Interpretive Guidance and Financial Reporting Costs: Evidence from Audit Fees

Abstract

We examine the effect of interpretive accounting guidance on a direct and observable cost of financial reporting: audit fees. Many contend that U.S. GAAP has too much interpretive guidance, making it complex and difficult to assimilate. This effect would lead to higher audit effort and higher fees. However, specific guidance could both lower litigation risk and increase audit efficiency by reducing the need for auditors to continually deliberate complicated accounting issues across engagements. These effects would lead to lower audit fees. Overall, using both levels and changes regressions, we find that interpretive accounting guidance is associated with higher audit fees. However, this effect is smallest for firms facing the highest ex-ante litigation risk. Finally, we examine whether increased audit fees persist and find that the audit fee effect disappears by the third year after the interpretive guidance becomes effective. Overall, we find no evidence that interpretive guidance decreases audit costs.