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    Fair Value Measurements and Audit Fees: Evidence from the...
    research summary posted March 1, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.03 Impact of New Accounting Pronouncements, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
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    Title:
    Fair Value Measurements and Audit Fees: Evidence from the Banking Industry
    Practical Implications:

    Overall, the results support concerns expressed by some observers that greater use of fair value measurements for financial instruments will trigger increased audit fees. We believe our results validate the compliance cost concerns expressed by some preparers (i.e. higher audit fees), and provide interesting and timely evidence relevant to the ongoing debate regarding the increased use of fair value measurements for financial instruments (FASB 2010; ABA2010).

    For more information on this study, please contact Michael Ettredge.

    Citation:

    Ettredge, M. L., Xu, Y., & Yi, H. S. (2014). Fair value measurements and audit fees: evidence from the banking industry. Auditing: A Journal of Practice & Theory 33(3): 33-58.

    Keywords:
    audit fees, fair value measurements, FAS 157, ASC 820, banks
    Purpose of the Study:

    This study examines the association between audit fees and the proportions of fair-valued assets held by the sample of public U.S. bank holding companies. Motivated by claims that fair-valued assets are unusually difficult to audit (Bratten et al., 2013), we explore

    • whether audit fees are positively associated with the proportions of bank assets that are fair-valued, and whether this relation is more evident for the least verifiable (Level 3) fair-valued assets. 
    • whether auditors who are bank industry specialists charge more or less than other auditors to audit banks and, in particular, to audit fair-valued bank assets.

    Consistent with the view that audit risk and effort increase with the extent of fair-valued assets, we provide evidence that auditors charge more for higher proportions of assets held in the form of fair-valued assets. Furthermore, within fair-valued assets, the positive association between logged audit fees and the proportions of total assets that are fair-valued using Level 3 inputs is greater than its positive association with the proportions of total assets that are fair-valued using Level 1 or Level 2 inputs. We believe our results validate the compliance cost concerns expressed by some preparers (i.e. higher audit fees), and provide interesting and timely evidence relevant to the ongoing debate regarding the increased use of fair value measurements for financial instruments (FASB 2010; ABA2010). 

    Design/Method/ Approach:

    Our data cover the years 2008-2011 with 299 unique banks for our main tests.

    Findings:

    The paper documents that

    • the proportions of fair-valued assets held by banks are positively associated with audit fees.
    • The positive association between audit fees and the proportions of total assets that are fair-valued using Level 3 inputs is greater than its positive association with the proportions of total assets that are fair-valued using Level 1 or Level 2 inputs.
    • We also document that bank specialist auditors charge lower audit fees to bank clients on average, suggesting cost efficiencies passed to clients as lower fees. However, bank expert auditors charge more for auditing the proportions of total assets that are fair-valued. 
    Category:
    Audit Quality & Quality Control, Standard Setting
    Sub-category:
    Impact of New Accounting Pronouncements, Industry Expertise – Firm and Individual