Fair value hierarchy, bargaining power, and audit pricing across audit firms’ client portfolios

• Published date: 01 October 2022
• Author: Stanley Clark,Brandon Vagner,Terry Ward
• Date: 01 October 2022
• DOI: http://doi.org/10.1002/jcaf.22563

Received:  March  Accepted:  April 

DOI: ./jcaf.

RESEARCH ARTICLE

Fair value hierarchy, bargaining power, and audit pricing

across audit firms’ client portfolios

Stanley Clark Brandon Vagner Terry Ward

Middle Tennessee State University,

Murfreesboro, Tennessee,USA

Correspondence

Brandon Vagner,Middle Tennessee State

University, Murfreesboro, East Main

Street Murfreesboro, TN ,USA.

Email: brandon.vagner@mtsu.edu

Abstract

This study explores how the presence of Level  and/or  fair value assets

(FVA_) influences audit pricing across small and large clients for Big- and

non-Big- audit firms. Through analysis of  firm-year observations, we inves-

tigate whether companies with FVA_ incur higher audit fees than companies

without FVA_ and the differences between how Big- and non-Big- firms

price risk for large and small companies. Our theoretical basis is product dif-

ferentiation and economic importance, which suggest competing influences on

audit fees based on firm and company size. We are the first to analyze the effect

of FVA_ on audit fees with the United States sample including all industries

during a stabilized regulatory period, and we are the first to explore the effect

of FVA_ on audit pricing across small and large audit clients for Big- and

non-Big- firms. We find companies with FVA_ incur higher audit fees than

companies without FVA_. More specifically, we find small and large compa-

nies realize different audit fees compared to companies of similar size without

FVA_. Additionally, Big- and non-Big- firms price audits with FVA_ dif-

ferently than audits without FVA_. Furthermore, Big- and non-Big- audit

pricing is influenced by FVA_ differentlybased on company size.

KEYWORDS

audit pricing, audit firm client portfolios, audit fee model, bargaining power, competitive strat-

egy, fair value hierarchy, product differentiation

1 INTRODUCTION

Fair value accounting has been a controversial account-

ing topic since , following the issuance of State-

ment of Financial Accounting Standards (SFAS) : Fair

Value Measurements (ASC  within Financial Account-

ing Standards Board (FASB)codification; Bens et al., ).

A principal component of the standard is a three-level

fair value measurement input hierarchy, which consists of

assets or liabilities classified as either Level  via quoted

prices (ASC ---), Level  via observable inputs

other than quoted prices (ASC ---), or Level 

via unobservable inputs (ASC ---). Level  fair

value assets, including financial instruments such as inter-

est rate swaps or corporate bonds, do not haveregular mar-

ket pricing, but they have an estimated fair value based on

models using observable inputs. Level  fair value assets

include complex derivatives, private equity shares, and

foreign securities with no observable comparable market

values. Consequently, estimating the fair value of Level

 or  assets involves significant management discretion,

which increases audit efforts necessary to verify manage-

ment assumptions. Relatedly, audit firms have reported

increased risk and scrutiny are associated with additional

J Corp Account Finance. ;:–. ©  Wiley PeriodicalsLLC. 59wileyonlinelibrary.com/journal/jcaf