Fair Value Measurements, Disclosure, and Audit Risk

• In Event: Continental Breakfast & Research and Education Forum
  In Paper Session: Table 9: Auditor Response to Risk

Abstract

This study examines whether the difference of fair value inputs affects audit fees, and investigates whether audit firms respond to the disclosure of fair value inputs, by focusing on fair value measurements of pension assets. FAS 132R(1), which requires firms to disclose the fair value inputs and measurements of pension assets, enables us to explore audit firms’ responses to the fair value hierarchy levels and the mandated disclosures with a natural experiment setting. We, first, find that audit fees are increasing function of Level 3 fair value assets. More importantly, auditors’ responses to Level 3 pension assets are more pronounced than are their responses to other fair value inputs. Next, we find that audit firms adjust their fees in the positive direction for the client firms with higher percentages of Level 3 pension assets after the adoption of FAS 132R(1). The results imply that the increased audit fees that are passed on to the clients derive from the increased audit costs associated with additional audit processes that are actively conducted under the mandated disclosure.

Authors

• Seokyoun Hwang, College of Staten Island, CUNY

• Bharat Sarath, Rutgers University - Newark