On accounting’s twenty-first century challenge: evidence on the relation between intangible assets and audit fees

Abstract

We inform the policy debate arising from the dramatic shift in US firms’ balance sheets towards intangible assets that has created a challenge for market participants to estimate firm value. While accounting guidelines have failed to keep pace with this change, the auditors’ perspective on this issue remains unknown. Our study reveals that auditors also find it relatively more challenging to audit firms with higher intangible assets. Specifically, we document a strong positive relation between audit fee and the proportion of intangible assets, after controlling for standard audit fee determinants. Further, we show that firms with higher proportion of intangible assets are associated with higher auditor effort and higher litigation risk for auditors, manifesting in higher audit fee. Ex post proxies of innovation success, such as patents, citation-weighted patents and ex ante R&D expense, indicate that firms with greater likelihood of innovation success are also charged higher audit fees. We find that high intangible asset firms in concentrated patent-generating industries (i.e. with lower expected patent litigation) are charged lower audit fees than similar firms in patent-competitive industries.