The Effects of Financial Statement Disaggregation on Audit Pricing

• In Event: Audit Pricing

Abstract

We examine whether the extent of financial statement disaggregation affects the pricing of audit engagements. We hypothesize and find that auditors assess higher engagement risk and charge higher audit fees for clients with more disaggregated financial statements. In particular, we find that the higher audit fees are not the result of (i) increased auditor effort to mitigate detection risk, or (ii) heightened inherent and control risks arising from lower financial reporting quality. Instead, we document that greater financial statement disaggregation is positively associated with the likelihood of lawsuits filed against alleged financial misstatements. This result suggests that the higher audit fees arise from auditors’ assessments of heightened client and auditor business risks. Our study provides evidence that while financial statement disaggregation has beneficial effects on the quality of financial information, it could also impose costs on firms in terms of higher audit fees and higher likelihood of litigation. Our findings are informative to the FASB, IASB, firms and auditors as they debate on the costs, benefits and extent of disaggregation to be presented in financial statements.

Authors

• Kevin Koh, Nanyang Technological University

• Yen H. Tong, Nanyang Technological University

• Zinan Zhu, National University of Singapore