The Use of Asset Log Transformations in Audit Fee Studies: Are there Differences Based on Fair Value Inputs?

• In Event: Breakfast and Research Forum
  In Roundtable Session: Table 4: Audit Fees: Measures, Markets, and Real Earnings Management

Abstract

Closed-end mutual funds report virtually all of the assets at fair value and commonly invest in securities other than those actively traded. Using this unique fair value reporting setting, we study the association between audit fees and the level 1, level 2, and level 3 fair value valuation inputs as defined by ASC 820. We investigate whether the widely-used log transformation applied to the client size variable in audit fee models is most appropriate when considering assets valued using different valuation inputs. The sixth root transformation (which approximates a log transformation) provides the best fit for level 1assets in an audit fee model, suggesting that there are large economies of scale for these assets. However, for level 2 and 3 assets, the square root transformation provide a better explanation for variation in audit fees, suggesting lower economies of scale for these types of assets. Our findings provide helpful insight in fees associated with auditing fair value measurements, indicating that separating assets into different fair valued categories is useful in assessing audit fees.

Authors

• Charles P Cullinan, Bryant University

• Hui Du, University of Houston–Clear Lake

• Xiaochuan Zheng, Bryant University