Moderating Effect of Business Risks on the Relationship Between Audit Effort and Audit Fees Among Audit Firms in Western Kenya

Abstract

Auditing is an important aspect of financial management oversight and is mandatory for public companies. Despite this critical role, audit firms have been criticized for failure to embrace business risk auditing approach to forestall the collapse of major clients during the period 2001-2012. Previous studies reveal that 88% of auditing client firms in western Kenya lack effective internal controls, exposing auditors to audit risk and possible litigation by client firms for professional negligence in failure to detect and report business risks. Studies further indicate that the audit firms are resource constrained, casting doubt on their ability to incorporate business risk audit, an approach that while mitigating exposure to litigation by clients would nonetheless call for greater audit effort and lead to charging commensurate audit fees. However, no study has been undertaken in western Kenya to determine the extent to which the audit firms perform business risk auditing. The purpose of this study was to examine the moderating effect of business risks on the relationship between audit effort and audit fees among audit firms in western Kenya. Specifically, the study sought to; establish the extent to which firms assess business risks, determine the relationship between audit effort and audit fees and to determine the moderating impact of business risks on the relationship between audit effort and audit fees. Cross-sectional survey design was used to collect data from 48 audit seniors or audit managers of each audit firm in western Kenya. Primary data was collected using questionnaires and secondary data from published accounts of client firms and analyzed by regression analysis. The study found that auditors assess business risks to a modest extent in the study area, mean = 3.367 (scale of 1- 5). Audit effort had a significant R 2 of .501 (p<0.01) indicating that 50.1% of variance in audit fees is explained by audit effort. The R2 after incorporating business risks was .708(p<0.01); ~R2 = .155 (p<01) implying business risks significantly moderates the relationship. Conclusions are that among the firms, business risk auditing is practiced to a moderate extent; audit effort predicts audit fees, incorporation of business risks significantly enhances its predictive power. The study recommends audit to focus on assessment of business risks so as to better utilize audit effort and accurately predict commensurate audit fees thus enhancing performance. Contrary to prior research, this study has shown that audit effort and business risks interacting together, affect audit fees.