An agreement between an auditor and a client is necessary to establish a clear understanding of the scope, objectives, and terms of the audit engagement. It also serves as a legal basis for the professional relationship. An effective agreement outlines clear expectations prior to beginning an audit and helps avoid misunderstandings during the engagement. It communicates the audit objectives and responsibilities of both parties and specifies the audit fee arrangement, among other things.
Auditors must work closely with clients in forming their financial reporting decisions, and conflicts can arise that lead to formal or informal negotiations. Prior research has studied auditor-client negotiation through behavioral experiments, surveys, and analytical models. These studies have found that management and auditors differ in their preferences for resolving disputes, but they have not directly compared the negotiation behavior of both sides when their preference for resolving the conflict is equal.
Our study adds to this literature by examining the negotiation behavior of both auditors and clients when their preference for resolving the dispute is equally strong. In addition, we find that both the auditor and the client prefer to remain at arm’s length, indicating an understanding and respect of the auditor’s ethical requirement to be independent. This finding should encourage auditors to clearly communicate their independence requirements and to refrain from acquiescing to clients when the demands threaten their independence.
Further, we test the hypothesis that disagreement between auditors and clients can increase litigation risks and management’s risk of manipulating earnings, and that successor auditors are more likely to charge higher audit fees for clients with disagreements with their predecessor auditors. agreement between auditor and client