Fair Value Exposure, Changes in Fair Value and Audit Fees: Evidence from the Australian Real Estate Industry

Abstract

This paper investigates the relationship between audit fees and both fair value exposure and changes in fair value of investment properties. The study is motivated by the limited and inconclusive evidence on the effect on audit fees of full fair value reporting for illiquid assets. Using hand‐collected data from the Australian real estate industry, we find a negative (positive) association between audit fees and fair value exposure (changes in fair value of investment properties). Our findings also indicate that the use of unobservable inputs in fair value estimates for investment properties does not significantly increase audit risk and audit fees. Further, we find that audit fees are higher for firms with fair values of investment – properties estimated by external and mixed valuers – compared to firms with fair values estimated by directors alone. This study enriches the audit fee literature by documenting auditors’ pricing decisions in an area that involves significant estimation and valuation risks.

Fair Value Accounting and Implications for the Auditing Profession: Historical Overview

“…In relation to theory, much of the prior literature discussed in this paper employed agency and/or signalling and/or stakeholder theories to explain the FVA concept and its relation to the GFC and audit profession development (Badia et al, 2017;Bell et al, 2015;Ruddock et al, 2006;Sangchan et al, 2020;Watts, 2003). Scholars generally agree that corporates seek to get an assurance from third parties that their FVMs are reliable.…”

“…Following the increased prevalence of FVA in accounting standards, specific attention was given to FVA issues. This is due to the important debate regarding the greater use of the valuation techniques underlying certain fair values which are complex and different from one industry to another and its reliance on unobservable inputs (Sangchan et al, 2020). As a result, using FVA to prepare firms' assets and liabilities estimates needs a third party to ensure the reliability and credibility of the fair values prepared by managers (Griffith et al, 2015;Lachmann et al, 2015).…”

“…As a result, using FVA to prepare firms' assets and liabilities estimates needs a third party to ensure the reliability and credibility of the fair values prepared by managers (Griffith et al, 2015;Lachmann et al, 2015). Auditors, in this case, should act as a monitoring tool to assist shareholders in making decisions by minimising the problem of asymmetric information caused by the agency conflict (Mattingly et al, 2009;Sangchan et al, 2020). The ongoing debate regarding the major role of FVA on the crisis had implications for accounting practices particularly the auditing profession.…”

“…Auditing fair value estimates with level 3 presented more challenges, and such estimates required specific attention from auditors who in this case, needed to develop technical knowledge in fair valuation techniques and relevant audit procedures. Such estimates, moreover, placed significant demands on auditors to enhance their professional scepticism, judgement, negotiation skills and moral bravery (Benston, 2006;Kumarasiri & Fisher, 2011;Sangchan et al, 2020).…”

“…Since the financial crisis unfolded in 2008, FVMs have become a crucial area of accounting and the emphasis on the need for fair value disclosure (Xu et al, 2013). FVMs uncertainty creates an urgent need to increase the transparency of corporate information (Benston, 2006;Laux & Leuz, 2009;Penman, 2007;Sangchan et al, 2020;Yao et al, 2018). A large debate has occurred among accounting scholars (see de Jager, 2014;Laux & Leuz, 2009) stressing the possible role of FVA in the GFC.…”