Fair value, management discretion, and audit fees: An empirical analysis

What is it about?

Abstract The main objective of this study is to investigate the impact of complexity resulting from fair value adoption on audit fees. Using a sample of 9,619 firm‐year observations from the United States, this study finds that auditors charge higher audit fees for firms exposed to higher level of complexity due to fair value adoption. More specifically, this study focuses on research and development expenditure, intangibles, goodwill, and property, plant and equipment to compute the intensity of complexity as these items are heavily affected by the fair value which is subject to management discretion. The results suggest that the greater level of complexity arising from the above sources increase auditors' efforts and risks level, thereby, results in higher audit fees. Further analysis, however, shows that auditors do not charge additional audit fees for complexity arising from goodwill if they have intangibles. It is because of economies of scale by auditors, they design their audit program which covers goodwill audit when they do audit for intangibles. Overall, the results support the proposition that judgmental or discretionary choice available for management increases audit risks, and auditors, to compensate higher risks, charge greater audit fees.

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Why is it important?

Overall, the results support the proposition that judgmental or discretionary choice available for management increases audit risks, and auditors, to compensate higher risks, charge greater audit fees.

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