Abstract
This study empirically examines how auditors view intangible assets that are recorded on the balance sheet. Intangible assets have been rising on corporate balance sheets and are growing in importance. In contrast to tangible assets, intangible assets pose unique challenges to auditors in terms judgment and complexity. The study uses a sample of COMPUSTAT firms over the period 2010-2015. The results show that auditors charge higher fees for firms with higher proportion of intangible assets on the balance. This result holds for all intangible assets, goodwill type intangible assets, and intangible assets other than goodwill. For firms with high book to market ratios these results are stronger indicating that potential impairment concerns lead auditors to charge even higher fees for such firms. A variety of sensitivity tests are conducted to verify the robustness of the results. These results are of interest to investors, regulators, firm managers, corporate boards, and auditors.
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Notes
An exception to expensing research and development costs on internally generated intangibles is the accounting rule on software development costs (FASB 1985).
An exception to internally developed costs being expensed is software development costs that are incurred after technological feasibility is established but before the product is available for sale to customers (FASB 1985). Software development costs are primarily associated with SIC code 7372 (Mulford and Roberts 2006) and Krishnan and Wang (2014) report only about 188 firms in this industry with software capitalization. Thus software development costs pertain to a small subset of firms with intangibles and more specifically only to a specific industry.
If a specialist has been used an additional concern is the lack of commonly accepted professional guidelines. To address the issue of concerns over valuation and the need for common ground for generally accepted rules of valuation, the American Institute of Certified Public Accountants (AICPA), American Society of Appraisers (ASA), Royal Institution of Chartered Surveyors (RICS), and The Appraisal Foundation (TAF), along with global valuation leaders from several large accounting firms and the International Valuation Standards Council (IVSC), have been working to develop a new professional credential for business valuation professionals.
Detection risk is typically considered a residual risk once the auditor assesses inherent and control risks.
Higher audit fees in the presence of high proportion of intangible assets is consistent with either the auditor expecting to spend more time and effort to audit the intangible assets or the auditor perceiving the intangibles to be a potential audit risk because of incorrect valuation or a combination of both. Jiang and Son (2014) find that auditors adjust both risk premium and audit efforts in response to altered control risk. On the other hand, Coulton et al. (2016) argue that risk rather than effort is a better explanation of higher than expected audit fees. In the context of intangibles, it is quite difficult to empirically test the audit effort explanation as data on number of audit hours spent on various financial statement items is not publicly available nor are measures used in the literature such as audit report delay attributable to the composition of the assets.
Note from Table 1 the maximum values of variables such as ROA and INTANG are quite high. These represent firms that are small and belong to the biotechnology industry. Such firms (BioLargo Inc. 2012; Sevion Therapeutics 2015) have large losses relative to their assets and hold a significant portion of their assets as intangible assets consisting of goodwill and other acquired intangibles. To address extreme values, two procedures are employed: all variables are trimmed at the extreme 1% level in reporting the results and in the sensitivity analysis, wonsorization is considered at the 2 and 5% levels.
Fields et al. (2004) use goodwill as a proxy for acquisitions and finds that it is positively related to audit pricing using a sample of 277 banks in 2000.
COMPUSTAT reports goodwill impairments separately and other impairments as part of Special items. This analysis is conducted by removing both these variables.
When non-audit fees are used as the dependent variable instead of audit fees, both the proportion of intangible assets and the proportion of goodwill are positive and significant.
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Visvanathan, G. Intangible assets on the balance sheet and audit fees. Int J Discl Gov 14, 241–250 (2017). https://doi.org/10.1057/s41310-017-0023-x
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DOI: https://doi.org/10.1057/s41310-017-0023-x