SSRN Id4637154

Principles Based Accounting Standards, Audit Fees and Going Concern: Evidence
Using Advanced Machine Learning
Meena Subedi, Ph.D.

Department of Accounting
University of Wisconsin-Whitewater
809 W. Starin Road
Whitewater, WI 53190
Email: SubediM23@uww.edu
Phone: (262) 472 2197
Acknowledgement: I appreciate the helpful insights and comments provided by the conference
participants at the 2021 American Accounting Association (AAA) Spark Meeting (May 2021) and
the 2021 American Accounting Association (AAA) Annual Meeting (August 2021). I also
appreciate valuable insights and comments provided by Avishek Bhandari and Hamid Vakilzadeh
to the earlier versions of this study.
Data Availability: Data are available from the public sources cited in the text.
November 2023
Electronic copy available at: https://ssrn.com/abstract=4637154

Principles Based Accounting Standards, Audit Fees and Going Concern: Evidence Using
Advanced Machine Learning
Abstract
Purpose –The current study utilizes an advanced machine learning method and aims to
investigate whether auditors perceive financial statements that are principles-based as less risky.
More specifically, the study explores the association between principles-based accounting
standards and audit pricing and between principles-based accounting standards and the
likelihood of receiving a going concern opinion.
Design/methodology/approach – The study employs an advanced machine-learning method to

understand the role of principles-based accounting standards in predicting audit fees and going
concern opinion. The study also uses multiple regression models defining audit fees and the
probability of receiving going concern opinion. The analyses are complemented by additional
tests such as economic significance, firm fixed effects, propensity score matching, entropy
balancing, change analysis, yearly regression results, and controlling for managerial risk-taking
incentives and governance variables.
Findings – The paper provides empirical evidence that auditors charge less audit fees to clients
whose financial statements are more principles-based. The finding suggests that auditors
perceive financial statements that are principles-based less risky. The study also provides
evidence that the probability of receiving a going-concern opinion reduces as firms rely more on
principles-based standards. The finding further suggests that auditors discount the financial
numbers supplied by the managers using rules-based standards. The study also reveals that the
degree of reliance by a US firm on principles-based accounting standards has a negative impact
on accounting conservatism (both conditional and unconditional), the risk of financial statement
misstatement, accruals, and the difficulty in predicting future earnings. This suggests potential
mechanisms through which principles-based accounting standards influence auditors' risk
assessments.
Research limitations/implications – The authors recognize the limitation of this study

regarding the sample period. Prior studies compare rules vs. principles-based standards by
focusing on the differences between US GAAP and IFRS or pre and post-IFRS adoption, which
raises questions about differences in cross-country settings and institutional environment and
other confounding factors such as transition costs. This study addresses these issues by
comparing rules vs. principles-based standards within the US GAAP setting. However, this
limits the sample period to the year 2006 because the measure of the relative extent to which a
US firm is reliant upon principles-based standards is available until 2006.

Originality/value – The study has major public policy suggestions because it demonstrates the
value of principles-based standards. The study responds to the call by Jay Clayton and Mary Jo
White, the former Chairs of the US Securities and Exchange Commission (SEC), to pursue high-
quality, globally accepted accounting standards to ensure that investors continue to receive clear
and reliable financial information as business transactions and investor needs continue to evolve
globally. The study also recognizes the notable public policy implications, particularly in light of
the current Chair of the International Accounting Standards Board (IASB) Andreas Barckow’s
recent public statement which emphasizes the importance of principles-based standards and their
ability to address sustainability concerns, including emerging risks like climate change. The
study fills the gap in the literature that auditors perceive principles-based financial statements as
less risky and further expands the literature by providing empirical evidence that the likelihood
of receiving a going concern opinion is increasing in the degree of rules-based standards.
Keywords: Principles-Based Standards, Rules-Based Standards, Advanced Machine Learning,

Generally Accepted Accounting Principles (GAAP), Audit Fees, Going-Concern Opinion
JEL Codes: M40, M41, M42, M48, M49
ii

I. INTRODUCTION
The Generally Accepted Accounting Standards (GAAP) used by companies in the
United States show significant variation in terms of the depth of the guidelines provided
(Donelson et al. 2012; Folsom et al. 2016). While significant implementation guidelines exist for
some standards (e.g. FAS 13 for leases, SFAS 123 for stock-based compensation), other
standards (e.g. ARB 43-4 for inventory) are more principles-based that allow more discretion for
implementation by management. The standards for which detailed guidelines exist are called
rules-based, whereas standards that require more management judgment for implementation are
called principles-based. This study examines whether principles-based or rules-based accounting
standards pose a greater risk to auditors and identifies potential mechanisms through which
principles-based accounting standards impact auditors’ risk assessments.
The advantage of the rules-based standards is that detailed guidelines reduce
opportunistic reporting by management (Schipper 2003). Consistent with this argument, Tan and
Jamal (2006) find that reducing accounting discretion prevents managers from engaging in
opportunistic earnings management behavior. However, the concern among regulators and
investors is that management uses detailed guidelines to circumvent the rules using transaction
structuring, thus leading to lower accounting quality (Folsom et al. 2016). Alternatively, the
principles-based standards allow more managerial flexibility in reporting decisions. In an
experimental study, Agoglia et al. (2011) find that managers choose less aggressive reporting if
the guidelines allow more managerial judgment. Fullana et al. (2021) find that unconditional
conservatism of firms declines after the adoption of IFRS. The concern among managers is that
applying standards in an aggressive manner potentially increases litigation risk. Given the

significant role auditors play in the financial reporting process, the study investigates auditors’
risk perception of the underlying accounting standards firms use.
The study predicts that auditors perceive financial statements that are principles-based as
less risky. Folsom et al. (2016) find that principles-based earnings are more informative and have
greater predictions of future cash flows. Thus, principles-based standards better reflect the
underlying economic performance of the firm. Furthermore, experimental studies suggest that
managerial judgment in the implementation of accounting standards increases the quality of
financial reporting (Agoglia et al. 2011). Realizing the drawback of rules-based standards,
regulators are also considering switching to more principles-based standards (FASB 2002, SEC
2003). Therefore, I predict that audit fees are decreasing in the firm’s reliance on more
principles-based accounting standards because auditors perceive these firms to be less risky.
Furthermore, the study argues that managers using rules-based (principles-based)
standards are more (less) likely to engage in transaction structuring to achieve certain beneficial
financial numbers at the expense of real fundamental economic outcomes. Therefore, auditors
discount the financial numbers supplied by the managers using rules-based standards. Thus,
auditors are more likely to give going concern opinion to financially constrained firms with
rules-based standards than compared to financially constrained firms with principles-based
standards. Consistent with this argument, the study expects that the probability of receiving
going-concern opinion reduces as firms rely more on principles-based standards.
The study uses an advanced machine learning approach to present evidence that a firm’s
reliance on principles-based standards plays a major role in predicting audit fees and going
concern opinion. The study confirms the main findings using multivariate regression analyses

and finds that audit fee is decreasing as firms rely more on principles-based standards.
Economically audit fees are about 6.38 percent or about $91,287 lower for firms in the top
quintile of principles-based standards compared to firms in the bottom quintile. Additionally, the
study finds that the probability of receiving a going concern opinion also decreases with the
principles-based standards. In terms of economic significance, an increase in one standard
deviation in principles-based standards score is associated with a 19.22% decrease in the odds of
receiving a going concern opinion. This finding suggests that auditors assess that the managers
using principles-based standards are less likely to supply overly optimistic financial numbers
than compared to managers using rules-based standards. The main results are robust as I include
firm fixed effects, employ propensity score matching, entropy balancing, change analysis, and
conduct several additional tests.
The main findings that audit fees and the likelihood of receiving a going concern opinion
are increasing in the degree of rules-based standards suggest that auditors exert greater effort and
audit more conservatively to reduce engagement risk in firms with greater reliance on rules-
based standards. In addition, the going concern finding indicates that auditors perceive managers
who rely on principles-based standards as less likely to provide overly optimistic financial
figures compared to those using rules-based standards. It suggests that the principles-based
approach fosters an environment where managers prioritize the accurate representation of
financial information. These findings highlight the value of principles-based standards in
enhancing the reliability and credibility of financial reporting, as perceived by auditors in their
assessment of audit fees and going concern considerations. The study conducts additional tests to
validate the potential channels via which principles-based standards influence auditors risk
assessment.

Fullana et al. (2021, p. 862) suggest that the negative relationship between principles-
based accounting standards and earnings management is mediated through a reduction in
unconditional conservatism. André et al. (2015) and DeFond et al. (2016) suggest that auditors
may also respond to conditional conservatism since, unlike unconditional conservatism,
conditional conservatism affects auditors' business risk. Synthesizing these prior studies, the
study expects that both unconditional and conditional accounting conservatism may impact
auditors' perceptions of audit risk or auditors' business risk. The study conducts additional
analyses and provides evidence that the relative extent to which a US firm is reliant upon
principles-based accounting standards have a negative relationship with both unconditional and
conditional conservatisms and a negative relationship with risk of financial statement
misstatement, accrual and difficulty in predicting future earnings. These findings suggest some
potential mechanisms through which principles-based accounting standards impact auditors’
audit risk or auditors’ business risk assessments.
The study expands the work of Fullana et al. (2021) in that Fullana et al. (2021) suggest
that principles-based accounting standards result in reduced earnings management through a
decrease in accounting conservatism. The current study extends this connection by
demonstrating implications for audit outcomes, such as a reduction in audit fees and
considerations of going concern. Similarly, the study expands on prior research suggesting that
firms are less likely to engage in earnings management during IFRS periods (Eiler et al. 2022;
Ho et al., 2015) and studies suggesting that principles-based standards are associated with higher
audit risk (Cho and Krishnan 2023). The study expands on these research by providing
comprehensive empirical evidence that the relative extent to which a US firm is reliant upon
principles-based standards have a negative relationship with accounting conservatism and

various metrics of financial reporting risks. These findings suggest potential mechanisms through
which principles-based accounting standards influence auditors' risk assessments.
The study acknowledges the significant public policy implications of its findings, as
emphasized by the former SEC Chair, Jay Clayton. One critical objective discussed by Clayton is
the provision of high-quality, globally accepted accounting standards to US investors. The study
also recognizes the notable public policy implications, particularly in light of Andreas Barckow’s
recent public statement as the current Chair of the International Accounting Standards Board
(IASB). Barckow emphasizes the importance of principles-based standards, emphasizing their
ability to address sustainability concerns, including emerging risks like climate change (Lugo
2021). The study responds to the call by Mary Jo White, the former Chair of the Securities and
Exchange Commission (SEC), to pursue high-quality, globally accepted accounting standards to
ensure that investors continue to receive clear and reliable financial information as business
transactions and investor needs continue to evolve globally (SEC 2017). 1 The evidence that
auditors perceive principles-based financial statements as less risky is important in advancing the
accounting literature and informing policy debates, such as whether the US GAAP should
converge with International Financial Reporting Standards (IFRS) or, otherwise, move to more
principles-based standards.
Prior studies compare rules vs. principles-based accounting standards by focusing on the
differences between US GAAP and IFRS, which raises questions about differences in cross-
country settings and institutional and legal environments (Daske 2006; Haverty 2006; Henry et
1
In her public statement, White also urges the succeeding SEC Chair, Jay Clayton to reduce the differences
between the GAAP and IFRS standards and to achieve a critical objective of providing high-quality, globally
accepted accounting standards to the US investors.

al. 2009; Fearnley and Gray 2015). Some studies focus on the transition from local accounting
standards to IFRS (Griffin et al. 2009; Georgakopoulou et al. 2010; Kim et al. 2012; De George
et al. 2013; González et al. 2014; Garrouch et al. 2014; Dayanandan et al. 2016; Nijam 2016;
Jung et al. 2016; Maglio et al. 2018) and compare audit fees and other firm-level characteristics
pre-post IFRS adoption which raises issues of uncertainties and transition costs including low-
balling of audit pricing associated during the transition period (El Guindy and Trabelsi 2020;
Tawiah 2022). The current study addresses these issues by comparing rules vs. principles-based
standards within the US GAAP setting, thus eliminating the confounding factors (i.e., transition
costs, country, legal, institutional, and cultural differences) that might cause the difference in
rules vs. principles-based standards. However, this contribution comes with a limitation of this
study regarding the sample period. 2 The study covers only up to the year 2006 because the
measure of the relative extent to which a US firm is reliant upon rules or principles-based
standards is available until 2006 (Folsom et al. 2016).
In addition, in contrast to earlier research that assigns equal importance to all significant
variables, the advanced machine learning methodology employed in the present study assesses
the impact of a specific explanatory variable within the broader context of the entire model
(Jones 2017). For instance, while principles-based standards may hold significance, they might
exhibit a relatively lower explanatory power compared to other variables when considering the
overall model.
This study also contributes to the debate about the nature of accounting standards
(Francis 1987; Nelson 2003; Acker et al. 2002; Jeanjean and Stolowy 2008; Liu and O’Farrell
2
The study notes the absence of significant accounting laws that could have resulted in substantial changes
in PSCORE after 2006. Importantly, the sample already encompasses the year 2002, which saw the enactment of the
Sarbanes-Oxley Act (SOX). Similar arguments have been presented in prior studies (Kohlbeck and Mayhew 2010).

2010; Donelson et al. 2012). More specifically, the main findings confirm that principles-based
standards reduce the risk of financial misreporting (Folsom et al. 2016; Agoglia et al. 2011) and
document that the auditors react to this risk by increasing audit fees. The study has major public
policy implications because it demonstrates the value of principles-based standards. Finally, the
study demonstrates that investors can rely more on firms using principles-based standards
because those firms better reflect the underlying performance of the firm using mandatory
disclosure.
The remainder of the paper is organized as follows. I discuss prior literature and develop
the hypotheses in section II. The research methodology is presented in section III. The paper
discusses the sample, results, and additional tests in section IV. Finally, I conclude and discuss
the research implications in section V.

II. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT
The debate over the nature of accounting standards persists. Levitt (1998) states that
high-quality accounting standards are critical for market regulation. However, there is debate
about the definition of high-quality accounting standards. The strength of the institutional
environment further complicates the definition of quality accounting standards. For example,
Hung (2000) determines that the value relevance of accrual accounting varies based on the
investor protection level. Analyzing the evolution of accounting standards in the US, Ijiri (2005)
indicates that the final stage of the evolution is the debate over rules-based versus principles-
based standards. The Sarbanes-Oxley Act (2002) ordered the Securities and Exchange
Commission (SEC) to study principles-based standards. Furthermore, the US Congress ordered
the SEC to report the pros and cons of the principles-based standards to the House and Senate
(Ijiri 2005). This clearly indicates that public policymakers are taking an active role in the
discussion of accounting standards.
Advocates of the rules-based accounting standards argue that detailed guidelines
provided by standard setters increase the consistent application of the accounting standards
(Schipper 2003). Therefore, rules-based standards reduce managers’ discretion in applying
accounting standards and increase comparability across companies’ financial statements
(Schipper 2003). Consistent with this argument, Donelson et al. (2012) find that rules-based
accounting standards reduce litigation risk. Donelson et al. (2012) indicate that the characteristics
of rules-based standards include “… scope and legacy exceptions, a high level of detail, and
extensive implementation guideline.” For example, FASB 13 has detailed guidelines for the
record of the balance sheet leases, and it is an example of a rules-based accounting standard
(Mergenthaler 2009). In the detailed analysis of the accounting standards (rules-based vs.

principles-based standards), Donelson et al. (2012) provide examples of variation among
standards within the US GAAP. For instance, SFAS 123, which is about stock-based
compensation, provides detailed guidelines and is an example of a rules-based standard. ARB
43-4, which is about inventory, provides fewer guidelines and is more principles-based.
Mergenthaler (2009), Donelson et al. (2012), and Folsom et al. (2016) studies show the variation
among the US GAAP standards, and the researchers develop measures classifying whether the
standards are more rules-based or principles-based. 3
Principles-based standards allow more judgment for the implementation. The advantage
of the principles-based accounting standards is that managers have greater latitude in reflecting
the underlying economic performance of the firm. Prior studies demonstrate that given the
opportunity, managers use the latitude to send signals about the prospects of the firm
performance because the managers have an information advantage (Louis and Robinson 2005).
Similarly, Srivastava (2014) demonstrates that reducing flexibility in revenue recognition
decreases the value relevance of earnings. Folsom et al. (2016) find that the earnings of firms are
more informative and related to future cash flows if the accounting standards that the firm
follows are more principles-based. Conducting experimental interviews with executives, Agoglia
et al. (2011) document that executives apply accounting standards less aggressively under the
principles-based scenario. These studies demonstrate that, given a choice, management uses
accounting standards to better reflect the firm’s underlying economic performance with
principles-based accounting standards.
The accounting standards that a firm follows are relevant for auditors because auditors
provide external monitoring of financial statements and adjust audit fees based on the underlying
3
The measures used in prior studies and in this study are discussed in the next section.

financial reporting quality as well as the business risk of the firm (Simunic 1980; Subedi 2022;
Dell et al. 2022). The accounting standards the client firms follow determine the scope of the
audit. If the client firm’s accounting standards are more rules-based, detailed guidelines exist for
the implementation. However, prior studies show that management opportunistically uses
detailed implementation guidelines to structure the transactions in such a way that results in
aggressive reporting (Agoglia et al. 2011). Furthermore, Folsom et al. (2016) show that financial
statements prepared using more principles-based standards better reflect the firm’s economic
performance and have higher informativeness. These studies suggest that management uses
principles-based standards to better inform investors about the firm’s economic performance.
Thus, the incentive for earnings management is less likely for firms following principles-based
standards. The failure of rules-based standards in high-profile financial reporting scandals further
prompted the SEC to shift accounting standards toward principles-based (Ijiri 2005; Folsom et al.
2016). Therefore, the study predicts that auditors perceive financial statements prepared under
more principles-based standards to be less risky because the management is less likely to use
principles-based standards to engage in earnings management. Thus, I expect a negative
association between audit fees and principles-based financial statements:
H1: Audit fee is decreasing on the degree of the firm’s reliance on the principles-based
accounting standards.
Theoretical studies in law and economics suggest that uncertainty associated with laws
and regulations reduces aggressive behavior by parties (Calfee and Craswell 1984; Craswell and
Calfee 1986). Regulators are concerned that rules-based standards provide detailed guidance for
companies to circumvent the rules (FASB 2002). 4 Thus, the unintended consequence of the
4
http://www.fasb.org/project/principles-based_approach.shtml
10

rules-based standards is that companies structure transactions to achieve certain accounting
outcomes that may not reflect the true underlying fundamentals. This strategy potentially allows
managers to adopt transactions that are detrimental to long-term performance and shareholders’
wealth. Nelson (2003) calls it “transaction structuring,” where companies organize economic
transactions to obtain the desired accounting outcome. The problem with this approach is that
“…. transactions are structured in a manner that is inconsistent with economic substance”
(Nelson 2003). Management pursuing this approach focuses on the form rather than the
substance of the transaction, which is the drawback of the rules-based standards. Therefore, the
FASB (2002) and SEC (2003) 5 are shifting towards more principles-based standards.
Since the application of principles-based standards encourages applying professional
judgment that reflects the underlying fundamental of the firm, management structures
transactions consistent with true economic substance. In this scenario, management is less likely
to present overly optimistic financial strength for the sake of achieving certain financial
outcomes at the expense of real fundamental outcomes. The study argues that auditors discount
the financial strength of numbers supplied by the managers using rules-based standards and,
therefore, financially constrained firms with rules-based standards are more likely to receive
going concern opinion than compared to financially constrained firms with principles-based
standards. Consistent with this argument, I expect that the probability of receiving a going-
concern opinion reduces as firms rely more on principles-based standards. This leads to the
second hypothesis:
H2: The likelihood that an auditor will issue a going concern opinion is decreasing on the
degree of the firm’s reliance on the principles-based standards.
5
https://www.sec.gov/news/studies/principlesbasedstand.htm#1a
11

III. RESEARCH DESIGN
Reliance on Principles-Based Standards Measure
The study adopts the measure developed by Mergenthaler (2009), Donelson et al. (2012)
and used in Folsom et al. (2016), which is called PSCORE. Initially developed by Mergenthaler
(2009), the measure analyzes the attributes of each accounting standard separately. The authors
examine whether each accounting standard has bright-line thresholds, scope and legacy
exceptions, large volumes of implementation guidelines, and a high level of detail. That way,
authors assign a score varying from zero to four, depending on how many of the characteristics
mentioned earlier the accounting standard possesses. According to this analysis, for example,
Donelson et al. (2012) determine that SFAS 140 is rules-based and SFAS 34 is principles-based. 6
Since the characteristics of standards might change, the author conducts this analysis for each
year.
In the next stage, using textual analysis, Folsom et al. (2016) determine the accounting
standards each firm uses. Since not all GAAP standards apply to every company, the authors
determine the applicable accounting standards for each company using textual analysis. For
example, if a company does not go through any business combination, then SFAS 414 would not
be applicable. At the final stage, Folsom et al. (2016) developed a PSCORE measure by
analyzing the total effect of all accounting standards on each company. The higher PSCORE
indicates more principles-oriented financial statements. 7
6
Please refer to Table 1 in Donelson et al. (2012, pp. 1257) for more examples. SFAS deals with the
recognition of financial assets/liabilities. SFAS 34 deals with the interest capitalization.
7
Donelson et al. (2012, pp. 1255-1258) and Folsom et al. (2016, 7-10) include the detailed discussion about
the development of the PSCORE. Donelson et al. (2012) does not use PSCORE, but uses RBC score, which is the
predecessor of the PSCORE. Folsom et al. (2016) develop the RBC score further into the PSCORE, which is used in
this study.
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Empirical Models
In developing the audit fee model, the current study follows major audit fee studies such
as Ashbaugh et al. (2003), Bhandari et al. (2018), Krishnan and Wang (2015), Simunic (1980),
Whisenant et al. (2003) and Bhandari et al. (2022). The audit fee model includes determinants
that are shown to affect audit fees, including size, complexity, risk, performance, auditor type,
and engagement attributes.
The audit fee model includes the natural log of total assets to control for the client’s size.
Mergers and acquisitions (MERGER), accounts receivables and inventory as a proportion of
total assets (INVREC), extraordinary items (XDOPS), foreign operations (FOROPS), and
segments (SQSEGS) are measures that control for client’s complexity. Based on prior research, I
expect a positive association between these variables and audit fees. I include book-to-market
ratio (BM) and sales growth (SALESGR) to control for clients’ growth. Consistent with Choi et
al. (2010), the study expects a negative association between these two variables and audit fees. I
include the client’s age (LNAGE) as well. To control for audit complexity, I include audit lag
(LNAUDLAG), the presence of pension plans (EMPLAN), and internal control weakness
(ICW). Accounting restatements (RESTATE) is the measure to control for financial reporting
quality. All of these measures are shown to be positively related to audit fees.
Return on assets (ROA) and profitability (LOSS) are two measures that control a client’s
business risk. I expect a negative coefficient for ROA and a positive one for LOSS. Leverage
(LEV), financing activities (NEWFIN), and going concern opinions (GC) are other measures for
clients’ business risk. I predict positive coefficients on LEV, and GC, and do not offer a
prediction on NEWFIN. The impact of NEWFIN on audit fees is unclear. New financing
13

activities may increase auditor risk and hence increase audit fees. It may also lower the risk of a
client’s bankruptcy and decrease audit fees.
The regression model also includes BIG4 auditor (BIG4), industry specialist (INDSP),
and whether the auditor has been with the client for one year or less (INITIAL) to control for
auditor attributes. BIG4 and INDSP are positively related to audit fees as they control for the
premium that companies pay to a big four/industry specialist auditor (e.g., Palmrose 1986;
Romanus et al. 2008). INITIAL is negatively associated with audit fees since it controls for the
lower fees as a result of lowballing practices (e.g., DeAngelo 1981). Lastly, Krishnan and Wang
(2015) suggest that audit fees are higher for clients with a December 31 fiscal year-end.
Therefore, I control for capacity constraint (FYE) to control for this effect.
The study defines the dependent variable as the natural log of audit fees (LNAUDIT).
The independent variables of interest are PSCORE and PSCOREQ, for H1. The study uses the
following regression specification to test the hypotheses (firm and year subscripts are omitted):
LNAUDIT= a0+ a1*PSCORE (or PSCOREQ)+ a2*LNAT+ a3*BM+ a4*LEV+ a5*ROA+
a6*INVREC+ a7*LOSS+ a8*XDOPS+ a9*FOROPS+ a10*SGROWTH+ a11*INITIAL +
a12*LNAUDLAG + a13*SQSEGS + a14*EMPPLAN+ a15*FYE+ a16*LNAGE+ a17*GC+
a18*RESTATE+ a19*MERGER+ a20*NEWFIN+ a21*BIG4+ a22*INDSP+ a23*ICW+ (Year
Dummies) + Industry or Firm Dummies) + ε Equation (1)
Definitions of variables used in the study appear in Appendix A. The estimated
coefficient for PSCORE (and PSCOREQ) is used to test H1. Consistent with H1, I expect a
negative coefficient (a1 < 0) that audit fee decreases with the degree of the firm’s reliance on
principles-based standards.
14

IV. SAMPLE SELECTION AND EMPIRICAL RESULTS
Sample Selection
The sample covers five years from 2002 to 2006, consisting of all the US publicly traded
firms with available data. Financial data and business segment information are pulled from the
Compustat database. The sample excludes financial firms (i.e., two-digit SIC codes 60–69) and
utility firms (i.e., two-digit SIC code 49). 8 The study uses the Center for Research in Security
Prices (CRSP) database to get stock return data and the Audit Analytics database to obtain audit
fees, non-audit fees, going concern opinion, auditor names, and internal control information. The
sample is up to the year 2006 because PSCORE data is available for years up to 2006. The study
uses PSCORE data that are made available by Folsom et al. (2016). 9 I drop firm-year
observations with missing information about variables used in the models. The sample size for
the main analysis has 12,928 firm-year observations from 3,590 unique firms. To diminish the
impact of outliers, the study winsorizes all continuous variables at the top and bottom one
percentile of their distributions.
Table 1 Panel A reports descriptive statistics of the variables. The mean (median) of audit
fees is close to $1.3 million ($0.5 million) in the sample. The mean (median) for PSCORE is
close to -17 (-15.6). The mean and median value of PSCOREQ is 3. Going concern firms
represent only 2% of the sample.
Correlation coefficients between LNAUDIT and PSCORE, PSCOREQ and other
variables are reported in Panel B and C of Table 1. Consistent with H1, both Pearson and
8
Financial firms are those firms with two-digit SIC codes between 60 and 69. Utility firms are those firm
with two-digit SIC code of 49.
9
I thank the authors for making the data publicly available. The PSCORE data, as supplemental material,
are available at http://dx.doi.org/10.1287/mnsc.2016.2465
15

Spearman correlations between LNAUDIT and PSCORE and between LNAUDIT and
PSCOREQ are negative and significant at 0.01 level, providing initial evidence in support of H1.
Consistent with prior research (Krishnan and Wang 2015; Bhandari et al. 2020), audit fee has a
statistically significant correlation with firm size, industry specialist, Big 4 auditors, firm
complexity, and internal control weakness. Next, I discuss the results using the machine learning
method and multivariate audit fee model.
Evidence from Machine Learning Method
The research employs an advanced machine learning approach known as the gradient
boosting model. This advanced algorithm, referred to as gradient boosting, is a powerful
technique in machine learning applications. This machine learning technique represents a
relatively recent advancement in statistical learning technology, providing an understanding of
the relative importance of variables in a model (Chen and Guestrin 2016; Friedman, 2001). It is
widely used for supervised learning tasks in regression analyses (Jones 2017; Hasan et al. 2022).
Regardless of the significance level attributed to the independent variable, it is crucial to evaluate
whether the specific independent variable makes logical sense in relation to its role and impact
on audit outcomes, such as audit fees and the issuance of going concern opinions (Jones 2015;
Jones 2017; Hasan et al. 2022).
The main advantage of this model is facilitated through Relative Variable Importance
(RVIs). The RVIs, as illustrated in Tables 2 and 7, serve as valuable tools for showcasing the
influence of a particular explanatory variable on the overall outcomes. In addition to RVIs,
traditional models, such as the OLS and logit models, produce parameter estimates that are
consistently linear concerning the dependent variable (Jones 2017). In contrast, the gradient
16

boosting model’s marginal effects capture all nonlinear impacts, offering a more informative
analysis of variables influencing audit fees and going concern outcomes.
The model has been shown to have the ability to achieve high predictive accuracy,
effectively capture non-linear relationships in data, highlight feature importance10, and provide
robustness to overfitting (Adler and Painsky 2022; Amini et al. 2021; Chen and Guestrin 2016;
Park and Ho 2019; Trizoglou et al. 2021). Recent accounting and finance literature have picked
up on this model. For example, Jones (2017) illustrates the clear advantages of the gradient
boosting model over traditional logit in predicting bankruptcy. Other studies that utilize and
discuss the effectiveness of this machine learning technique include Jones et al. (2015) and
Hasan et al. (2022).
In light with many advantages of the machine learning method, the current study employs
the gradient boosting model, an advanced machine-learning method, to understand the role of
principles-based accounting standards in predicting audit fees. Previous studies (Jones 2017;
Bhuyan and Bhandari 2020; Hasan et al. 2022) have demonstrated that machine learning models
offer several advantages, including the incorporation of numerous explanatory variables,
improved out-of-sample prediction accuracy, and valuable insights derived from enhanced
prediction outcomes. In this analysis, I employ a tree-based advanced machine learning model
called extreme gradient boosting (xgboost), which effectively identifies the important variables
within the predictive model (Friedman, 2001). The extreme gradient boosting model addresses
the limitations by delivering high prediction accuracy and mitigating the weaknesses associated
with other traditional prediction models (Jones, 2017; Bhuyan and Bhandari 2020).
10
Gradient boosting method furnishes a metric for determining the relative importance of variables,
enabling users to assess the variables that exert a more substantial influence on the predictive performance of the
model (Adler and Painsky 2022).
17

Table 2 presents the rankings and relative variable importance (RVI) scores, ranging
from 0 to 100, for all the predictors in the audit fee model from Equation (1). These scores and
rankings provide insights into the significance of individual variables in explaining audit fees.
The findings indicate that firm size is the most influential variable, ranking first among all 23
explanatory variables. Additionally, a firm’s reliance on principles-based accounting standards
(PSCORE) ranks second among these variables. It is important to note that the table displays the
top 20 performing variables out of the total 23 predictors included in Equation (1). The results
highlight the importance of PSCORE as one of the key explanatory factors for audit fees, as
identified through an advanced machine-learning approach.
Empirical Results from Multivariate Regression Analysis
Table 3 reports the results explaining the audit fee (Equation 1). The explanatory power
(adjusted R2) is about 83 percent for models with year and industry fixed effects and is about 93
percent for the models with year and firm-fixed effects. The coefficients on many control
variables are significant and are consistent with prior literature. Audit fee is positively associated
with firm size, leverage, internal contrail weakness, and other measures of firm’s complexity,
and negatively associated with ROA and INITIAL. Audit fee is also decreasing in NEWFIN,
suggesting that new financing activities increase the auditor’s assessment of the client’s business
risk. The t-statistics are based on robust standard errors clustered by both firm and year. 11 The
coefficients on the variable of interest, PSCORE, are -0.021 and -0.013, respectively, for the
models with industry and firm fixed effects, respectively. These coefficients are significant at the
11
The top three VIFs for the PSCORE model variables are, respectively, 3.16 (LNAT), 2.16 (ROA), and
1.92 (LOSS). These VIFs are < 10, at which multicollinearity is usually considered a problem (Belsley et al. 1980).
Hence, I argue that multicollinearity is not an issue in the regression analyses. Consistent with prior research
(Krishnan and Wang 2015), I don’t cluster standard errors in the models with firm fixed effects regressions.
18

1 percent level. Similarly, the coefficients on PSCOREQ are -0.128 and -0.066, respectively, for
models with industry and firm fixed effects, respectively. These coefficients are also significant
at the 1 percent level. Thus, I find that audit fee is decreasing in the degree of the client firm’s
reliance on principles-based standards. This finding confirms H1 and is consistent with the
argument that auditors consider firms relying more on principles-based standards less risky
because these companies are less likely to engage in earnings manipulation.
Furthermore, the earnings of companies relying more on principles-based standards better
reflect the underlying economic performance, which increases auditors’ confidence in those
numbers. Therefore, auditors consider the clients using more principles-based standards less
risky. The results are economically significant as the study finds that audit fees are lower by
about 6.38 percent or about $91,287 for observations in the top quintile of PSCORE relative to
observations in the bottom quintile. 12 Thus, the results are both statistically and economically
significant.
Additional Tests for Audit Fee Model
The study performs additional analysis to evaluate the robustness of the main results.
These tests include different specifications and additional control variables. The discussion of the
additional tests is presented next.
12
In order to examine the economic significance of the impact of PSCORE on audit fees, this study
calculates total dollar values impact on audit fees in the top quintile of PSCORE relative to observations in the
bottom quintile. Based on the coefficient of -0.066 for PSCOREQ (with firm-fixed effect model), exp0.066 -1= -
0.0682. In the main audit fee sample, the mean value of audit fee is $1,338,000. Thus, $1,338,000 * 0.0682 =
$91,287.
19

Change Analysis
To the extent that potential correlated omitted variables are constant across years, a
change analysis helps to mitigate the correlated omitted variable concern. I, therefore, investigate
whether firms with changes in their PSCORE (and PSCOREQ) exhibit changes in their audit
fees. The results of this analysis are reported in Table 4. Consistent with the results of the main
analysis, I find changes in the degree of a firm’s reliance on principles-based standards are
negatively and significantly associated with corresponding changes in audit fees.
Propensity Score Matching (PSM) and Entropy Balancing Procedures
The second sensitivity analysis includes a propensity score matching (PSM) procedure to
control for heterogeneities that may exist between the high and low PSCORE groups while
estimating PSCORE treatment effects. The study follows Rosenbaum and Rubin (1983) and
Lawrence et al. (2011) for the PSM procedure. I create an indicator variable
(PSCORE_DUMMY) equal to 1 for PSCORE greater than the median value of the sample
PSCORE and zero otherwise. I match on all I match a company with high reliance on principles-
based standards (PSCORE_DUMMY=1) with companies with low reliance on principles-based
standards (PSCORE_DUMMY=0) on three firm attributes LNAT, ROA, and LEV. The
matching is based on the closest predicted value within a maximum distance of 3 percent. As
shown in Panel A of Table 5, the matching procedure results in 6,794 firm-year observations. 13
As Lawrence et al. (2011) explain, after controlling for these firms’ characteristics and
restricting the control group to a set of companies that are very similar, I should not find any
significant effects of PSCORE, if PSCORE is indeed irrelevant. However, the main results hold
13
Untabulated comparisons of the matched samples indicate the similar LNAT, ROA, and LEV between
the two groups.
.
20

even after using PSM matched sample. In untabulated analyses, I also match on LNAT, ROA,
and LEV separately, thereby creating three different matched samples, and I find similar results.
All analyses include control variables from Equation (1) and year and industry fixed effects.
To create a more efficient balanced sample, the study employs entropy balancing to
account for differences in PSCORE levels (high and low) based on mean, variance, and
skewness. The advantage of using entropy balancing over propensity score matching (PSM) is
that it assigns weights to observations on a continuous scale, incorporating all observations rather
than discarding unmatched ones with weights of 1 or 0 like PSM (Wilde 2017; Chapman et al.
2019; Bhuyan and Bhandari 2020). This approach optimally matches treatment observations
while retaining the original sample size, improving efficiency. 14 In Panel B of Table 5, I find that
even after applying entropy weighting, the results are consistent with those reported in the main
analyses. In Panel C of Table 5, we find that our main results hold even after controlling for
accounting conservatism.
Controlling for CEO/CFO Equity Incentives
Fargher et al. (2014) and Kannan et al. (2014), among others, show that equity incentives
of executives are associated with audit fees. To examine the impact of the executive equity
incentives on the main results, I control for CEO equity incentives in the analysis. For this
purpose, I follow Core and Guay (2002) and Coles et al. (2006) to control for the magnitude of
changes in the value of a CEO’s firm equity holdings to a change in firm share price (CEO delta)
and to a change in the volatility of firm stock return (CEO Vega). The sample size is reduced to
5,089 observations as a result of these additional data requirements. Untabulated results indicate
that the coefficients of PSCORE and PSCOREQ continue to be negative and significant (p-
14
Untabulated comparisons of the entropy balanced samples indicate the similar mean, variance and
skewness between variables in the entropy balanced sample.
21

value<0.01), in both models with firm and industry fixed effects. 15 Furthermore, consistent with
Kannan et al. (2014), CEO delta is insignificant, whereas CEO Vega is positive and significant
(p-value<0.001).
Controlling for Governance
The fourth sensitivity test controls for the corporate governance variables. Gompers et al.
(2003) and Bebchuk et al. (2008), among others, have used variations in specific takeover
defenses or anti-takeover laws as a proxy for corporate governance. I re-estimate Equation (1)
using the G-Index (Gompers et al. 2003) as an additional control variable, which reduces the
sample size to 5,006 observations. Untabulated results show that the coefficients of PSCORE
and PSCOREQ are negative and significant in both models with firm and industry fixed effects.
Next, I include Takeover Index developed by Cain et al. (2017). Due to endogeneity concerns of
G-Index, Cain et al. (2017) use other legal environment factors and other variables, such as
aggregate capital liquidity and firm age, that are supposedly exogenous to develop an index of
takeover susceptibility (Takeover Index). 16 Adding Takeover Index to the model reduces the
sample size to 12,569 observations. Untabulated results show that the main results continue to
hold even after controlling for the Takeover Index. In addition, I also control for Bebchuk et al.
(2008) entrenchment index (E-Index) in Equation (1). This requirement reduces the sample size
considerably to 5,006 observations. Untabulated analysis shows that the main results continue to
hold even after controlling for E-Index. I also control for various alternative measures of
governance. These include CEO-Chair duality, the ratio of inside directors, independent
15
In addition, Delta and Vega are available for several top executives. I averaged these variables per firm-
year and use the average values of executive Delta and executive Vega in Equation (1). The untabulated results for
Delta and Vega variables and for PSCORE and PSCOREQ appear qualitatively similar to the ones discussed above.
16
Cain et al. (2017)’s Takeover Index captures significant variation in both the cross-section and time-
series relating to the disciplinary market for corporate control. Higher values of the Takeover Index indicate greater
susceptibility to takeovers, hence better corporate governance.
22

directors, and gray directors. Untabulated analyses show that the main results are robust to
alternative governance measures.
Yearly Regression Results
Since unobserved time-invariant factors may affect the results, the study estimates the
audit fee model annually to control for the impact of time series. This analysis would also
address concerns regarding the variations of the coefficients over time. I follow Fama and
MacBeth (1973) to estimate the significance of coefficients in a year-by-year basis. The results
(untabulated) show that the coefficients on PSCORE and PSCOREQ are, respectively, -0.025
and -0.147. These coefficients are significant at the 1 percent level, and average R2 values are
close to 80%. Overall, the main results are robust to yearly regression results.
Going Concern Model and Analysis
In this section, this study designs the going concern model. The study uses the going
concern model to test the second hypothesis (H2). The current study relies on DeFond et al.
(2002), Lim and Tan (2008), and Krishnan and Wang (2015) in selecting the determinants and
developing a logistic model to explain the issuance of a going concern opinion. Following
DeFond et al. (2002) and Lim and Tan (2008), the model controls for several measures to capture
the client risk. These include non-diversifiable risk (BETA), stock returns volatility (VOLRET),
leverage (LEV), change in leverage (ΔLEV), prior year firm losses (PLOSS), default risk as
measured by Altman’s Z-score (ZSCORE), and days of reporting lag between fiscal year-end
and the earnings announcement date (LNAUDLAG). I expect positive coefficients on these
variables. The model also controls for Big-four audit firms (BIG4) as a measure of audit quality.
I expect a positive coefficient on auditor quality. Following prior research, the model also
includes several measures to capture the client performance indicators such as firm size (LNAT),
23

annual stock return (RETURN), investment securities (INVEST), operating cash flow (OPCFO),
firm age (LNAGE), and new financing activities (NEWFIN). I expect negative coefficients on
the client performance indicators. Finally, I control for fee ratio (FEERATIO), which is the ratio
of non-audit fees to total fees paid to the incumbent auditor. Blay and Geiger (2013) find that
non-audit service fees paid to auditors reduce the frequency of going concern opinions. 17 The
going concern research model also includes year and industry fixed effects.
The study uses the Center for Research in Security Prices (CRSP) database to get stock
return data. Following DeFond et al. (2002) and Carey and Simnett (2006), I classify firms
reporting either a negative cash flow from operations and/or a loss in the current year as
financially distressed firms. The going concern sample includes only financially distressed firm-
year observations. In addition, I drop observations with missing variables required for the going
concern opinion model. In the model, I add PSCORE (or PSCOREQ) as the independent
variables of interest to test H2. Definitions of variables are presented in Appendix A. The final
sample size for going concern analysis includes 4,849 firm-year observations (2,093 unique
firms), including 193 observations with going concern opinions. The study estimates the
following logistic model (firm and year subscripts are omitted here for simplicity):
GC = ß0+ ß1*PSCORE (or PSCOREQ) + ß2*LNAT+ ß3*LEV+ ß4* ΔLEV+ ß5*PLOSS+
ß6*OPCFO+ ß7*ZSCORE+ ß8*BETA+ ß9*RETURN+ ß10*VOLRET+ ß11*INVEST+
ß12*NEWFIN + ß13*BIG4+ ß14*LNAUDLAG+ ß15*LNAGE+ ß16*FEERATIO+ Year Dummies +
Industry Dummies + ε Equation (2)
17
However, Raghunandan, Read, and Whisenant (2003) conclude that non-audit fees do not impact the
audit quality.
24

The appendix includes the detailed definitions of the variables. Panel A of Table 6
presents the descriptive statistics of the variables used in the going concern model. Panel B of
Table 6 presents Pearson and Spearman correlation coefficients between GC and PSCORE,
PSCOREQ, and other variables. Correlations between GC and PSCORE are negative, but
insignificant. Firm size, Altman bankruptcy score, leverage, beta, stock return, stock return
volatility, and fee ratio, are significantly associated with going concern opinion.
Similar to the advanced machine-learning method used in the audit fee model, the study
employs an advanced machine-learning method to understand the role of principles-based
accounting standards (PSCORE) in predicting an auditor’s likelihood of issuing a going concern
opinion (GC). Table 7 presents the rankings and relative variable importance (RVI) scores,
ranging from 0 to 100, for all the predictors in the going concern model described by Equation
(2). The findings indicate that operating cash flow is the most influential variable, ranking first
among all 18 explanatory variables. Additionally, a firm’s reliance on principles-based
accounting standards (PSCORE) holds the 10th rank among these variables. The results suggest
the importance of PSCORE as one of the key explanatory factors for the auditor’s likelihood of
issuing a going concern opinion.
The multivariate regression results for the estimation of Equation (2) regarding the effect
of the reliance on principles-based standards on the going concern opinions are reported in Table
8. The left column of Table 8 tests H2 and presents the results using financially distressed firms
in the going concern model. The right column of Table 8 tests H2 and presents the results for
severely financially distressed firms 18 (Callaghan et al. 2009; Blay and Geiger 2013).
18
I consider a firm-year observation as a financially distressed when it reports either a loss and/or negative
operating cash flows and a firm that reports both loss and negative operating cash flows is considered severely
financially distressed firm.
25

In financially distressed firms, I find that the coefficients on PSCORE and PSCOREQ are
-0.026 and -0.167, respectively. Both coefficients are significant at the 5 percent level. 19 In the
severely financially distressed sample, I find that the coefficients on PSCORE and PSCOREQ
are -0.048 and -0.206, respectively. 20 Both are significant at the 1 percent level. Overall, Table 8
analyses support H2 and provide evidence that the likelihood of an auditor issuing a going
concern opinion is decreasing on the client’s reliance on the principles-based standards.
Coefficients on control variables are consistent with prior research. For example, firm size,
operating cash flows, beta, stock return, investments, and fee ratio are negatively associated with
going concern opinion. Whereas leverage, loss, Altman bankruptcy score, volatility of stock
returns, new financing, and audit report lag are positively associated with going concern opinion.
In order to assess the economic significance of going concern results, I use the
standardized value of PSCORE and substitute it for PSCORE in Column 1 (representing
Severely Financially Distressed firms) and Column 3 (representing Financially Distressed firms)
of Table 8. The resulting coefficients on the standardized values of PSCORE are -0.2135 and -
0.3995, respectively. This implies that a one standard deviation increase in PSCORE is
associated with a 19.22% decrease in the odds of receiving a going concern opinion (e^β =
0.8077; 1 - 0.8077) for Severely Financially Distressed firms and a 32.29% decrease in the odds
(e^β = 0.6706; 1 - 0.6706) for Financially Distressed firms. Thus, I conclude that the going
concern results are economically significant.
19
The odds ratio for PSCOREQ (calculated as the exponential value of the coefficient on PSCOREQ) is
equal to 0.847. This suggests that the odds of an auditor issuing a going concern opinion for firms relying more on
principles-based standards (i.e., firms on top quintile PSCOREQ) are 15.3 percent (calculated as, 1 minus 0.847)
lower compared to firms relying less on principles-based standards (i.e., firm on bottom quintile PSCOREQ).
20
The severely financially distressed sample includes 2,396 firm-year observations, which includes 150
observations with going concern opinions.
26

Additional Tests for Going-Concern Opinion Model
In this sub-section, I test the robustness of the going concern results and show that the
results remain consistent with the use of matching methodologies and the inclusion of additional
control variables. I discuss the results using propensity score-matched (PSM) samples first.
Results of Equation (2) for propensity score matched samples are in Table 9. I present the results
in two columns. In the left column, I match 193 distressed going concern firms (GCF) with 193
distressed firms without going concern opinions (NGCF). I match, without replacement, each
GCF (treatment group) to the closest NGCF (control group) in ZSCORE, total assets (LNAT),
two digit SIC and year. 21, 22 However, even after matching using a propensity score approach, as
presented in Panel A of Table 9, I continue to get similar results. The coefficient on PSCORE is
-0.064 (significant at a 5 percent level), and on PSCOREQ is -0.236 (significant at the 10 percent
level).
To further substantiate the PSM procedure, I also follow the PSM matching criteria of
Krishnan et al. (2007) and Amin et al. (2014). I match, without replacement, 193 GCF firms to
the closest 193 NGCF firms on ZCSORE, LNAT, LOSS, and INVEST. I present regression
results on this matched sample in the right column in Panel A of Table 9. The coefficients on
PSCORE and PSCOREQ are -0.074 and -0.365, respectively. Both coefficients are significant at
the 1 percent level.
These matching attributes are based on prior research (Blay and Geiger 2013; Geiger and Rama 2003)
21
The industry controls in the regression analyses represent the Fama-French 48-industry classification. In
22
PSM model, I match treatment and control on two digit SIC in order to be consistent with the prior research (Geiger
and Rama 2003; Blay and Geiger 2013; Krishnan et al. 2007; Amin et al. 2014). The results are consistent if I match
on Fama-French 48 industry classification instead of two digit SIC code.
27

In Panel B of Table 9, I follow the entropy balancing procedure and find that the main
going concern results hold even after using entropy balanced sample. 23 Following prior studies
on going concern companies (e.g., Ogneva and Subramanyam 2007; Kausar et al. 2009), I also
estimate Equation (2) with first-time going concern cases. In particular, I define a going concern
audit report as first-time if a firm has not received a going concern opinion in the previous fiscal
year. The results, which are untabulated, indicate that the coefficients on PSCORE and
PSCOREQ continue to be negative and statistically significant.
To mitigate concerns about omitted variables in Equation (2), I add a number of control
variables that can potentially affect the auditor’s likelihood of issuing a going concern opinion.
Chen et al. (2001) provide evidence that a client’s earnings management is positively associated
with receiving modified audit opinions. I re-estimate Equation (2) after controlling for the
modified Jones (Jones 1991; Dechow et al. 1995) measure of discretionary accruals. Untabulated
results show that the main results are consistent with those reported in Table 8. I also consider
alternative measures of earnings quality: Dechow and Dichev’s (2002) measure of discretionary
accruals and the absolute value of Dechow and Dichev’s (2002) discretionary accruals.
Untabulated regression results again confirm that the main results hold after controlling for the
alternative measures of earnings quality.
Krishnan and Wang (2015) provide evidence that the likelihood of issuing a going
concern opinion is decreasing in managerial ability. To address this concern, I control for
Demerjian et al. (2012)’s managerial ability measure as an additional determinant of going
concern opinion. Untabulated regression results also confirm that the main results hold after
controlling for the managerial ability and are consistent with those reported in Table 8. In order
23
Untabulated comparisons of the entropy balanced samples indicate the similar mean, variance and
skewness between variables in the entropy balanced sample.
28

to control corporate governance, I use the Takeover Index (Cain et al. 2017) as an additional
determinant in Equation (2). Untabulated regression analyses show that the main result is
consistent with those reported in Table 8. 24
Additional Tests for Conservatism and Financial Reporting Risk
The study tests some potential mechanism through which principles-based accounting
standards impact auditors’ audit risk or auditors’ business risk assessments. More specifically, in
Panel A of Table 10, the study provides evidence that a firm’s reliance on principles-based
accounting standards is negatively associated with the risk of financial statement misstatement
(FSCORE), accrual (ACCRUAL) and difficulty in predicting future earnings (EPSVOL). These
variables are defined in Appendix A. For a detailed explanation of the construction of FSCORE
and ACCRUAL, please refer to Appendix B in the revised manuscript. In Panel B of Table 10,
the study provides evidence that a firm’s reliance on principles-based accounting standards is
negatively associated with both conditional accounting conservatism (C_SCORE) and
unconditional accounting conservatism (CON_ACC). The findings in Table 10 extend prior
studies (Cho and Krishnan 2023; Eiler et al. 2022; Fullana et al. 2021) by demonstrating
implications of principles-based standards on auditors’ risk assessments via reduction in
financial reporting risks and accounting conservatism.
24
Controlling other governance measures such as CEO duality and percent of gray directors drops the
sample size considerably to around 800 firm year observations with only eight going concern firm year observations.
Hence, the study does not control for these governance measures in Equation (2).
29

V. CONCLUSION
This research employs an advanced machine learning approach and examines the
relationship between principles-based standards and how auditors perceive client risk. The
findings suggest that auditors consider financial statements prepared using principles-based
standards to be less risky and, therefore, price lower audit fees. Prior studies suggest that
financial statements relying more on principles-based standards better reflect the underlying
economic performance of the firm because management in such firms makes economic decisions
that benefit the firm instead of engaging in transactions for accounting outcome purposes.
Therefore, the study also predicts that firms whose financial statements rely more on principles-
based standards make better economic decisions, reducing the likelihood of financial and
economic problems. Consistent with this argument, the study finds that such firms are less likely
to receive going concern opinion.
The additional analyses support our main results in that the study provides evidence
showing that the relative extent to which a US firm is reliant upon principles-based standards
have a negative relationship with unconditional and conditional conservatisms and a positive
relationship with the risk of financial statement misstatement, accrual and difficulty in predicting
future earnings. These findings suggest potential mechanisms through which principles-based
accounting standards influence auditors' assessments risk. These findings extend prior studies
(Cho and Krishnan 2023; Eiler et al. 2022; Fullana et al. 2021) by demonstrating implications of
principles-based standards on auditors’ risk assessments via reduction in financial reporting risks
and accounting conservatism.
The study adds to the discussion of the quality of accounting standards. Furthermore, this
research demonstrates the benefits of principles-based accounting standards from auditors’ and
30

firms’ perspectives. Therefore, the study is relevant for both academicians and regulators as the
results have public policy implications. The evidence that auditors perceive principles-based
financial statements as less risky is important to advance literature discussing accounting
standards. In addition, the study invites policy debates, such as whether the current accounting
standards in the United States (i.e., GAAP) should move towards more principles-based
standards or converge with International Financial Reporting Standards (IFRS). Future research
may investigate the principles vs. rules orientation within international accounting standards.
31

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38

APPENDIX A
Variable Definitions
PSCORE = Folsom et al. (2016) measure of the relative extent to which a firm is
reliant upon rules- or principles-based standards. Firms that rely on
relatively more principles-based standards (rules-based standards) for
financial reporting receive a higher (lower) PSCORE;
PSCOREQ = the quintile rank value of PSCORE;
LNAT = the natural log of total assets;
BM = book to market ratio, calculated as book value of equity divided by
market value of equity;
LEV = total liabilities divided by total assets;
ROA = return on assets, calculated as income before extraordinary items divided
by total assets;
INVREC = sum of inventory and accounts receivables divided by total assets;
LOSS = 1 if income before extraordinary item is negative, and 0 otherwise;
XDOPS = 1 if the firm has extraordinary items, and 0 otherwise;
FOROPS = 1 if the firm has foreign operations as indicated by B44foreign currency
adjustments to income, and 0 otherwise;
SGROWTH = growth rate in sales over the previous fiscal year;
INITIAL = 1 if the firm’s auditor has been with the client for one year or less, and 0
otherwise;
LNAUDLAG = the natural log of the number of days between audit opinion signature
date and fiscal year-end;
SQSEGS = the square root of the number of business segments;
EMPLAN = 1 if the firm has an employee retirement plan, and 0 otherwise;
FYE = 1 if the firm’s fiscal year-end is December 31, and 0 otherwise;
LNAGE = the natural log of the number of fiscal years since the firm was included
in the Compustat;
GC = 1 if the firm received a qualified going concern opinion issued by the
auditor expressing substantial uncertainty about its ability to continue,
and 0 otherwise;
RESTATE = 1 if the firm restated its financial statements, and 0 otherwise;
MERGER = 1 if there was a merger or acquisition, and 0 otherwise;
NEWFIN = 1 if the firm received any financing, and 0 otherwise;
BIG4 = 1 if the auditor is a Big4 auditor, and 0 otherwise;
INDSP = 1 if the auditor is the industry leader, and 0 otherwise. Following
Mayhew and Wilkins (2002), an auditor is considered industry leader if
it has the highest industry market share measured as the total audit fees
earned by auditor firm i in industry k (Fama French 48 industry) deflated
by the total audit fees generated by all the clients in the industry;
39

ICW = 1 if there is a significant deficiency or material weakness in internal
control, and 0 otherwise;
ΔLEV = change in LEV during the year;
PLOSS = an indicator variable that equals 1 if the firm reports a loss in the prior
year, and 0 otherwise;
OPCFO = cash flow from operations scaled by total assets;
ZSCORE = Altman (1968) Z-score. ZSCORE= 2 if Z is less than 1.81; ZSCORE= 1
if Z is between 1.81 and 2.99; ZSCORE = 0 if Z is greater than 3;
ZSCORE= 2 indicates that failure is a real possibility; ZSCORE= 1
indicates a gray area. The lower the score the greater the odds of failure.
Z-score is calculated as: Z= 1.2 × working capital/total assets + 1.4 ×
retained earnings/total assets + 3.3 × earnings before interest and
taxes/total assets + 0.6 × market value equity/book value of total debt +
0.999 × sales/total assets;
BETA = the firm’s beta estimated using a market model over the fiscal year;
RETURN = market adjusted annual stock returns;
VOLRET = standard deviation of daily stock returns on a per firm and per fiscal year
basis;
INVEST = short- and long-term investment in securities deflated by total assets; and
FEERATIO = the ratio of non-audit fees to total fees;
FSCORE = the firm’s risk of financial statement misstatement measure developed
by Dechow et al. (2011). Please refer to Appendix B for the detailed
construction of FSCORE;
ACCRUAL = total accruals based on Dechow et al. (1995). Please refer to Appendix B
for the detailed construction of ACCRUAL;
EPSVOL = the difficulty of future earnings prediction calculated as the standard
deviation of earnings per share over the five-year period after year t;
C_SCORE = Conditional conservatism measure based on Khan and Watts (2009);
Please refer to Appendix B for the detailed construction of C_SCORE;
CON_ACC = Unconditional conservatism measure based on Ahmed and Duellam
(2013). Please refer to Appendix B for the detailed construction of
CON_ACC;
40

APPENDIX B
Calculation of FSCORE
The study follows Dechow et al. (2011) to compute the likelihood of a firm’s financial
statement misstatement using firm’s characteristics. Following Dechow et al. (2011), the study,
first, calculates the predicted values, p, using the following model:
pi,t = (-7.893) + 0.790 × RSST_ACCi,t + 2.518 × ΔRECi,t + 1.191 × Δ INVi,t + 1.979 × SOFTi,t + 0.171 ×
ΔCashSalei,t + (-0.932) × Δ ROAi,t + 1.029 × ISSUEi,t, (i)
where RSST_ACC represents Richardson et al.’s (2005) accrual measure for company i
during fiscal year t. It's derived as the sum of three components, all scaled by the average total
assets. The three components are: change in non-cash working capital, the change in net non-
current operating assets, and the change in net financial assets; ΔREC is computed as the change
in receivables, scaled by average total assets; ΔINV is computed as the change in inventory, scaled
by average total assets; SOFT refers to the portion of soft assets, calculated as total assets minus
property, plant, and equipment, and cash, scaled by average total assets; ΔCashSale is calculated
as the percentage change in cash sales; ΔROA is computed as the change in return on assets; and
ISSUE is an indicator that takes value of one if the company has issued new debt or equity during
fiscal year t, and zero otherwise.
FSCORE is the predicted probability from the above model, scaled by the unconditional
probability of having accounting manipulations. A greater FSCORE value signifies an increased
likelihood of a financial misstatement.
Calculation of ACCRUAL
The study follows Dechow et al. (1995) to compute total accruals (ACCRUAL).
ACCRUAL is computed as: (ΔCA- ΔCL- ΔCash + ΔSTD- Dep)/(TA) where ΔCA = change in
current assets; ΔCL = change in current liabilities; ΔCash = change in cash and cash equivalents;
ΔSTD = change in debt included in current liabilities; Dep = depreciation and amortization
expense. All variables are scaled by beginning total assets (TA).
Calculation of C_SCORE
Khan and Watts (2009) uses Basu (1997) asymmetric timeliness model and proposed
C_SCORE as a proxy for Conditional accounting conservatism. C_SCORE measure has been
used in other recent studies (Ahmed and Duellman 2013; Ettredge et al., 2012; Heflin et al.,
2015). Following Basu (1997), Khan and Watts (2009) calculated the timeliness of good news
(G_SCORE) and bad news (C_SCORE), finding evidence consistent with conservatism
increasing in the C_SCORE. In line with their approach, I estimated the C_SCORE for each
firm-year by applying a cross-sectional approach based on size, leverage, and market-to-book
ratio. This computation led to firm-specific conservatism measures at the end of each year within
the sampled period.
The study uses the below equation that is based on earnings being more sensitive to bad
news than good news. In the equation (ii) below, NI is net income before extraordinary items
41

scaled by the total assets, RET is the annual returns, and D is an indicator variable equal to 1 if
RET is less than zero, and 0 otherwise.
NI = 𝛽𝛽1 + 𝛽𝛽2D𝑡𝑡 + 𝛽𝛽3RET𝑡𝑡 + 𝛽𝛽4D𝑡𝑡 ∗ RET𝑡𝑡 + 𝜀𝜀 (ii)
After proposing equation (ii), the study uses the below equations to define G_SCORE
and C_SCORE. These equations are based on market value (MV), market-to-book ratio (MTB),
and leverage (LEV).
𝐺𝐺_SCORE𝑡𝑡 = 𝛽𝛽3 = 𝜇𝜇1 + 𝜇𝜇2 SIZE 𝑡𝑡 + 𝜇𝜇3MTB𝑡𝑡 + 𝜇𝜇4LEV𝑡𝑡 (iii)

C_SCORE𝑡𝑡 = 𝛽𝛽4 = 𝜆𝜆1 + 𝜆𝜆2 SIZE 𝑡𝑡 + 𝜆𝜆3MTB𝑡𝑡 + 𝛾𝛾𝛾𝛾4LEV𝑡𝑡 (iv)
The study substitutes Equations (iii) and (iv) for β3 and β4 in Equation (ii), yielding the
following estimable equation.
NIt = β1 + β2Dt + (µ1 + µ2 SIZE t + µ3MTBt + µ4LEVt) ∗ RETt + (λ1 + λ2 SIZE t + λ3MTBt
+ λ4LEVt) ∗ Dt ∗ RETt + ε (v)
Following Khan and Watts (2009), I estimate Equation (v) using annual cross-sectional
regressions to obtain the year-specific coefficients for the variables. The estimates of λi from
Equation (v) were substituted into Equation (iv) along with firm-specific measures of SIZE (the
natural logarithm of total assets), MTB, and LEV to compute the firm-specific C_SCORE. Higher
values of C_SCORE indicate higher conditional conservatism.
Calculation of CON_ACC
The study uses Ahmed and Duellam (2013) measure of unconditional conservatism. First,
the study calculates accruals as the earnings before extraordinary items minus the operating cash
flow plus depreciation deflated by the average of the assets. Second, the study averages the
accruals over the five years centered around year t multiplied by -1. Higher values of CON_ACC
indicate greater unconditional conservatism.
42

TABLE 1
Descriptive Statistics and Correlations: Audit Fee Sample
Panel A: Descriptive Statistics
Variable N MEAN SD Q1 MED Q3
Audit Fees ($ 000’s) 12928 1,338 2,338 217.453 538.498 1,355
LNAUDIT 12928 13.258 1.271 12.29 13.197 14.119
PSCORE 12928 -17.009 8.28 -21.278 -15.571 -11.22
PSCOREQ 12928 3 1.414 2 3 4
LNAT 12928 5.721 1.934 4.313 5.635 6.983
BM 12928 0.497 0.402 0.242 0.416 0.659
LEV 12928 0.457 0.247 0.261 0.439 0.609
ROA 12928 -0.026 0.216 -0.033 0.035 0.078
INVREC 12928 0.272 0.191 0.12 0.242 0.385
LOSS 12928 0.332 0.471 0 0 1
XDOPS 12928 0.018 0.131 0 0 0
FOROPS 12928 0.109 0.311 0 0 0
SALESGR 12928 0.185 0.489 -0.001 0.098 0.242
INITIAL 12928 0.095 0.293 0 0 0
LNAUDLAG 12928 4.028 0.427 3.807 4.127 4.29
SQSEGS 12928 2.287 0.87 1.732 1.732 3
EMPLAN 12928 0.276 0.447 0 0 1
FYE 12928 0.676 0.468 0 1 1
LNAGE 12928 2.682 0.704 2.197 2.565 3.178
GC 12928 0.02 0.139 0 0 0
RESTATE 12928 0.221 0.415 0 0 0
MERGER 12928 0.158 0.365 0 0 0
NEWFIN 12928 0.574 0.495 0 1 1
BIG4 12928 0.812 0.391 1 1 1
INDSP 12928 0.253 0.435 0 0 1
ICW 12928 0.158 0.365 0 0 0
FSCORE 12860 1.079 1.167 0.554 0.904 1.347
ACCRUAL 12916 -0.035 0.113 -0.078 -0.038 0
EPSVOL 12928 0.991 1.582 0.269 0.515 1.023
C_SCORE 12927 0.088 3.553 0.006 0.171 0.322
CON_ACC 12925 0.029 0.078 -0.007 0.015 0.047
Notes: Table 1 Panel A presents sample descriptive statistics for the variables used in audit fee analyses. See
Appendix A for variable definitions.
43

Panel B: Pearson and Spearman Correlations—Variables LAUDIT to SROWTH
Variable (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
(1) LNAUDIT 1.000 -0.576 -0.562 0.804 -0.080 0.337 0.166 0.009 -0.197 0.062 0.148 0.036
(2) PSCORE -0.567 1.000 0.980 -0.520 0.005 -0.335 0.098 0.136 -0.034 -0.094 -0.150 0.027
(3) PSCOREQ -0.564 0.890 1.000 -0.508 0.002 -0.325 0.095 0.133 -0.033 -0.088 -0.147 0.028
(4) LNAT 0.820 -0.509 -0.504 1.000 0.027 0.365 0.290 -0.050 -0.328 0.074 0.099 0.032
(5) BM -0.133 0.041 0.026 -0.023 1.000 -0.148 -0.158 0.165 0.003 0.027 -0.006 -0.228
(6) LEV 0.311 -0.326 -0.308 0.305 -0.194 1.000 -0.096 0.139 0.002 0.040 0.026 -0.066
(7) ROA 0.206 -0.010 -0.009 0.358 0.058 -0.077 1.000 0.202 -0.797 -0.003 0.030 0.236
(8) INVREC -0.040 0.156 0.163 -0.083 0.152 0.104 0.216 1.000 -0.199 -0.019 0.055 -0.022
(9) LOSS -0.195 -0.036 -0.033 -0.321 0.063 0.048 -0.650 -0.177 1.000 -0.013 -0.037 -0.198
(10) XDOPS 0.061 -0.114 -0.088 0.074 0.027 0.036 0.014 -0.018 -0.013 1.000 0.016 0.014
(11) FOROPS 0.148 -0.143 -0.147 0.099 -0.019 0.025 0.042 0.035 -0.037 0.016 1.000 0.002
(12) SGROWTH -0.060 0.037 0.039 -0.066 -0.154 -0.042 -0.037 -0.088 0.011 0.015 -0.018 1.000
(13) INITIAL -0.147 0.009 0.015 -0.120 0.069 -0.003 -0.046 0.024 0.050 -0.005 -0.010 -0.021
(14) LNAUDLAG 0.088 -0.092 -0.065 -0.143 -0.002 0.086 -0.104 0.033 0.096 0.017 0.022 0.056
(15) SQSEGS 0.236 -0.205 -0.195 0.243 0.057 0.122 0.129 0.086 -0.124 0.033 0.011 -0.046
(16) EMPLAN 0.468 -0.340 -0.333 0.510 0.016 0.318 0.195 0.092 -0.193 0.045 0.087 -0.094
(17) FYE 0.066 -0.113 -0.104 0.050 -0.062 0.092 -0.076 -0.148 0.074 0.026 0.012 0.062
(18) LNAGE 0.310 -0.105 -0.085 0.365 0.056 0.170 0.244 0.191 -0.243 0.033 0.056 -0.143
(19) GC -0.059 -0.007 -0.003 -0.128 -0.047 0.111 -0.271 -0.024 0.164 0.011 -0.024 -0.001
(20) RESTATE 0.043 -0.093 -0.085 0.025 0.035 0.058 -0.003 0.006 0.032 0.018 0.003 -0.001
(21) MERGER 0.110 -0.111 -0.131 0.099 -0.022 -0.014 0.053 -0.042 -0.064 -0.010 0.022 0.116
(22) NEWFIN 0.391 -0.272 -0.278 0.468 -0.099 0.301 0.061 -0.075 -0.109 0.028 0.047 0.074
(23) BIG4 0.405 -0.244 -0.269 0.445 -0.010 0.091 0.094 -0.118 -0.101 0.034 0.066 -0.066
(24) INDSP 0.196 -0.135 -0.129 0.212 -0.004 0.051 0.056 -0.017 -0.051 0.002 0.027 -0.038
(25) ICW 0.154 -0.126 -0.113 -0.030 -0.018 0.042 -0.043 0.025 0.083 0.011 0.034 0.013
44

Panel C: Pearson and Spearman Correlations—Variables INITIAL to ICW
Variable (13) (14) (15) (16) (17) (18) (19) (20) (21) (22) (23) (24) (25)
(1) LNAUDIT -0.150 0.049 0.183 0.451 0.059 0.264 -0.061 0.048 0.121 0.389 0.410 0.189 0.157
(2) PSCORE 0.013 -0.056 -0.176 -0.339 -0.109 -0.061 -0.007 -0.089 -0.133 -0.284 -0.275 -0.134 -0.117
(3) PSCOREQ 0.015 -0.048 -0.172 -0.333 -0.104 -0.063 -0.003 -0.085 -0.131 -0.278 -0.269 -0.129 -0.113
(4) LNAT -0.122 -0.195 0.202 0.504 0.041 0.318 -0.124 0.036 0.110 0.473 0.461 0.207 -0.028
(5) BM 0.058 0.006 0.092 0.038 -0.079 0.098 -0.073 0.040 0.004 -0.099 0.009 0.001 0.000
(6) LEV -0.006 0.053 0.128 0.352 0.081 0.197 0.081 0.052 0.001 0.334 0.106 0.057 0.036
(7) ROA -0.052 -0.167 0.064 0.150 -0.084 0.219 -0.172 -0.060 0.037 0.068 0.078 0.047 -0.095
(8) INVREC 0.020 0.008 0.127 0.145 -0.155 0.231 -0.031 0.004 -0.026 -0.075 -0.099 -0.017 0.028
(9) LOSS 0.050 0.137 -0.112 -0.193 0.074 -0.247 0.164 0.032 -0.064 -0.109 -0.101 -0.051 0.083
(10) XDOPS -0.005 0.008 0.027 0.045 0.026 0.031 0.011 0.018 -0.010 0.028 0.034 0.002 0.011
(11) FOROPS -0.010 0.018 0.004 0.087 0.012 0.053 -0.024 0.003 0.022 0.047 0.066 0.027 0.034
(12) SGROWTH -0.048 0.040 -0.020 -0.081 0.045 -0.106 -0.049 -0.006 0.200 0.119 -0.016 -0.020 0.012
(13) INITIAL 1.000 0.037 -0.012 -0.058 0.020 -0.027 0.023 0.006 -0.014 -0.069 -0.238 -0.093 0.068
(14) LNAUDLAG 0.033 1.000 -0.015 -0.131 0.094 -0.060 0.109 0.115 0.012 -0.038 -0.129 -0.024 0.326
(15) SQSEGS -0.015 -0.003 1.000 0.240 -0.009 0.225 -0.044 0.004 0.062 0.109 0.043 0.017 0.009
(16) EMPLAN -0.058 -0.092 0.271 1.000 0.044 0.413 -0.039 -0.036 0.004 0.236 0.207 0.113 -0.030
(17) FYE 0.020 0.105 0.000 0.044 1.000 -0.161 0.007 -0.063 0.019 0.058 0.051 0.014 0.009
(18) LNAGE -0.028 -0.037 0.261 0.446 -0.143 1.000 -0.043 -0.033 -0.061 0.138 0.016 0.027 0.001
(19) GC 0.023 0.103 -0.045 -0.039 0.007 -0.043 1.000 0.009 -0.025 -0.002 -0.077 -0.025 0.055
(20) RESTATE 0.006 0.108 -0.002 -0.036 -0.063 -0.038 0.009 1.000 0.016 0.031 0.004 0.010 0.186
(21) MERGER -0.014 0.010 0.063 0.004 0.019 -0.060 -0.025 0.016 1.000 0.106 0.053 0.001 0.017
(22) NEWFIN -0.069 -0.009 0.126 0.236 0.058 0.143 -0.002 0.031 0.106 1.000 0.177 0.091 -0.003
(23) BIG4 -0.238 -0.114 0.058 0.207 0.051 0.040 -0.077 0.004 0.053 0.177 1.000 0.280 -0.111
(24) INDSP -0.093 -0.019 0.027 0.113 0.014 0.039 -0.025 0.010 0.001 0.091 0.280 1.000 -0.038
(25) ICW 0.068 0.322 0.013 -0.030 0.009 -0.006 0.055 0.186 0.017 -0.003 -0.111 -0.038 1.000
Notes: Table 1 Panels B and C present correlation coefficients between variables used in the audit fee model. The coefficients below (above) the diagonal are the Pearson (Spearman)
correlation coefficients. The coefficients in bold are significant at the 0.01 level. The coefficients in italic are significant at the 0.05 level. The other coefficients are not
significant at the 0.05 level.
See Appendix A for variable definitions.
45

TABLE 2: Principles-Based Standards on Audit Fees: Machine Learning Approach
VAR RVI SCORE RANK RVIs

LNAT 100.000 1
PSCORE 16.195 2
INVREC 9.423 3
ROA 5.860 4
LEV 5.538 5
BM 5.231 6
SGROWTH 4.963 7
LNAUDLAG 3.778 8
LNAGE 3.532 9
SQSEGS 2.358 10
BIG4 1.742 11
ICW 1.565 12
EMPLAN 0.931 13
INITIAL 0.707 14
INDSP 0.666 15
FOROPS 0.423 16
MERGER 0.386 17
NEWFIN 0.370 18
RESTATE 0.307 19
FYE 0.243 20
Notes: Table 2 displays the outcomes of the extreme gradient boosting machine learning model analyzing the
relationship between a firm’s reliance on principles-based accounting standards and audit fees. To maintain
consistency with the baseline audit fee model, this machine learning analysis utilizes 23 explanatory variables. The
table presents the relative variable importance (RVI) scores and rankings for 20 top-performing explanatory
variables of audit fees. These rankings reflect the contribution of each variable within the model. The explanatory
variable with the highest sum of improvements is assigned an RVI score of 100, while the remaining variables
receive progressively lower RVI scores, indicating their relative importance compared to the top-performing factor.
A lower RVI score suggests less significance of a particular factor in the estimation model when compared to the
top-performing factor.
46

TABLE 3
Regression of Reliance on Principles-Based Standards on Audit Fees
Full Sample (N=12,928)
Variable Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat
Intercept 8.346*** 105.47 8.374*** 54.42 9.038*** 99.76 8.765*** 56.14
PSCORE -0.021*** -16.67 -0.013*** -12.16
PSCOREQ -0.128*** -17.95 -0.066*** -11.56
LNAT 0.482*** 65.23 0.325*** 24.44 0.484*** 67.54 0.331*** 24.93
BM -0.192*** -10.09 0.038** 2.39 -0.201*** -10.56 0.033** 2.04
LEV 0.042 1.08 0.126*** 3.63 0.044 1.12 0.133*** 3.83
ROA -0.358*** -8.48 -0.159*** -4.79 -0.354*** -8.33 -0.163*** -4.89
INVREC 0.424*** 7.43 0.233*** 3.44 0.435*** 7.63 0.241*** 3.55
LOSS 0.074*** 4.37 0.036*** 3.11 0.077*** 4.49 0.038*** 3.27
XDOPS -0.029 -0.75 0.010 0.37 0.002 0.04 0.020 0.73
FOROPS 0.110*** 5.53 0.031** 2.31 0.105*** 5.33 0.031** 2.29
SGROWTH -0.048*** -4.38 -0.000 -0.03 -0.046*** -4.24 0.000 0.05
INITIAL -0.089*** -4.77 -0.096*** -7.62 -0.090*** -4.87 -0.095*** -7.50
LNAUDLAG 0.203*** 11.90 0.195*** 17.11 0.215*** 12.82 0.203*** 17.86
SQSEGS 0.022** 2.38 0.032*** 2.68 0.024** 2.51 0.033*** 2.77
EMPLAN 0.151*** 6.37 0.097*** 2.65 0.146*** 6.19 0.097*** 2.65
FYE 0.065*** 3.79 0.163*** 2.60 0.068*** 3.95 0.148** 2.35
LNAGE 0.006 0.47 0.356*** 7.05 0.011 0.83 0.344*** 6.81
GC 0.115*** 2.64 0.117*** 3.43 0.114** 2.56 0.110*** 3.25
RESTATE 0.000 0.02 -0.024** -2.05 0.002 0.13 -0.024** -2.05
MERGER 0.008 0.55 0.001 0.06 -0.000 -0.02 -0.001 -0.10
NEWFIN -0.029** -2.06 0.015 1.54 -0.036** -2.53 0.013 1.39
BIG4 0.302*** 13.21 0.265*** 12.91 0.286*** 12.56 0.260*** 12.69
INDSP 0.048*** 2.66 -0.057** -2.17 0.052*** 2.90 -0.057** -2.17
ICW 0.248*** 14.38 0.138*** 11.64 0.249*** 14.56 0.139*** 11.71
Year FE Yes Yes Yes Yes
Industry FE Yes Yes
Firm FE Yes Yes
Adj. R2 82.95% 93.32% 83.02% 93.31%
Notes: In Table 2, the regression models include year and industry (Fama-French 48 industry) or firm fixed effects, and
reported significance is based on robust standard errors of two-tailed tests. Reported p-values are based on standard errors that
are clustered by firm and year except for regressions with firm fixed effects. ***, **, and * represent significance at 1%, 5%,
and 10% levels, respectively. See Appendix A for variable definitions.
47

TABLE 4
Regression of Change in Reliance on Principles-Based Standards on Change in Audit
Fees
Sample (N=9,103)
Variable Coeff. t-stat Coeff. t-stat
Intercept 0.185*** 20.46 0.184*** 20.40
ΔPSCORE -0.010*** -8.58
ΔPSCOREQ -0.049*** -7.84
ΔLNAT 0.292*** 15.78 0.297*** 16.04
ΔBM 0.023 1.26 0.020 1.10
ΔLEV 0.097** 2.29 0.103** 2.43
ΔROA -0.121*** -3.32 -0.125*** -3.42
ΔINVREC 0.168** 2.05 0.172** 2.11
ΔLOSS 0.028** 2.35 0.030** 2.50
ΔXDOPS -0.050* -1.89 -0.047* -1.79
ΔFOROPS 0.024* 1.84 0.025* 1.87
ΔSGROWTH 0.022*** 2.71 0.023*** 2.80
ΔINITIAL -0.067*** -5.14 -0.067*** -5.15
ΔLNAUDLAG 0.294*** 24.63 0.299*** 25.10
ΔSQSEGS 0.017 1.02 0.016 0.94
ΔEMPLAN 0.056 1.24 0.056 1.25
ΔFYE 0.203** 2.07 0.222** 2.26
ΔLNAGE 0.413*** 4.55 0.401*** 4.42
ΔGC 0.005 0.13 0.001 0.01
ΔRESTATE 0.001 0.08 0.001 0.10
ΔMERGER 0.027*** 2.61 0.027** 2.55
ΔNEWFIN 0.016* 1.65 0.016 1.64
ΔBIG4 0.205*** 7.65 0.201*** 7.47
ΔINDSP -0.013 -0.39 -0.013 -0.39
ΔICW 0.112*** 8.83 0.112*** 8.79
2
Adj. R 15.43% 15.32%
Notes: In Table 4, the change in all variables is measured as the difference between the variable in year t and t-1.
Industry fixed effects are based on the Fama-French 48 industries classification and reported significance is based
on robust standard errors of two-tailed tests. ***, **, and * represent significance at 1%, 5%, and 10% levels,
respectively. See Appendix A for variable definitions.
48

TABLE 5
Propensity Score Matching, Entropy Balancing and Controlling of Conservatism: Audit
Fee Model
Panel A: SIZE, ROA, LEV, Year, and Industry Matched Sample (N=6,794)
-1 -2 -3 -4
Intercept 8.350*** 72.2 8.490*** 35.13 9.066*** 72.21 8.952*** 36.5
PSCORE -0.023*** -13.78 -0.016*** -9.53
PSCOREQ -0.127*** -15.64 -0.071*** -8.81
Controls Yes Yes Yes Yes
Adj. R2 73.82% 90.17% 74.03% 90.14%
Panel B: Entropy Balanced Sample (N=12,928)

Intercept 8.441*** 65.12 8.500*** 53.39 9.228*** 62.81 8.974*** 56.03
PSCORE -0.027*** -14.05 -0.016*** -13.14
PSCOREQ -0.129*** -13.81 -0.068*** -12.35
Adj. R2 75.97% 91.56% 75.97% 91.55%
Panel C: Controlling for Accounting Conservatism Sample (N=12,927)

Intercept 8.3547*** 105.90 8.3709*** 54.38 9.0505*** 100.17 8.7603*** 56.10
PSCORE -0.0215*** -16.81 -0.0125*** -12.11
PSCOREQ -0.1282*** -18.06 -0.0660*** -11.55
C_SCORE -0.1384*** -6.09 -0.0281* -1.73 -0.1354*** -5.93 -0.0291* -1.79
Adj. R2 83.03% 93.32% 83.10% 93.31%
Notes: Regressions in Table 5 include untabulated control variables from Equation (1), year and industry or firm
fixed effects. Columns 1 and 3 (columns 2 and 4) have industry (firm) fixed effects. Industry fixed effects are
based on the Fama-French 48 industries classification. Reported t-statistics are based on standard errors that are
clustered by firm and year except for regressions with firm fixed effects. ***, **, and * represent significance at
1%, 5%, and 10% levels, respectively. See Appendix A for variable definitions.
49

TABLE 6
Descriptive Statistics and Correlations: Going Concern Sample
Panel A: Descriptive Statistics (N=4,849)
Variable MEAN SD Q1 MED Q3
GC 0.04 0.196 0 0 0
PSCORE -17.147 8.349 -21.4 -15.705 -11.349
PSCOREQ 3 1.415 2 3 4
LNAT 4.908 1.691 3.72 4.747 5.952
LEV 0.471 0.299 0.236 0.427 0.646
ΔLEV 0.033 0.15 -0.023 0.022 0.084
PLOSS 0.69 0.463 0 1 1
OPCFO -0.095 0.226 -0.148 -0.026 0.04
ZSCORE 0.995 0.945 0 1 2
BETA 0.989 0.719 0.41 0.922 1.481
RETURN -0.122 0.546 -0.465 -0.237 0.032
VOLRET 0.042 0.017 0.029 0.039 0.051
INVEST 0.313 0.28 0.063 0.228 0.527
NEWFIN 0.511 0.5 0 1 1
BIG4 0.768 0.422 1 1 1
LNAUDLAG 4.087 0.483 3.829 4.22 4.331
LNAGE 2.478 0.646 2.079 2.303 2.89
FEERATIO 0.225 0.188 0.07 0.187 0.34
Notes: Table 6 Panel A presents sample descriptive statistics for the variables used in going concern analysis. See
Appendix A for variable definitions.
50

Panel B: Pearson and Spearman Correlations
Variable (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16) (17) (18)
(1) GC 1.000 -0.005 0.003 -0.129 0.103 0.054 0.078 -0.143 0.064 -0.040 -0.077 0.138 -0.054 0.033 -0.080 0.142 -0.014 -0.055
(2) PSCORE -0.001 1.000 0.980 -0.552 -0.295 -0.067 -0.011 -0.217 -0.032 -0.301 0.039 0.058 0.136 -0.205 -0.248 -0.066 -0.053 -0.141
(3) PSCOREQ 0.002 0.883 1.000 -0.537 -0.281 -0.063 -0.007 -0.212 -0.030 -0.293 0.037 0.061 0.129 -0.200 -0.239 -0.058 -0.051 -0.138
(4) LNAT -0.127 -0.555 -0.534 1.000 0.293 0.027 -0.170 0.420 -0.032 0.466 0.004 -0.384 -0.252 0.335 0.413 -0.117 0.199 0.186
(5) LEV 0.124 -0.285 -0.253 0.253 1.000 0.321 -0.063 0.170 0.080 -0.030 0.014 -0.075 -0.451 0.294 0.037 0.147 0.208 0.031
(6) ΔLEV 0.081 -0.041 -0.036 -0.006 0.365 1.000 0.015 -0.058 0.111 0.021 -0.183 0.047 -0.047 -0.013 0.044 0.056 -0.042 0.005
(7) PLOSS 0.078 -0.003 -0.008 -0.178 -0.016 0.004 1.000 -0.313 0.136 0.089 0.041 0.316 0.341 -0.025 0.036 -0.035 -0.215 -0.030
(8) OPCFO -0.215 -0.199 -0.207 0.431 0.009 -0.131 -0.296 1.000 -0.099 -0.040 0.057 -0.286 -0.451 0.004 0.081 -0.024 0.242 0.148
(9) ZSCORE 0.063 -0.050 -0.030 -0.034 0.143 0.124 0.136 -0.119 1.000 0.032 -0.114 0.112 0.154 -0.104 0.043 0.041 -0.063 -0.023
(10) BETA -0.042 -0.273 -0.284 0.420 -0.014 0.028 0.098 -0.006 0.035 1.000 -0.057 0.060 0.228 0.136 0.265 -0.115 -0.037 0.042
(11) RETURN -0.028 0.014 0.022 -0.039 0.020 -0.138 0.081 0.029 -0.076 -0.042 1.000 -0.148 -0.015 0.082 -0.014 -0.013 0.050 -0.054
(12) VOLRET 0.143 0.063 0.055 -0.367 -0.009 0.043 0.283 -0.285 0.105 0.046 0.078 1.000 0.211 -0.119 -0.058 -0.089 -0.308 0.125
(13) INVEST -0.052 0.181 0.176 -0.270 -0.343 -0.032 0.326 -0.442 0.164 0.191 0.037 0.166 1.000 -0.191 0.116 -0.155 -0.311 -0.061
(14) NEWFIN 0.034 -0.212 -0.200 0.357 0.259 -0.025 -0.025 -0.005 -0.104 0.131 0.071 -0.101 -0.150 1.000 0.098 0.029 0.097 0.033
(15) BIG4 -0.082 -0.214 -0.239 0.396 0.034 0.032 0.036 0.074 0.044 0.256 -0.005 -0.064 0.114 0.098 1.000 -0.139 -0.052 0.136
(16) LNAUDLAG 0.121 -0.101 -0.066 -0.080 0.156 0.052 -0.050 -0.023 0.035 -0.088 -0.006 -0.105 -0.152 0.059 -0.122 1.000 0.051 -0.232
(17) LNAGE -0.018 -0.115 -0.079 0.281 0.177 -0.027 -0.219 0.236 -0.069 -0.038 -0.019 -0.292 -0.307 0.106 -0.022 0.051 1.000 -0.015
(18) FEERATIO -0.055 -0.131 -0.139 0.200 0.011 0.005 -0.036 0.121 -0.020 0.046 -0.034 0.101 -0.073 0.031 0.131 -0.236 -0.009 1.000
Notes: Table 6 Panel B presents correlation coefficients between variables used in the going concern model. The coefficients below (above) the diagonal are the Pearson (Spearman) correlation
coefficients. The coefficients in bold are significant at the 0.01 level. The coefficients in italic are significant at the 0.05 level. The other coefficients are not significant at the 0.05 level.
See Appendix A for variable definitions.
51

TABLE 7: Principles-Based Standards on Going Concern Opinion: Machine Learning
Approach
VAR RVI SCORE RANK RVIs

OPCFO 100.000 1
RETURN 82.251 2
INVEST 74.179 3
LNAUDLAG 67.626 4
VOLRET 60.909 5
LNAT 57.401 6
ΔLEV 55.644 7
LEV 55.438 8
BETA 48.174 9
PSCORE 47.558 10
FEERATIO 41.221 11
LNAGE 39.692 12
PLOSS 7.015 13
ZSCORE 5.530 14
NEWFIN 1.008 15
BIG4 0.000 16
Notes: Table 7 displays the outcomes of the extreme gradient boosting machine learning model analyzing the
relationship between a client firm’s reliance on principles-based accounting standards and the auditor’s likelihood of
issuing a going concern opinion. To maintain consistency with the baseline going concern model, this analysis
utilizes 16 explanatory variables. The table presents the relative variable importance (RVI) scores and rankings in
the order of top-performing explanatory variables of the auditor’s likelihood of issuing a going concern opinion.
These rankings reflect the contribution of each variable within the model. The explanatory variable with the highest
sum of improvements is assigned an RVI score of 100, while the remaining variables receive progressively lower
RVI scores, indicating their relative importance compared to the top-performing factor. A lower RVI score suggests
less significance of a particular factor in the estimation model when compared to the top-performing factor.
52

TABLE 8
Logistic Regression of Reliance on Principles-Based Standards on Going Concern Opinion
Financially Distressed Firms Severely Financially Distressed
(N=4849) Firms (N=2396)
Intercept -9.132*** -7.34 -8.307*** -6.02 -9.385*** -5.76 -8.363*** -4.70
PSCORE -0.026** -2.07 -0.048*** -2.90
PSCOREQ -0.167** -2.21 -0.206** -2.37
LNAT -0.303*** -3.07 -0.297*** -3.08 -0.408*** -3.20 -0.367*** -2.94
LEV 0.522* 1.71 0.541* 1.78 0.171 0.48 0.214 0.60
ΔLEV -0.138 -0.29 -0.139 -0.30 -0.281 -0.54 -0.299 -0.57
PLOSS 0.640*** 2.63 0.633*** 2.60 0.457 1.30 0.430 1.23
OPCFO -2.574*** -6.98 -2.567*** -6.93 -2.483*** -5.64 -2.501*** -5.68
ZSCORE 0.208** 2.16 0.208** 2.15 0.070 0.65 0.064 0.60
BETA -0.026 -0.18 -0.025 -0.16 -0.146 -0.84 -0.131 -0.75
RETURN -0.266* -1.69 -0.260* -1.66 -0.226 -1.22 -0.226 -1.23
VOLRET 22.742*** 4.68 22.947*** 4.72 17.485*** 3.00 18.208*** 3.14
INVEST -2.809*** -6.12 -2.783*** -6.05 -2.855*** -5.76 -2.862*** -5.76
NEWFIN 0.496*** 2.65 0.487*** 2.61 0.721*** 3.22 0.700*** 3.14
BIG4 -0.131 -0.64 -0.162 -0.80 -0.056 -0.23 -0.072 -0.30
LNAUDLAG 1.070*** 5.39 1.094*** 5.60 1.183*** 4.47 1.232*** 4.68
LNAGE 0.197 1.31 0.199 1.31 0.223 1.16 0.221 1.15
FEERATIO -1.158** -2.14 -1.171** -2.16 -1.034 -1.60 -1.057 -1.64
Industry FE Yes Yes Yes Yes
McFadden R2 26.29% 26.34% 27.37% 27.14%
Notes: In Table 8, the dependent variable is GC, which equal to 1 if the firm received a qualified going concern
opinion issued by the auditor expressing substantial uncertainty about its ability to continue, and 0 otherwise. The
logit regression models include year and industry (Fama-French 48 industry) fixed effects, and reported significance
is based two-tailed tests. ***, **, and * represent significance at 1%, 5%, and 10% levels, respectively. See Appendix
A for variable definitions.
53

TABLE 9
Propensity Score Matching and Entropy Balancing: Going Concern Model
Panel A: Propensity Score Matching
Matched on ZSCORE and Assets, Matched on ZSCORE, Assets, LOSS,
Year, and Industry (N=386) INVEST, Year and Industry (N=386)
(1) (2) (3) (4)
Intercept -9.838*** -3.74 -8.262*** -2.89 -11.934*** -4.8 -9.571*** -3.61
PSCORE -0.064** -2.24 -0.074*** -2.72
PSCOREQ -0.236* -1.74 -0.365*** -2.72
McFadden R 36.80%
2
36.37% 33.19% 33.11%
Panel B: Entropy Balanced Sample

Financially Distressed Firms Severely Financially Distressed Firms
(N=4849) (N=2396)
Intercept -0.1371* -1.96 -0.0639 -0.90 -0.2212 -1.24 -0.1232 -0.68
PSCORE -0.0030*** -5.48 -0.0044*** -4.31
PSCOREQ -0.0127*** -4.78 -0.0173*** -3.59
Adj. R 2
75.97% 91.56% 75.97% 91.55%
Notes: Table 9 Panel A uses nearest neighbor matching and match 193 going concern firms (GCF) with 193 non-
going concern firms (NGCF) using propensity scores and employs the logit regression models. In left hand side
column, the matching attributes (ZSCORE, Total Assets, Year, and Industry) are based on Blay and Geiger
(2013) and Geiger and Rama (2003). In right hand side column, the matching attributes (ZSCORE, LNAT,
LOSS, INVEST, Year and Industry) are based on Krishnan et al. (2007) and Amin et al. (2014). Table 9 Panel B
uses entropy balanced sample and employs regular OLS, rather than logit, because the weighted balance entorpy
score is not allowed in logit models. All regression models include year and industry (Fama-French 48 industry)
fixed effects, and reported significance is based two-tailed tests. ***, **, and * represent significance at 1%, 5%,
and 10% levels, respectively. See Appendix A for variable definitions.
54

TABLE 10: Additional Analysis
Panel A: Risk of Misstatements, Accruals and Difficulty of Earnings Prediction
Dep Variable= FSCORE (N=12860) ACCRUAL (N=12916) EPSVOL (N=12928)
Variable Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat Coeff. t-stat
Intercept -0.2469* -1.78 -0.0853 -0.53 -0.0418*** -3.17 -0.0291** -2.03 -0.2735 -1.12 0.3117 1.08
PSCORE -0.0035* -1.75 -0.0004** -2 -0.0240*** -5.77
PSCOREQ -0.0281** -2.35 -0.0023** -2.42 -0.1143*** -5.59
Controls Yes Yes Yes Yes Yes Yes
Year FE Yes Yes Yes Yes Yes Yes
Industry FE Yes Yes Yes Yes Yes Yes
Adj. R2 22.98% 23.01% 14.48% 14.48% 10.20% 9.93%
Panel B: Accounting Conservatism

Dep Variable= C_SCORE (N=12927) CON_ACC (N=12925)
Intercept 0.0641* 1.84 0.0891** 2.36 0.0972*** 9.29 0.1160*** 10.16
PSCORE -0.0012** -2.21 -0.0004*** -3.21
PSCOREQ -0.0050* -1.85 -0.0033*** -4.11
Industry FE Yes Yes Yes Yes
Adj. R2 37.06% 37.04% 29.20% 29.29%
Notes: Reported p-values are based on standard errors that are clustered by firm and year. The regression models include year and industry
(Fama-French 48 industry) fixed effects, and reported significance is based on robust standard errors of two-tailed tests. ***, **, and * represent
significance at 1%, 5%, and 10% levels, respectively. See Appendix A for variable definitions.
55

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Principles Based Accounting Standards, Audit Fees and Going Concern: Evidence

Using Advanced Machine Learning

Meena Subedi, Ph.D.

Electronic copy available at: https://ssrn.com/abstract=4637154

Design/methodology/approach – The study employs an advanced machine-learning method to

Research limitations/implications – The authors recognize the limitation of this study

Electronic copy available at: https://ssrn.com/abstract=4637154

Keywords: Principles-Based Standards, Rules-Based Standards, Advanced Machine Learning,

JEL Codes: M40, M41, M42, M48, M49

Electronic copy available at: https://ssrn.com/abstract=4637154

The Generally Accepted Accounting Standards (GAAP) used by companies in the

called principles-based. This study examines whether principles-based or rules-based accounting

principles-based accounting standards impact auditors’ risk assessments.

The advantage of the rules-based standards is that detailed guidelines reduce

principles-based standards allow more managerial flexibility in reporting decisions. In an

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risk perception of the underlying accounting standards firms use.

managerial judgment in the implementation of accounting standards increases the quality of

Furthermore, the study argues that managers using rules-based (principles-based)

rules-based standards than compared to financially constrained firms with principles-based

going-concern opinion reduces as firms rely more on principles-based standards.

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principles-based standards. In terms of economic significance, an increase in one standard

conduct several additional tests.

approach fosters an environment where managers prioritize the accurate representation of

financial information. These findings highlight the value of principles-based standards in

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based accounting standards and earnings management is mediated through a reduction in

may also respond to conditional conservatism since, unlike unconditional conservatism,

conditional conservatisms and a negative relationship with risk of financial statement

potential mechanisms through which principles-based accounting standards impact auditors’

audit risk or auditors’ business risk assessments.

that principles-based accounting standards result in reduced earnings management through a

decrease in accounting conservatism. The current study extends this connection by

principles-based standards have a negative relationship with accounting conservatism and

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which principles-based accounting standards influence auditors' risk assessments.

(IASB). Barckow emphasizes the importance of principles-based standards, emphasizing their

Exchange Commission (SEC), to pursue high-quality, globally accepted accounting standards to

Electronic copy available at: https://ssrn.com/abstract=4637154

standards is available until 2006 (Folsom et al. 2016).

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the research implications in section V.

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Commission (SEC) to study principles-based standards. Furthermore, the US Congress ordered

discussion of accounting standards.

Advocates of the rules-based accounting standards argue that detailed guidelines

(Schipper 2003). Therefore, rules-based standards reduce managers’ discretion in applying

accounting standards and increase comparability across companies’ financial statements

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compensation, provides detailed guidelines and is an example of a rules-based standard. ARB

standards are more rules-based or principles-based. 3

Similarly, Srivastava (2014) demonstrates that reducing flexibility in revenue recognition

principles-based accounting standards.

Electronic copy available at: https://ssrn.com/abstract=4637154

principles-based standards to engage in earnings management. Thus, I expect a negative

association between audit fees and principles-based financial statements:

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Since the application of principles-based standards encourages applying professional

degree of the firm’s reliance on the principles-based standards.

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Reliance on Principles-Based Standards Measure

LNAUDIT= a0+ a1PSCORE (or PSCOREQ)+ a2LNAT+ a3BM+ a4LEV+ a5*ROA+

a6INVREC+ a7LOSS+ a8XDOPS+ a9FOROPS+ a10SGROWTH+ a11INITIAL +

a12LNAUDLAG + a13SQSEGS + a14EMPPLAN+ a15FYE+ a16LNAGE+ a17GC+

a18RESTATE+ a19MERGER+ a20NEWFIN+ a21BIG4+ a22INDSP+ a23ICW+ (Year

GC = ß0+ ß1PSCORE (or PSCOREQ) + ß2LNAT+ ß3LEV+ ß4 ΔLEV+ ß5*PLOSS+

ß6OPCFO+ ß7ZSCORE+ ß8BETA+ ß9RETURN+ ß10VOLRET+ ß11INVEST+

ß12NEWFIN + ß13BIG4+ ß14LNAUDLAG+ ß15LNAGE+ ß16*FEERATIO+ Year Dummies +