (1)[15]:
LN FE it 0 1 FI RY Rit 2 SECY Rit a3 EX P_B4it a4 EX P_CROSS it
a5 EX P_B4it  FI RY Rit 6 EX P_B4it  SECY Rit
7 EX P_CROSS it  FI RY Rit 8 EX P_CROSS it  SECY Rit ;
9 LN TAit 10 ARit 11 I N V it 12 LEV it 13 SOE it
14 I N DEX it 15 LOSS it 16 OPI N it
17 AU DSI Z E it 18 M I DAU DI T it 19 SU Bit
X
11
20 I N I TI ALit 20 K I N DKit eit (1)
K1

where, for company i in year t, LNFE is the natural log of audit fees; FIRYR an
indicator variable that equals 1 when the year t is 2007 and 0 otherwise; SECYR
an indicator variable that equals 1 when the year t is 2008 and 0 otherwise; EXP_B4 an
indicator variable that equals 1 when the audit firm is a joint venture of an international
Big 4 accounting firm and 0 otherwise; EXP_CROSS an indicator variable that equals 1
when the company issues shares in a stock exchange that requires IFRS reporting in
addition to A-shares and 0 otherwise; LNTA the natural log of total assets; AR the
amount of accounts receivable divided by the total assets; INV the amount of inventory
divided by the total assets; LEV the total liabilities divided by total assets; SOE an
indicator variable that equals 1 when the company is state-owned and 0 otherwise;
INDEX the index of market intermediaries and the legal environment; LOSS an
indicator variable that equals 1 when the company has a loss in year t and 0 otherwise;
OPIN an indicator variable that equals 1 when an unqualified opinion is issued in year
t and 0 otherwise; AUDSIZE an indicator variable that equals 1 when the audit firm is a
domestic Big 6 accounting firm in China and 0 otherwise[16]; MIDAUDIT an indicator
variable that equals 1 when the company has a mid-term audit and 0 otherwise;
ARA INITIAL an indicator variable that equals 1 if it is the initial audit of the company by
24,1 the audit firm and 0 otherwise; SUB the number of foreign subsidiary that a company
has; and IND the industry indicator variables.
Given that our interest is to examine the change in audit fees in the initial years of
IFRS adoption, our sample period is restricted to two years before and after the
adoption of the Chinese IFRS (i.e. 2005-2008). In Equation (1), two year indicator
52 variables, FIRYR and SECYR, are included to capture the fixed effect of a possible
macro trend on audit fees in the post-adoption period (i.e. 2007 and 2008) not controlled
by the other determinants. The fixed effect in the pre-adoption period (2005 and 2006) is
reflected in the intercept. Our primary test variables are the interaction terms between
EXP_B4 and the two year indicator variables and those between EXP_CROSS and the
two year indicator variables. The former are included to test the marginal effects of
audit firms experience on audit fees in the initial years of IFRS adoption, and the latter
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are used to test the marginal effect of audit clients experience on audit fees.
The coefficients on the interaction terms between EXP_B4 and the two year indicator
variables are expected to be positive. As discussed in 2.3, the demand for IFRS
experience in the initial year of Chinese IFRS adoption was high, but most auditors in
China did not have prior experience with IFRS-based financial statements. Prior
experience in auditing IFRS-based financial reporting thus provides competitive
advantages to Big 4 joint ventures. Moreover, the increasing demand for subjective
judgment under principle-based accounting standards increases the audit risk. As a
result, an upward adjustment in audit fees is more likely than a downward adjustment.
The coefficients on the interaction terms between EXP_CROSS and the two year
indicator variables are expected to be negative. As discussed earlier, the more
experience audit clients have in preparing IFRS-based financial statements, the less
likely it is that significant financial reporting errors could be made. This implies better
financial reporting quality and lower audit risk, both of which are negatively related to
audit fees.
In addition to the primary test variables, EXP_B4 is included to control the higher
audit premiums charged by Big 4 joint ventures independent of IFRS adoption.
Previous studies argue that Big 4 audit firms can charge higher audit premiums than
non-Big 4 audit firms based on the reputation they have established (Palmrose, 1986;
Francis and Simons, 1987; Craswell et al., 1995). Qi et al. (2004) also find that Big 4
member firms charge significantly higher audit premiums than other accounting firms
in China. Moreover, due to their deep pockets, the compensatory damage tends to be
large (DeAngelo, 1981b; Dye, 1993). Both the reputation theory and the deep pocket
theory lead to a positive coefficient on EXP_B4. EXP_CROSS is included to control for
the effect of cross-listing on audit fees independent of IFRS adoption[17]. When
companies issue multiple types of shares, their capital structure becomes more complex
than that of those that issue only a single type of shares. Such companies are subject to
different regulations from different stock exchanges. As a result, auditors need to exert
extra effort to understand the capital structure and review the business transactions of
this type of company to make appropriate auditing-related judgments or decisions.
Hence, more audit fees are expected to be associated with cross-listed firms.
We also include other variables that have been examined as factors affecting audit
fees by prior studies. LNTA is included to control for the effect of the size of audit
clients on audit fees. The larger the size of the audit client is, the higher the audit fees
will be; thus, we expect a positive coefficient on LNTA. The ratio of accounts receivable
to total assets (AR) and the ratio of inventory to total assets (INV) are included
to measure the audit complexity. Both bad debts estimate and inventory valuation Effects of
increase the audit complexity. Furthermore, the confirmation of receivables and IFRS
inventory physical count are required by generally accepted auditing procedures.
We expect that the more receivables and inventory there are, the higher the audit
experience on
complexity and the higher the audit fees will be. Therefore, the coefficients on AR and audit fees
INV are expected to be positive. SOE is included to control for the lower audit fees paid
by listed state-owned companies following Wang et al. (2008). INDEX is included to 53
capture the impact of the legal environment on audit fees. Following Wang et al. (2008)
and Firth et al. (2012), we use an index of market intermediaries and the
legal environment to control the effect of the degree of legal development in different
provinces in China on audit fees[18]. Given that the litigation risk is higher in a
better-developed legal environment, higher audit premiums are expected to be charged
by auditors to compensate for the higher litigation risk. A positive coefficient on
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INDEX is expected.
Following prior studies (Francis, 1984; Craswell et al., 1995), LEV and LOSS
are included to measure the operational risk of audit clients. On the other hand, OPIN is
included to reflect the evaluated risk of the audit client by auditors. Following Chen et al.
(2000, 2001, 2010) and Wang et al. (2008), we classify modified opinion, qualified opinion,
adverse opinion, and disclaimers of opinion as qualified opinion, and OPIN equals 1
only when a standard unqualified opinion report is issued. Because an unqualified
opinion last year indicates that the evaluated risk of the audit client is low, we expect a
negative association between OPIN and the level of audit fees. DeAngelo (1981a) and
Craswell and Francis (1999) indicate that audit firms charge lower audit fees on initial
audit engagements (a low-balling strategy). Hence, we expect that the coefficient on
INITIAL will be negative. In addition, most literature suggests that larger audit firms
charge higher audit fees (Francis, 1984; Palmrose, 1986; Hay et al., 2006). To control for
the effects of audit firm size on audit fees, we identify the domestic Big 6 accounting firms
in China based on their total audited assets and include AUDSIZE in the equation.
The coefficient on AUDSIZE is expected to be positive. MIDAUDIT is included to control
for higher audit fees charged for mid-term audits[19]. SUB is included to control for the
effect of foreign subsidiaries. Finally, industry classification (IND) is included to capture
the industry effect on audit fees. Based on industry classification of listed companies
issued by the China Securities Regulatory Commission, we include 11 indicator variables
to capture 12 industries[20]. Different audit procedures and audit tests may be applied
when auditing different industries. It is therefore possible for audit firms to charge audit
fees based on the industry they audit.

4. Data
Our primary sample consists of listed companies that issued A-shares in the Shanghai
and Shenzhen stock exchanges from 2005 to 2008. Information regarding audit fees and
audit opinion is collected from companies annual reports. All financial data are
retrieved from the Taiwan Economic Journal database.
Table I summarizes the sample selection process. We apply the following filters in
selecting samples. First, we exclude firms that were delisted or filed for an initial
public offering (IPO) during the sample period. This ensures that we include only
companies that were listed throughout the entire sample period. In addition, Simunic
and Stein (1996) suggest that the audit risk is higher when auditors audit IPO
companies because there are more procedures with which to be compliant.
By excluding IPO companies from the sample, we are also able to control such an
ARA Total
24,1
Original observation 5,389
Less
1. IPO and delisted companies
Delisted companies (70)
IPO companies (112)
54 2. Financial industry (68)
3. A and B share (336)
Table I. 4. Missing audit fee data (628)
Sample selection 5. Missing financial data (46)
process Final sample 4,129
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effect. Second, we exclude firms in the financial industry since they are subject to
different regulations. Third, companies that issue B-shares in addition to A-shares
were excluded from our sample to avoid the confounding effect of the abandonment
of the dual audit rule for B-shares in 2007 on our results (see footnote 6 for a related
discussion). Finally, we exclude observations with missing audit fees and missing
data for the required financial variables after merging data from different sources.
In addition to the above filters, we replace the top and bottom 1 percent extreme
values of variables LNTA, LEV, AR, and INV with the values corresponding to the
upper and lower 1 percent limits[21]. This enables us to control the effects of extreme
values and, at the same time, to save more sample observations. The final sample
comprises 4,129 firm-year observations.
Table II provides descriptive statistics for the dependent and explanatory variables
in the model. The following observations are worth noting. Consistent with previous
studies that indicate a small market share for the Big 4 in China (DeFond et al., 2000;
Wang et al., 2008), 5.2 percent of our observations are audited by Big 4 joint ventures.
On the other hand, 14.2 percent of sample observations are audited by domestic Big 6
accounting firms. The above findings suggest that a large percentage of our sample
companies are audited by small domestic accounting firms. On average, the Chinese
government retains more than 66 percent of the equity in the sample observations,
indicating that a high percentage of the sample listed companies are controlled by the
government. An unqualified opinion is issued by auditors most of the time. About
91 percent of firm-year observations receive standard unqualified opinions from their
auditors. Most of our sample observations have profitable operation results and low
operational risk as only 14.5 percent of our sample observations reported loss. Finally,
about 2.7 percent of the sample observations issued shares in a stock exchange that
requires IFRS reporting in addition to A-shares and about 7 percent of sample
companies conducted mid-year audits.
The untabulated results indicate that, on average, 15 out of 48 asset and liability
accounts require IFRS-related adjustments (i.e. the mean of COUNT_BS is 15).
The maximum and minimum numbers of balance sheet accounts being adjusted are 41
and four, respectively. On average, nine of 16 income statement accounts require
IFRS-related adjustments (i.e. the mean of COUNT_IS is 6). The maximum and
minimum numbers of the income statement accounts affected are 14 and 2,
respectively. The statistics on COUNT_BS and COUNT_IS suggest that not all listed
companies were affected significantly by the adoption of the Chinese IFRS. Some of
the companies do not make many adjustments under the Chinese IFRS.
Variablea Mean SD Min. Med. Max. Effects of
IFRS
LNFE 13.123 0.650 11.513 13.017 18.005
FIRYR 0.240 0.427 0 0 1
experience on
SECYR 0.258 0.437 0 0 1 audit fees
EXP_B4 0.052 0.222 0 0 1
EXP_CROSS 0.027 0.163 0 0 1
LNTA 14.498 1.113 11.633 14.445 17.872 55
AR 0.102 0.090 0 0.081 0.416
INV 0.173 0.150 0.001 0.137 0.745
LEV 0.563 0.337 0.077 0.538 2.755
LOSS 0.145 0.352 0 0 1
SOE 0.667 0.471 0 1 1
INDEX 8.423 3.955 2.79 7.23 16.61
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OPIN 0.908 0.289 0 1 1


AUDSIZE 0.142 0.349 0 0 1
MIDAUDIT 0.074 0.261 0 0 1
INITIAL 0.097 0.296 0 0 1
SUB 0.071 0.497 0 0 11
Notes: n 4,129. aVariables definition, LNFE is the natural log of audit fee; FIRYR, a dummy variable
that equals 1 if t equals 2007 and 0 otherwise; SECYR , dummy variable that equals 1 if it equals 2008
and 0 otherwise; EXP_B4, a dummy variable that equals 1 if the audit firm is a joint venture of Big 4
international accounting firms and 0 otherwise; EXP_CROSS, a dummy variable that equals 1 if a
company issues shares in a stock exchange that requires IFRS reporting in addition to A-shares and 0
otherwise; LNTA, the natural logarithm of total assets; AR, the amount of accounts receivable divided
by total assets, INV, the amount of inventory divided by total asserts; LEV, total liabilities divided by
total assets; LOSS, a dummy variable that equals 1 if the company reported net loss in year t 1 and 0
otherwise; SOE, a dummy variable that equals 1 if the company is state-owned and 0 otherwise;
INDEX, the index of market intermediaries and legal environment; OPIN is a dummy variable that
equals 1 if unqualified auditor opinion was issued in year t 1 and 0 otherwise; AUDSIZE is a dummy
variable equals 1 if the audit firm is a Big 6 accounting firm in China and 0 otherwise; MIDAUDIT, a
dummy variable that equals 1 if a company has mid-year audit and 0 otherwise; INITIAL, a dummy
variable that equals 1 it is the initial audit of the company by the audit firm and 0 otherwise; SUB, the Table II.
number of foreign subsidiary that a company has Descriptive statistics

5. Empirical results
5.1 Results from multivariate tests
Table III presents the empirical multivariable test results based on Equation (1).
Column (1) of Table III reports the results for the full sample. A significantly positive
marginal effect of auditors experience on audit fees is found for the first two years of
Chinese IFRS adoption. As reported in column (1) of Table III, the coefficients on
EXP_B4 FIRYR and EXP_B4 SECYR are significantly positive. These positive
coefficients suggest that Big 4 joint ventures charged larger incremental audit
premiums than their counterparts in each of the initial two years of IFRS adoption.
The positive coefficients on these interaction terms also suggest that Big 4 joint
ventures did not cut audit fees in the initial years of IFRS adoption even though they
may have been able to complete audit tasks with a lower cost based on their existing
IFRS resources and experience, and their economy of scale advantage. Instead, the
results support the reputation theory that higher audit premiums were charged by more
experienced auditors to compensate for the established reputation in the area of IFRS.
Contrary to the positive effect of auditor experience on audit fees, audit clients
IFRS experience had a negative impact on audit fees during the initial years of IFRS
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56
24,1
ARA

Table III.

on audit fee
IFRS experience
Results of effects of
(1) Full sample (2) COUNT_BS HIGHa (3) COUNT_BS LOWa (4) COUNT_IS HIGHb (5) COUNT_IS LOWb
Variablec Coeff. p-Value Coeff. p-Value Coeff. p-Value Coeff. p-Value Coeff. p-Value

Intercept 8.391 0.001*** 8.067 0.001*** 9.180 0.001*** 8.179 0.001*** 8.817 0.001***
FIRYR 0.041 0.006*** 0.041 0.020** 0.035 0.068* 0.057 0.010*** 0.025 0.205
SECYR 0.055 0.001*** 0.059 0.007*** 0.055 0.002*** 0.063 0.003** 0.050 0.009***
EXP_B4 0.519 0.001*** 0.493 0.001*** 0.362 0.001*** 0.472 0.001*** 0.609 0.001***
EXP_B4 FIRYR 0.322 0.001*** 0.365 0.001*** 0.114 0.442 0.319 0.001*** 0.296 0.040**
EXP_B4 SECYR 0.329 0.001*** 0.357 0.001*** 0.219 0.140 0.345 0.001*** 0.247 0.093*
EXP_CROSS 1.246 0.001*** 1.290 0.001*** 1.061 0.001*** 1.232 0.001*** 1.283 0.001***
EXP_CROSS FIRYR 0.184 0.068* 0.307 0.015** 0.012 0.944 0.210 0.078* 0.123 0.553
EXP_CROSS SECYR 0.153 0.123 0.226 0.066* 0.067 0.686 0.191 0.102 0.023 0.913
LNTA 0.313 0.001*** 0.340 0.001*** 0.259 0.001*** 0.330 0.001*** 0.280 0.001***
AR 0.072 0.322 0.173 0.129 0.050 0.572 0.134 0.234 0.048 0.607
INV 0.154 0.001*** 0.156 0.024 0.093 0.124 0.108 0.130 0.176 0.003***
LEV 0.123 0.001*** 0.055 0.148 0.134 0.001*** 0.129 0.001*** 0.127 0.001***
LOSS 0.026 0.154 0.039 0.164 0.008 0.731 0.046 0.097* 0.006 0.802
SOE 0.080 0.001*** 0.083 0.001*** 0.095 0.001 0.083 0.001*** 0.098 0.001***
INDEX 0.016 0.001*** 0.022 0.001*** 0.004 0.084* 0.018 0.001*** 0.009 0.001***
OPIN 0.091 0.001*** 0.186 0.001*** 0.040 0.191 0.150 0.001*** 0.025 0.455
AUDSIZE 0.100 0.001*** 0.090 0.001*** 0.119 0.001*** 0.125 0.001*** 0.066 0.005***
MIDAUDIT 0.093 0.001*** 0.145 0.001*** 0.051 0.083* 0.157 0.001*** 0.060 0.034**
INITIAL 0.054 0.006*** 0.051 0.086* 0.045 0.074* 0.065 0.020** 0.050 0.070*
SUB 0.047 0.001*** 0.032 0.013** 0.067 0.055* 0.043 0.009*** 0.032 0.060*
IND Included Included Included Included Included
Adj R2 67.3% 73.6% 46.4% 71.3% 53.3%
n 4,129 2,065 2,064 2,135 1,994
Notes: aCOUNT_BS HIGH when the number of balance sheet accounts being affected is higher than the median, and COUNT_BS LOW otherwise;
b
COUNT_IS HIGH when the number of income statement accounts being affected is higher than the median, and COUNT_IS LOW otherwise; cVariables
are as defined in Table II. IND are 11 industry indicator variables. The 12 industries we include are: Agriculture, forestry, animal husbandry, and fishery;
Mining; Manufacturing; Electric power, heat, gas and water production and supply; Construction; Transport, storage, and postal service; Wholesale and retail;
Real estate; Accommodation and catering; Culture, sports, and entertainment; Information transmission, software, and information technology services; and
other. *,**,***Significant at 10, 5, and 1 percent level, respectively (two-tailed)
adoption. As reported in column (1) of Table III, the coefficient on EXP_CROSS FIRYR Effects of
is significantly negative at the 10 percent level. The negative coefficient suggests that IFRS
audit clients with IFRS experience paid lower incremental audit fees in the first year of
the Chinese IFRS implementation compared to their counterparts. This supports the
experience on
hypothesis that audit clients IFRS experience provided them a fee advantage when IFRS audit fees
were initially implemented. However, the negative effect in the second year of
IFRS adoption was not as significant as in the first year. 57
Columns (2) and (3) report the results by the degree of changes in the complexity of
balance sheet, and columns (4) and (5) report the results by the degree of changes in the
complexity of income statement, respectively. The incremental audit fees charged by
Big 4 joint ventures were higher and more significant when the degree of changes in
financial complexity for their clients was high (columns (2) and (4)) than when it was
low (columns (3) and (5)) in both 2007 and 2008. The incremental fees charged by
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auditors with IFRS experience are significant except for the group with
COUNT_BS LOW. The effect of audit clients IFRS experience also depends on
the degree of changes in financial reporting complexity. Audit clients with IFRS
experience paid significantly lower incremental fees than their counterparts only in the
group with high complexity, and this fee advantage was most significant in the
first year of IFRS adoption. In the group with low complexity (columns (3) and (5) of
Table III), the incremental audit fees paid by those with and without IFRS experience
did not differ in all years. Thus, having prior experience in preparing IFRS-based
financial statements does not necessarily give audit clients an advantage in negotiating
lower audit fees. It further depends on how the client firms financial reporting was
affected by the adoption of the Chinese IFRS.
The results for the following four control variables are worth noting. First,
the significantly positive coefficients on EXP_B4 in all columns of Table III indicate
that auditors with IFRS experience, as measured by Big 4 joint ventures, charge higher
audit premiums than other audit firms in the Chinese audit market independent of the
Chinese IFRS adoption. This finding is consistent with Qi et al. (2004). Second, the
coefficients on EXP_CROSS are significantly positive in all columns of Table III,
suggesting that auditors charged higher audit premiums when a company issued
shares in a stock exchange that required IFRS reporting. Third, the coefficients on SOE
are significantly negative in all columns of Table III, suggesting that the state
ownership of listed companies is negatively associated with the level of audit fees. This
result is in line with previous findings that state-owned companies paid lower audit
fees than non-state-owned companies when other things were equal (Wang et al., 2008).
Finally, the coefficients on INDEX are significantly positive in all columns of Table III,
indicating that the level of audit fees is positively associated with the score for legal
institutions development. This suggests that audit fees increased as the regional legal
liability became stricter in China. The rest of the control variables are significant in the
expected direction except INV, which has a negative coefficient instead of a positive
coefficient. The negative coefficients on INV contradict the results from prior studies in
the USA, yet they are consistent with previous studies in China (Chen et al., 2007;
Wang et al., 2008). An explanation for this anomaly has not been provided, and further
investigations will be needed in the future.

5.2 Additional analysis


5.2.1 The effect of other accounting firms with IFRS experience. As an additional
analysis on the effect of auditors IFRS experience on audit fees, we separate audit
ARA firms that are not among the Big 4 yet have previous audit experience with
24,1 IFRS in our test. Specifically, companies that issue B-shares in the Shanghai and
Shenzhen stock exchanges, and those issue H-shares in the Hong Kong Stock
Exchange were required to issue their financial statements based on international
accounting standards prior to 2007. We identify audit firms, other than Big 4, that
audit those companies as those having experience in auditing IFRS-based
58 financial statements. We add a variable EXP_NB4 that equals 1 when a non-Big 4
audit firm has previous experience in auditing IFRS-based financial statements and
0 otherwise in Equation (1)[22]. The interaction terms between EXP_NB4 and the
two year indicator variables are also included. The results of this test are reported
in Table IV.
Column (1) of Table IV reports the results based on the full sample. Similar to
Big 4 joint ventures, a significantly positive incremental premium was charged by
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non-Big 4 audit firms with IFRS experience in the first year of Chinese IFRS adoption.
This result is in line with the hypothesis that audit firms charged higher premiums in
the initial years of IFRS adoption when they had previous IFRS experience.
The incremental premiums charged by those non-Big 4 firms were lower than what the
Big 4 charged (the coefficient on EXP_NB4 FIRYR is significantly smaller than the
coefficient on EXP_B4 FIRYR based on a t-test ( p 0.001)). However, unlike Big 4,
non-Big 4 firms with IFRS experience did not consistently charge higher premiums. As
reported in columns (2) and (4) of Table IV, significantly positive premiums were
charged in the first year of IFRS adoption for clients with a high degree of change in
complexity. In contrast, in the group of low complexity (columns (3) of Table IV),
no significant premium is observed in both years. These results suggest that non-Big 4
audit firms with IFRS experience charged incremental premiums based on how their
clients financial reporting complexity was affected. With IFRS experience, non-Big 4
audit firms could still charge increased premiums. However, these premiums were less
significant and lasted less time than what Big 4 joint ventures charged, reflecting the
advantage of having more intensive experience in IFRS-based financial statements
with Big 4 joint ventures.
5.2.2 Other measures of the change in financial reporting complexity. In this section,
we measure the degree of changes in financial reporting complexity by considering
the monetary effect of the Chinese IFRS adoption on financial statements.
Specifically, we measure the monetary difference between Chinese GAAP-based
and Chinese IFRS-based account balances. To measure the monetary effect of the
IFRS adoption on the balance sheet, we first total the absolute value of the difference
for each asset account between Chinese GAAP and Chinese IFRS. We then divide
the total absolute difference by Chinese GAAP-based total assets (the ratio is
called DIFF_BS). For the income statement, we take the total of the absolute
value of the difference for each income statement account and divide it by Chinese
GAAP-based sales (the ratio is called DIFF_IS). The higher the two ratios are,
the more significantly the Chinese IFRS adoption has affected a companys financial
reporting. A company is classified as having a high (low) degree of changes
in balance sheet/income statement complexity when its DIFF_BS/DIFF_IS is
greater (smaller) than the median values[23]. Table V reports the results based
on this classification.
As reported in all columns of Table V, the effects of the auditors IFRS experience on
audit fees are consistently significantly positive. Regardless of the degree of changes in
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(1) Full Sample (2) COUNT_BS HIGHa (3) COUNT_BS LOWa (4) COUNT_IS HIGHb (5) COUNT_IS LOWb
c
Variable Coeff. p-Value Coeff. p-Value Coeff. p-Value Coeff. p-Value Coeff. p-Value

Intercept 8.394 0.001*** 8.073 0.001*** 9.176 0.001*** 8.174 0.001*** 8.824 0.001***
FIRYR 0.028 0.081* 0.032 0.124 0.028 0.163 0.042 0.077* 0.012 0.566
SECYR 0.046 0.004*** 0.046 0.054* 0.053 0.008** 0.058 0.014** 0.038 0.062*
EXP_B4 0.522 0.001*** 0.498 0.001*** 0.365 0.001*** 0.472 0.001*** 0.617 0.001 ***
EXP_B4 FIRYR 0.338 0.001*** 0.382 0.001*** 0.127 0.393 0.336 0.001*** 0.312 0.030**
EXP_B4 SECYR 0.339 0.001*** 0.367 0.001*** 0.225 0.131 0.350 0.001*** 0.255 0.082*
EXP_CROSS 1.243 0.001*** 1.287 0.001*** 1.058 0.001*** 1.231 0.001*** 1.273 0.001***
EXP_CROSS FIRYR 0.194 0.055* 0.302 0.016** 0.011 0.946 0.216 0.070* 0.140 0.501
EXP_CROSS SECYR 0.155 0.117 0.219 0.073* 0.078 0.642 0.191 0.101 0.028 0.893
EXP_NB4 0.013 0.602 0.025 0.460 0.015 0.680 0.002 0.958 0.038 0.281
EXP_NB4 FIRYR 0.100 0.021** 0.129 0.032** 0.058 0.333 0.100 0.100* 0.100 0.091*
EXP_NB4 SECYR 0.059 0.144 0.073 0.193 0.027 0.633 0.031 0.586 0.078 0.160
LNTA 0.313 0.001*** 0.340 0.001*** 0.259 0.001*** 0.330 0.001*** 0.280 0.001***
AR 0.064 0.377 0.161 0.158 0.046 0.606 0.123 0.276 0.051 0.583
INV 0.155 0.001*** 0.157 0.023** 0.092 0.127 0.106 0.137 0.182 0.002***
LEV 0.122 0.001*** 0.049 0.197 0.135 0.001*** 0.128 0.001*** 0.127 0.001***
LOSS 0.027 0.149 0.039 0.166 0.009 0.707 0.047 0.088* 0.005 0.853
SOE 0.078 0.001*** 0.077 0.001*** 0.094 0.001*** 0.080 0.001*** 0.097 0.001***
INDEX 0.015 0.001*** 0.022 0.001*** 0.003 0.171 0.018 0.001*** 0.007 0.001***
OPIN 0.092 0.001*** 0.193 0.001*** 0.039 0.210 0.151 0.001*** 0.024 0.465
AUDSIZE 0.098 0.001*** 0.088 0.001*** 0.116 0.001*** 0.123 0.001*** 0.063 0.008***
MIDAUDIT 0.095 0.001*** 0.151 0.001*** 0.051 0.080* 0.158 0.001*** 0.063 0.025**
INITIAL 0.054 0.006*** 0.048 0.102 0.046 0.070* 0.065 0.020** 0.050 0.068*
SUB 0.044 0.001*** 0.028 0.028** 0.065 0.060* 0.042 0.011*** 0.026 0.126
IND Included Included Included Included Included
R2 67.4% 73.7% 46.4% 71.3% 53.6%
n 4,129 2,065 2,064 2,135 1,994
Notes: aCOUNT_BS HIGH when the number of balance sheet accounts being affected is higher than the median, and COUNT_BS LOW otherwise;
b
COUNT_IS HIGH when the number of income statement accounts being affected is higher than the median, and COUNT_IS LOW otherwise; cEXP_NB4
equals 1 when a non-Big 4 audit firm has previous experience in auditing IFRS-based financial statements and 0 otherwise. Other variable are as defined in
Tables II and III. *,**,***Significant at 10, 5, and 1 percent level, respectively (two-tailed)
Effects of

experience on
audit firms' IFRS
Additional analysis
59
audit fees
IFRS

audit fee
effects of non-Big 4
Table IV.
experience on
ARA (1) (2) (3) (4)
24,1 DIFF_BS HIGH DIFF_BS LOW DIFF_IS HIGH DIFF_IS LOW
Variable Coeff. p-Value Coeff. p-Value Coeff. p-Value Coeff. p-Value

Intercept 8.222 0.001*** 8.400 0.001*** 8.343 0.001*** 8.396 0.001***


FIRYR 0.061 0.002*** 0.017 0.431 0.054 0.011** 0.027 0.194
60 SECYR 0.078 0.001*** 0.031 0.142 0.065 0.002*** 0.044 0.036**
EXP_B4 0.474 0.001*** 0.570 0.001*** 0.480 0.001*** 0.564 0.001***
EXP_B4 FIRYR 0.338 0.001*** 0.294 0.018** 0.371 0.001*** 0.271 0.009***
EXP_B4 SECYR 0.334 0.001*** 0.298 0.019** 0.419 0.001*** 0.221 0.036**
EXP_CROSS 1.294 0.001*** 1.140 0.001*** 1.195 0.001*** 1.317 0.001***
EXP_CROSS FIRYR 0.216 0.107 0.144 0.356 0.234 0.075* 0.128 0.422
EXP_CROSS SECYR 0.233 0.082* 0.062 0.682 0.246 0.057* 0.048 0.755
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LNTA 0.324 0.001*** 0.317 0.001*** 0.314 0.001*** 0.314 0.001***


AR 0.202 0.060* 0.001 0.996 0.190 0.069* 0.020 0.844
INV 0.222 0.001*** 0.002 0.983 0.137 0.037** 0.114 0.092*
LEV 0.149 0.001*** 0.058 0.263 0.112 0.001*** 0.109 0.014**
LOSS 0.014 0.549 0.050 0.098* 0.019 0.405 0.042 0.201
SOE 0.055 0.002*** 0.097 0.001*** 0.103 0.001*** 0.061 0.001***
INDEX 0.013 0.001*** 0.017 0.001*** 0.020 0.001*** 0.011 0.001***
OPIN 0.091 0.001*** 0.071 0.131 0.090 0.002*** 0.092 0.064*
AUDSIZE 0.098 0.001*** 0.096 0.001*** 0.095 0.001*** 0.107 0.001***
MIDAUDIT 0.049 0.117 0.134 0.001*** 0.059 0.070* 0.120 0.001***
INITIAL 0.050 0.050** 0.050 0.097* 0.031 0.224 0.087 0.005**
SUB 0.057 0.001*** 0.030 0.074* 0.039 0.004*** 0.061 0.010***
IND Included Included Included Included
R2 68.9% 66.8% 68.2% 66.8%
n 2,054 2,075 2,071 2,058
Table V. Notes: DIFF_BS HIGH when the total absolute value of difference of each asset account divided by
a

Additional analysis Chinese GAAP-based total assets is higher than the median, and DIFF_BS LOW otherwise;
effects of IFRS b
DIFF_IS HIGH when the total absolute value of difference of each income statement account
experience on audit divided by Chinese GAAP-based sales is higher than the median, and DIFF_IS LOW otherwise;
c
fees by different Variables are as defined in Tables II and III. *,**,***Significant at 10, 5, and 1 percent level,
complexity measure respectively (two-tailed)

the financial reporting complexity, Big 4 joint ventures charged significantly increased
audit fees during the initial two years of IFRS adoption. On the other hand,
audit clients IFRS experience is significantly negatively associated with audit fees
when these firms encountered a high degree of changes in their income statement
complexity (column (3) of Table V). A similar negative effect is found when the
degree of change in balance sheet complexity is high; however, the coefficients on
EXP_CROSS FIRYR and EXP_CROSS SECYR are less significant. In short, the
results based on different classifications of financial complexity are qualitatively
similar to our main results.
5.2.3 Endogeneity. To account for the possibility of self-selection bias of Big 4
audit fees, we perform a standard Heckman (1979) two-stage estimation. Following
Lawrence et al. (2011), we include the Big 4 indicator variable (EXP_B4) as the
dependent variable in the first stage estimation. Four independent variables are
included in the first stage: the size of firm (LNTA), the sales revenues scaled by
total assets (ATURN), the leverage ratio (LEV), and the rate of returns on assets
(ROA, income before tax divided by total assets). The inverse mills ratio estimated Effects of
from the first stage is then added to Equation (1) as the second stage estimation. IFRS
The results of the second stage estimation are reported in Table VI. After accounting
for the selection bias, the coefficient on EXP_B4 is no longer significant. In the
experience on
meantime, the coefficients of interaction terms between EXP_B4 and the two year audit fees
indicator variables remain significantly positive. These results confirm our previous
conclusion that Big 4 audit firms charge higher premium for their IFRS-related 61
experience in the initial years of IFRS adoption.

6. Conclusions
Existing literature has documented the effects of IFRS adoption on audit fees in
various countries around the world. One general conclusion is that audit fees
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increased following the adoption of IFRS. We extend previous literature by


examining the effect of IFRS experience on audit fees during the initial years of IFRS
adoption in China. We find that audit firms with IFRS experience prior to 2007
charged an incremental audit premium in the initial years of IFRS adoption.
Contrarily, audit clients with previous IFRS experience paid lower incremental audit
premiums in the initial years of IFRS adoption. We also find that auditors pricing
decisions were affected by the degree of changes in financial reporting complexity
due to the adoption of new accounting standards. Generally, when the adoption of the
Chinese IFRS introduced a high degree of changes in financial reporting complexity,
the adjustment in audit fees was more significant. This suggests that the increase in
audit fees in the initial years of IFRS adoption as documented by previous literature
was likely not universal. Instead, the adjustment in audit fees varied across firms
and depends on how each firms financial reporting was affected by the adoption
of new standards.
The above evidence complements the existing international studies on the effects
of IFRS on audit fees. The findings from this study also shed some light on the
differences in the effects between auditors and audit clients IFRS experience on audit
fees. We provide evidence showing that auditors charged higher premiums for their
experience while audit clients had a bargaining advantage based on their experience.
These findings provide an interesting perspective about the effects of experience on
audit fees that has not been addressed in the previous literature. Moreover, the
measure of auditor experience we provide is different from what has been used in
previous literature on auditor industry expertise. This stream of literature measures
auditor industry expertise based on auditors market share in an industry.
The market share of an audit firm, however, is sensitive to audit clients auditor
switch decisions and could be a noisy measure for auditor industry expertise.
Our measure is based on auditors prior IFRS experience, which is not affected by
audit clients decisions. It thus can be used as a more stable measure for auditor
expertise in the area of IFRS auditing. Future studies may develop other measures
to examine the impact of auditor expertise in different areas on audit fees. Finally, our
study sets an example for other emerging markets that are in the process of adopting
international accounting standards. While it is expected that the convergence
of international accounting standards enhances market liquidity and financial
reporting quality, it also significantly increases the costs for the new adopters.
Future IFRS adopters should consider the related costs, and the regulatory
authorities should establish related policy to ensure a smooth IFRS transition.
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62
24,1
ARA

estimation
Table VI.

second stage
results from the
Additional analysis
(1) Full sample (2) COUNT_BS HIGHa (3) COUNT_BS LOWa (4) COUNT_IS HIGHb (5) COUNT_IS LOWb
Variablea Coeff. p-Value Coeff. p-Value Coeff. p-Value Coeff. p-Value Coeff. p-Value

Intercept 2.826 0.712 13.00 0.052* 8.446 0.001*** 7.219 0.001*** 8.817 0.001***
FIRYR 0.021 0.693 0.024 0.669 0.028 0.297 0.029 0.239 0.025 0.209
SECYR 0.036 0.049 0.029 0.597 0.050 0.059* 0.036 0.133 0.050 0.010**
EXP_B4 5.846 0.479 3.694 0.441 2.410 0.455 0.510 0.691 0.608 0.001***
EXP_B4FIRYR 0.816 0.001*** 0.823 0.001*** 0.468 0.010*** 0.752 0.001*** 0.296 0.041**
EXP_B4SECYR 0.822 0.001*** 0.819 0.001*** 0.571 0.002*** 0.781 0.001*** 0.247 0.095*
EXP_CROSS 1.599 0.001*** 1.645 0.001*** 1.231 0.001*** 1.537 0.001*** 1.283 0.001***
EXP_CROSSFIRYR 0.544 0.116 0.672 0.031** 0.162 0.486 0.524 0.001*** 0.123 0.556
EXP_CROSSSECYR 0.515 0.128 0.598 0.047** 0.240 0.301 0.511 0.001*** 0.023 0.914
LNTA 0.718 0.197 0.019 0.968 0.314 0.001*** 0.398 0.003*** 0.279 0.001***
AR 0.044 0.866 0.159 0.590 0.034 0.792 0.133 0.289 0.048 0.610
INV 0.172 0.306 0.174 0.330 0.096 0.266 0.134 0.091* 0.176 0.004***
LEV 0.134 0.078* 0.211 0.400 0.004 0.001*** 0.113 0.005*** 0.126 0.001***
LOSS 0.024 0.717 0.017 0.822 0.009 0.792 0.049 0.129 0.006 0.804
SOE 0.081 0.089* 0.082 0.107 0.096 0.001*** 0.079 0.001*** 0.098 0.001***
INDEX 0.018 0.002*** 0.025 0.001*** 0.004 0.222 0.021 0.001*** 0.009 0.001***
OPIN 0.093 0.302 0.191 0.064* 0.042 0.338 0.161 0.001*** 0.025 0.459
AUDSIZE 0.082 0.183 0.064 0.306 0.112 0.001*** 0.095 0.001*** 0.066 0.001***
MIDAUDIT 0.083 0.298 0.131 0.117 0.051 0.224 0.144 0.001*** 0.060 0.035**
INITIAL 0.056 0.431 0.050 0.516 0.048 0.183 0.063 0.043** 0.049 0.072*
SUB 0.053 0.208 0.037 0.261 0.068 0.172 0.051 0.005*** 0.032 0.062*
IND Included Included Included Included Included
R2 13.2% 28.8% 29.3% 66.6% 53.3%
n 4,129 2,065 2,064 2,135 1,994
Notes: aVariables are as defined in Tables II and III. *,**,***Significant at 10, 5, and 1 percent level, respectively (two-tailed)
Notes Effects of
1. After the bankruptcy of Arthur Anderson, and the merger between Price Waterhouse and IFRS
Coopers & Lybrand, the joint ventures of the Big 4 accounting firms are: Ernst & Young
Huaming, Pricewaterhouse Coopers Zhongtian, KPMG Huazhen, and Deloitte Touche
experience on
Tohmatsu (DTT) Huayung CPA Ltd. audit fees
2. For example, India has announced a plan to adopt IFRS for listed companies phased in from
2012 to 2014. Taiwan has adopted a plan to adopt IFRS in two phases starting in 2013 63
(www.iasplus.com/country/useias.htm).
3. See Deloitte et al. (2006) for a detailed discussion of the differences between the Chinese
IFRS and IFRS.
4. In order to assess the impact of IFRS experience on audit cost, audit plan or audit strategy
will need to be analyzed. Because such data is typically unavailable to researchers, we are
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unable to examine this issue in this study. However, this is an interesting topic for future
research to consider.
5. The time between the formal announcement and the formal implementation of the Chinese
IFRS was only one year. In comparison, the European Union (EU) announced in 2002
its decision to implement IFRS for public listed firms beginning in 2005. This decision
gave both public listed companies and accounting firms at least two years to prepare for
the changes.
6. Among 70 audit firms that can audit listed companies, only Big 4 joint ventures and 12
other audit firms have experience in auditing IFRS-based financial statements
(see Section 5.2.1 for the related discussion).
7. The IFRS-related experience can be from individual auditors or accounting firm. Because
only the name of the accounting firm is required on the auditors report for IFRS-based
financial statements, it is impractical to identify which individual auditor(s) audit
IFRS-based financial statements. Due to this restriction, we measure the experience at the
firm-level. Nonetheless, how individual auditors experience affects audit fees is an
interesting issue that can be explored in future study. We thank one of the anonymous
reviewers for pointing out this research opportunity.
8. In our sample, companies that issue shares in the London Stock Exchange also issue shares
in the Hong Kong Stock Exchange.
9. Currently the USA is still adopting GAAP rather than IFRS. However, according
to the regulation by the Central Peoples Government of the Peoples Republic
of China, companies that issue shares overseas must prepare financial statements in
accordance with both the Chinese GAAP and the international accounting standards.
The US listed Chinese companies still need to prepare IFRS-based financial statements
accordingly.
10. Some of the Chinese companies issue B-shares in addition to A-shares in the Shanghai and
Shenzhen Stock Exchanges. A-shares are equity securities that trade in Chinese Yuan
(Renminbi), and B-shares are equity securities that trade in US dollars (Shanghai) and
Hong-Kong dollars (Shenzhen). Prior to 2007, companies that issue B-shares were required
to prepare financial statements in accordance with international accounting standards.
Thus, companies that issue B-shares in addition to A-shares also have IFRS-related
experience. In the meantime, the B-share companies were required to undergo a
supplementary audit that followed the IFRS in addition to the statutory audit.
This supplementary requirement was abandoned in 2007 along with the adoption of IFRS
in China. Because the coincidence of the abandonment of the supplementary audit
requirement and the adoption of Chinese IFRS in 2007, it is difficult to distinguish the
ARA effects of the two coincident events on audit fees. To avoid possible confounding effects,
we exclude companies that issue B-shares in addition to A-shares from our sample.
24,1 Nevertheless, the results from a separate analysis on the effect of B-share experience on
audit fees indicate that companies issue B-shares in addition to A-shares experienced a
significant decrease in audit fees during the sample period, which is consistent with
the results based on companies that issue shares in other stock exchanges requiring
IFRS reporting.
64
11. Despite the regulation, we are not able to fully exclude the possibility that companies
restated their 2006 financial statements due to prior period adjustments or other reasons.
We acknowledge this as one of research limitations.
12. Except for the summary accounts, such as total current assets, total non-current assets,
total assets, total current liabilities, total non-current liabilities, and total liabilities, we
include the rest of the asset and liability accounts. Specifically, the accounts we consider
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include cash, trading securities, derivative assets, short-term investments, notes


receivable, accounts receivable, prepaid items, interest receivable, dividends receivable,
other receivables, inventory, current portion of noncurrent assets, other current assets,
available-for-sale securities, held-to-maturity securities, long-term receivables, long-term
equity investments, long-term debt securities investments, investment property,
property, plant, and equipment, construction in progress, construction materials,
biological assets, petroleum and natural gas assets, intangibles, goodwill, long-term
prepaid items, deferred tax assets, other non-current assets, short-term borrowing,
transactional monetary liabilities, derivative liabilities, notes payable, accounts payable,
unearned revenue, payroll payable, tax payable, interest payable, dividends payable,
other payables, current portion of long-term liabilities, other current liabilities, long-term
borrowing, long-term payable, special accounts payable, estimated liabilities, deferred
income tax liabilities, and other non-current liabilities. A total of 48 asset and liability
accounts are used.
13. The income statement accounts we consider include operating revenue, interest
revenue, fees and commission revenue, operating costs, selling expense, administrative
expense, financing expense, asset impairment loss, gain or loss on changes in fair
value, investment revenue, foreign currency translation gain or loss, non-operating
revenue, non-operating expense, gain or loss on disposal of non-current assets, income
tax expense, and unrealized investment loss. A total of 16 income statement accounts
are included.
14. Because the adjustments on a companys balance sheet and the adjustments on its income
statement are interrelated, to avoid possible collinearity problems, we measure the change
in the complexity of two financial statements separately.
15. Following Gow et al. (2010), we report test statistics based on the one-way cluster-robust
standard errors (cluster by firm).
16. Due to the low market share of the Big 4 in China, most literature uses the Big 10 to
control for the size of the audit firm when examining the Chinese audit market
(e.g. DeFond et al., 2000; Wang et al. 2008). We selected Big 10 accounting firms in
China based on the total audited assets. Accounting firms with the top ten total
audited assets for at least three years during our sample period are selected as the
Big 10. Based on this criterion, the Big 10 include Pricewaterhouse Coopers
Zhongtian CPAs, Deloitte and Touche Hujiang CPAs, KPMG Huazhen CPAs, Ernst &
Young Huaming CPAs, Shu Lun Pan CPAs, RSM China CPA, Beijing Jingdo
CPAs, Ascenda CPAs, Shinewing CPAs, and Zhejiang Pan-China CPAs. Excluding
member firms of international Big 4 CPA firms, the remaining CPA firms are called the
local Big 6.
17. As indicated in Choi et al. (2009), difference in legal regime also affects the audit Effects of
premiums paid by cross-listed firms. In our sample, cross-listed firms are Chinese listed
firms that are also listed in the Hong Kong Stock Exchange, the London Stock Exchange,
IFRS
or the New York Stock Exchange. Previous literature (e.g. Choi et al., 2009 and experience on
La Porta et al., 2002) has suggested that the legal environment of Hong Kong, the USA, audit fees
and the UK is similar. Therefore, we do not add another variable to control for the
effect of legal regime. The general effect of cross-listing is captured by the variable
EXP_CROSS. 65
18. The index is compiled by Chinas National Economic Research Institute, and it is measured
by the percentage of lawyers and certified public accountants in the total population,
lawsuit enforcement efficiency, intellectual property rights protections, and consumer rights
protections. The index we use is from Fan et al. (2010).
19. Mid-term audits are required for certain companies. For instance, the Shenzhen stock
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exchange requires listed companies to have mid-term audits when they plan to issue
stock dividends, to convert earned surplus into capital stock, or to use earned surplus to
write off deficits or when the China Securities Regulatory Commission or the Shenzhen
stock exchange deem it necessary. This is according to information disclosure rule no. 3,
The Contents and Format of Interim Financial Reports, as amended by the China
Securities Regulatory Commission. Other companies may have their interim financial
reports audited optionally.
20. Following previous literature, we exclude financial service industry due to its industry
characteristics. The 12 industries we include are: Agriculture, forestry, animal
husbandry, and fishery; Mining; Manufacturing; Electric power, heat, gas and water
production and supply; Construction; Transport, storage, and postal service;
Wholesale and retail; Real estate; Accommodation and catering; Culture, sports, and
entertainment; Information transmission, software and information technology services;
and Others.
21. In addition to the top and bottom 1 percent limits, we also use the border of three
standard deviations from the mean to replace the extreme values. The results are
qualitatively comparable with the results we report in this paper. Moreover, when we
eliminate the extreme variables directly from the sample, the results remain qualitatively
comparable.
22. These audit firms include: Shanghai CPA, Shu-Lun Pan CPA (Horwath), Zhonghua CPA
(BDO), RSN China CPA (RSN), Baker Tilly Beijing (Baker Tilly), Jiangsu Gongzheng CPA,
BDO Reanda (BDO), Zhejiang Pan China CPA, Shinewing CPA, Shenzhen Dahua Delu
(BDO), Shenzhen Peng-Cheng CPA, and Shenzhen Nanfang-Minhe CPA (Moore Stephens
International). The mean of EXP_NB4 is 0.132.
23. The median values of DIFF_BS and DIFF_IS are 0.134 and 0.081, respectively.

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Corresponding author
Ai-Ru Yen can be contacted at: A-YEN@NEIU.EDU
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