Audit Procedures and Financial Statement Quality: The Positive Effects of Negative Assurance

• In Event: Audit Risks, Audit Opinions, and Disclosures

Abstract

Can independent financial statement “reviews” (that limit audit verification procedures to confirmatory data analytics and inquiries) economically improve financial statement quality? The answer is important to assess quality and cost-effectiveness of CPA firm services as a function of audit inputs and to separately evaluate the effects of review procedures from the combined effects of internal control and detailed testing that comprise “full audits.” To find out, we obtain management-prepared private company financial statements and statements resulting from CPA firm compilations (no verification procedures), reviews, and audits, plus data on CPA service fees. Applying common reporting quality and fraud proxies, we find compiled statements exhibit significantly higher quality than management-prepared statements and reviews are significantly higher than compilations and somewhat lower than audits, although reviews are not statistically distinguishable from audits when using some accruals-based quality proxies. To explore possible cost-effectiveness of CPA firm assurance relative to compilations, we estimate that our private firms’ cost of debt averages 120 (149) basis points lower for reviews (audits), while incremental-to-compilation fees for a review (audit) are approximately 100% (400%). Overall, our results indicate limited-procedure reviews may be a cost-effective alternative to compilations, audits, or mandated audits (recently allowed by the SEC for small crowdfunding offerings), and also that confirmatory data analytics and inquiries warrant research to enhance stand-alone reviews and mechanism design of procedures for full audits.

Authors

• Brad Badertscher, University of Notre Dame

• Jaewoo Kim, University of Rochester

• William R Kinney, University of Texas at Austin

• Edward Owens, Emory University