Fair value, management discretion, and audit fees: An empirical analysis

• Published date: 01 April 2019
• Date: 01 April 2019
• DOI: http://doi.org/10.1002/jcaf.22385
• Author: Muhammad Shahin Miah

BLIND PEER REVIEW

Fair value, management discretion, and audit fees: An empirical

analysis

Muhammad Shahin Miah

Department of International Business,

University of Dhaka, Dhaka, Bangladesh

Correspondence

Muhammad S. Miah, University of Dhaka,

Dhaka, Bangladesh.

Email: mshahin@du.ac.bd

Abstract

The main objective of this study is to investigate the impact of complexity resulting

from fair value adoption on audit fees. Using a sample of 9,619 firm-year observa-

tions from the United States, this study finds that auditors charge higher audit fees

for firms exposed to higher level of complexity due to fair value adoption. More

specifically, this study focuses on research and development expenditure, intangi-

bles, goodwill, and property, plant and equipment to compute the intensity of com-

plexity as these items are heavily affected by the fair value which is subject to

management discretion. The results suggest that the greater level of complexity

arising from the above sources increase auditors' efforts and risks level, thereby,

results in higher audit fees. Further analysis, however, shows that auditors do not

charge additional audit fees for complexity arising from goodwill if they have

intangibles. It is because of economies of scale by auditors, they design their audit

program which covers goodwill audit when they do audit for intangibles. Overall,

the results support the proposition that judgmental or discretionary choice available

for management increases audit risks, and auditors, to compensate higher risks,

charge greater audit fees.

KEYWORDS

audit fees, complexity, discretionary choice, judgments, research and development expenditure

1|INTRODUCTION

This study examines the association between accounting

components based complexity and audit fees of the US listed

companies. In particular, this study investigates the impact

of complexity arising from four different accounting items

(such as, research and development [R&D] expenditure,

intangibles, goodwill, and property, plant and equipment

[PPE]) on audit fees.

This study is mainly motivated by claims that higher

level of R&D expenditure increases audit risk, and which

requires auditors' additional efforts, thereby results in higher

audit fees (Cheng, Lu, & Kuo, 2016; Liu & Ouyang, 2014).

Another stream research shows that intangibles, goodwill,

PPE, and treatment for these accounting items are highly

complex because of impairment testing difficulty (due fair

value adoption) under both Generally Accepted Accounting

Principles (U.S. GAAP) and International Financial

Reporting Standards (IFRS; De George, Ferguson, & Spear,

2013; Miah, 2017). However, no prior research incorporates

all of the above complex components and how the complex-

ity arising from those components affect audit fees which

are explored in this study. I also investigate whether auditors

charge lower audit fees for a firm who maintains accounting

together for intangibles and goodwill, or charge higher for

firms who maintain separate accounting for intangibles and

goodwill. Prior research shows that impairment test, required

under International Accounting Standards (IAS)-38, and IAS

36, is subject to management discretion as they involve fair

value determination (Cotter, 2012). In contrast, the

Received: 28 October 2018 Revised: 23 March 2019 Accepted: 25 March 2019

DOI: 10.1002/jcaf.22385

82 © 2019 Wiley Periodicals, Inc. wileyonlinelibrary.com/journal/jcaf J Corp Acct Fin. 2019;30:82–91.