Relevance of supplementary fair value disclosures under market uncertainty: effects on audit fees and investors’ pricing

Fair value (FV) means the market value of an asset, which can be observed directly (Level 1), or indirectly (Level 2). In some cases, the FVs are not observable in the market and managers of companies estimate the valuation internally using statistical models based on the best information available. These are known as Level 3 FV. The measurement uncertainty is the highest for Level 3 FVs as they rely on managerial discretion, creating concerns about their representational faithfulness and relevance among auditors and investors. This concern is likely to be heightened in the wake of market uncertainty during 2020 caused by the COVID pandemic. Regulators (e.g., ASIC) suggested that disclosing supplementary information (i.e., beyond the minimum required by regulation) on FV can help mitigate such concerns. In this study, I examine the relevance of supplementary disclosures intended to improve the representational faithfulness and relevance of Level 3 FV by investigating their impacts on audit fees and investors’ valuation in the uncertain market condition of 2020. My sample comprises Level 3 investment properties held by Australian real estate companies. I find that managers of real estate companies increased supplementary FV disclosures during 2020. I document a negative association between supplementary disclosures and audit fees, implying that disclosures reduce the audit risk effect by signalling higher transparency. However, I find no incremental impact of disclosures on audit fees during the pandemic. Additionally, I find that investors’ pricing of FV increased with the increase in disclosures during the market uncertainty of 2020, while in the pre-uncertainty period, their pricing influence was not significant. The findings of this study inform regulators and other financial reporting stakeholders about the role of supplementary FV disclosures in mitigating the perceived audit risk for auditors and the faithful representation concerns for investors in a distressed market environment.

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 for non-current assets and audit fees: Evidence from Australian companies

This paper investigates the effect of fair value reporting and its attributes on audit fees. We use as our primary sample the European real estate industry around mandatory IFRS adoption (under which reporting of property fair values becomes compulsory), due to its unique operating and reporting characteristics. We document lower audit fees for firms reporting property assets at fair value relative to those employing depreciated cost ― a difference that appears driven (in part) by impairment tests that occur only under depreciated cost. We further find that audit fees are decreasing in firm’s exposure to fair value, and increasing both in the complexity of the fair value estimation and for recognition (versus only disclosure) of fair values. We corroborate our findings in two alternative settings: contrasting UK and US real estate firms; and using UK investment trusts. Overall, the results suggest that fair values can lead to lower monitoring costs; however, any reductions in audit fees will vary with salient characteristics of the fair value reporting, including the difficulty to measure and the treatment within the financial statements.

This paper investigates the effect of fair value reporting and its attributes on audit fees. We use as our primary sample the European real estate industry around mandatory IFRS adoption (under which reporting of property fair values becomes compulsory), due to its unique operating and reporting characteristics. We document lower audit fees for firms reporting property assets at fair value relative to those employing depreciated cost—a difference that appears driven, in part, by impairment tests that occur only under depreciated cost. We further find that audit fees are decreasing in firms’ exposure to fair value and increasing both in the complexity of the fair value estimation and for recognition (versus only disclosure) of fair values. We corroborate our findings in two alternative settings: contrasting UK and US real estate firms and using UK investment trusts. Overall, the results suggest that fair values can lead to lower monitoring costs; however, any reductions in audit fees will vary with salient characteristics of the fair value reporting, including the difficulty to measure and the treatment within the financial statements.

PurposeThis study investigates the association between the estimates of fair value and external auditor's fees.Design/methodology/approachBased on a sample of 32 Jordanian financial companies listed on the Amman Stock Exchange (ASE) over the period 2005–2018. We employ random effect models to test our hypothesis.FindingsWe found a positive relationship between audit fees and the proportion of fair value assets, which implies that external auditors are more likely to spend more effort for complex estimates, thereby increasing audit fees. We examined the relationship between audit fees and three levels of fair value inputs and found a positive relationship between the level of effort spent on assessment of higher uncertainty fair value inputs and audit fees. The findings are consistent with the expectation that more audit effort is required in a highly regulated environment due to the possibility of a higher cost of litigation.Practical implicationsThe findings of this study could be beneficial for a number of users of financial information, such as investors, regulators, auditors. This group of users might consider the results of this study when they are using a company's financial information, and consequently, better able to make the right decisions.Originality/valueAlthough prior studies have researched fair value, no study to date among developing countries has investigated its relationship with audit fees. This study, therefore, provides new empirical evidence that the complexity and risk of fair value estimates significantly influences auditors' motivation to expend additional effort, resulting in higher audit cost.

This study examines the role of PCAOB inspection reports as a regulatory and monitoring mechanism. Specifically, I examine whether the issuance of PCAOB inspection reports with fair value deficiencies results in increased auditor scrutiny of fair value estimates and ultimately reduce the information uncertainty associated with level 2 and level 3 fair value estimates. Using models derived from Fields, Fraser and Wilkins (2004) and Riedl and Serafeim (2011), I predict and find evidence that corroborates a positive and significant audit effort (as proxied by audit fees) associated with level 3 fair value estimates after the issuance of a fair value inspection report. I also find a reduction in the information uncertainty associated with level 2 and level 3 fair value estimates (as proxied by implied asset-specific betas). Upon further subsample analysis, I find these results are driven by issuer clients that engage annually inspected audit firms versus those that engage triennially inspected audit firms.

The study aimed to identify the role of non-current assets’ fair value in determining audit fees, in addition to studying the impact of non-current assets’ fair value on audit fees. This was achieved through different valuation methods and the corporate governance represented by board independence for the period of 2013 to 2018. The study included 50 industrial companies listed on the ASE. 'The panel data was processed using the fixed effects model, and the study found that there is a reverse effect of the non-current assets’ fair value on the audit fees. Furthermore, the study found a difference in the non-current assets’ fair value on audit fees through corporate governance represented by the independent board of directors as well as a difference in the non-current assets’ fair value on audit fees by different fair value valuation methods measured at the first, second and third levels.

In 2006, the new accounting standards introduced the fair value measurement model. The fair value was implemented in the listed company on January 1, 2007. In 2014, fair value was redefined and classified disclosure requirements were improved. Subsequently, the scale of assets and liabilities measured by fair value in China keeps expanding, especially in manufacturing, construction, real estate, electric power and other engineering management enterprises. The internal control problems of engineering management companies lead to audit fee standards are not standardized, and the uncertainty of fair value will worsen this situation. The greater the uncertainty, leading to increase with the risk of audit accordingly, is finally reflected in the audit fees in the form of premium. The purpose of this paper is to study the relationship between fair value and audit fees taking evidences from engineering management enterprise from 2015 to 2018 year, such as construction industry, Water conservancy, environment and public facilities management industry and real estate industry, and to further explore the condition of audit fees, and providing reference for engineering management enterprise to control and manage audit fees.

Fair value disclosure of pension plan assets and audit fees

Purpose – The purpose of this paper was to examine whether a less precise (or imprecise) estimate may increase investors’ confidence and improve investors’ perceptions of fair value reliability. The main criticism of fair value accounting has been its lack of reliability perceived by investors. Design/methodology/approach – A 2 × 3 randomized experiment was used where management incentive and information precision are manipulated. Findings – The results from this study indicate that perceived reliability is jointly affected by management’s incentives and information precision. Reliability rating is the highest for fair value stated as a point estimate with a specified confidence level attached to it. Further analysis indicates that higher perceived reliability is related to its representational faithfulness because participants perceive that a point estimate with a specified confidence level better matches uncertainty in measuring future cash flows. Originality/value – This is the first study to examine whether a less precise (or imprecise) estimate may increase investors’ confidence and improve investors’ perceptions of fair value reliability. Because of the subjectivity and uncertainty in fair value estimates, less precise fair value estimates may not be viewed as less reliable. In fact, using a precise format to represent fair value estimates may not be appropriate (neither reliable nor credible), because a precise point estimate fails to capture its underlying uncertainty in future cash flows. A less precise format could represent a credible choice for fair value because it reflects uncertainty and subjectivity and effectively communicates management’s assessments of variability in future cash flows.

The purpose of the study is to investigate the value relevance of investment property of Malaysian listed firms based on cost model and fair value model for measuring their investment properties. Some studies suggested fair value model is more value relevant and some other studies suggested cost model is more value relevant. The sample was selected using a simple random sampling so that all listed firms have equal chance to be selected. A final sample of 108 firm-year from various industries was selected for a period from 2018 to 2019. Equity valuation models developed by Landsman (1986) and Ohlson (1995) were used to test the value relevance of investment property employed by listed firms in Malaysia. The models were used to test the value relevant of pooled sample, fair value sample and cost sample. The results show that firms’ investment properties are value relevant regardless whether cost model or fair value model was selected. It was also found that depreciation included in cost model and fair value gain or loss included in fair value model net profits are value relevant. The study implicates that cost model is more value relevant in measuring investment property. The result provides useful insight to standard setter about the effect of selection of fair value model and cost model towards share market value. Standard setters, researchers and academics would benefit from this as prior research in Malaysia suggests that investment properties (in general) are not value relevant even though investment properties of property companies are value relevant.

PurposeThis paper investigates the application of the product differentiation and shared efficiency approaches to understand the impact of the auditor industry specialisation (IS) on audit fees in relation to Fair Value Disclosures (FVD).Design/methodology/approachThe study uses 1,470 firm-year observations for the period 2005–2018 and is focused on Jordanian financial firms. Two competing theoretical approaches of IS proxied by audit fee-based measures were employed: firstly, the product differentiation approach measured using Market Share-based (MS) measure and secondly, the shared efficiency approach measured using Portfolio Share-based (PS) measure. The paper employs the Ordinary Least Squares regression to test the association between the proportion of fair-valued assets (using fair value hierarchy inputs) and audit fees.FindingsThe results suggest that the association between the proportion of fair-valued assets and audit fees is strengthened (weakened) when the client hires specialist auditors identified by MS (PS). This association varied across the fair value inputs. Level 1 assets were found to be only moderated by both scenarios positively (negatively) for MS (PS) experts. The results are robust after controlling the endogeneity of auditor self-selection.Practical implicationsThe results provide valuable insights for policymakers into challenges of auditing FVD. These insights present a valuable input for the development of FVD policies and practices as well as providing guidance for updating auditor prices. Additionally, the results provide a foundation for policymakers and regulators to introduce and update fair value auditing practices. The current findings are generalisable to other countries, including the Middle East and North Africa, and are particularly beneficial for those countries which have adopted the fair value model.Originality/valueThis study contributes to the theory by demonstrating the impact of the auditor industry expertise on post-implementation costs of FVD. The novelty of the study lies in introducing principle-based standards requirements of FVD to test the relationship. This approach is based on the IFRS disclosure requirements using data from the Jordanian financial sector to examine this relationship.

The literature suggests that fair value (FV) estimates from external third-party sources are more reliable than those from managerial inputs. However, using a sample of private insurance companies, we provide evidence that even verifiable FV estimates derived from external third-party sources are not immune to managerial opportunism due to the discretion insurers have in switching sources. We posit that such source switches could either be driven by managerial incentive to faithfully report FV (objective valuation) or to inflate FV estimates to avoid other-than-temporary impairment (OTTI) (FV opinion shopping). Our results indicate FV opinion shopping is the more dominant motive and that source-switches yield less accurate and more upwardly biased FV estimates. Upward switches also reduce both the likelihood and magnitude of OTTI especially for high-impairment-risk securities. Overall, our evidence suggests that opportunism with respect to source-switching potentially compromises the disciplining role of independent third parties in the valuation of fair-valued assets.

Purpose This study aims to provide a timely review concerning the determinants and economic consequences of fair value reporting in real estate industry, as these topics have been gaining momentum in accounting literature recently. Design/methodology/approach Diverse editorial sources (e.g. Elsevier, Emerald, Meridian Allenpress, Springer, Sage, Taylor & Francis and Wiley-Blackwell) were consulted to identify relevant studies for this review. Keywords used to collect studies include “fair value” and “IAS 40” or “investment property” and “fair value or “fair value and real estate.” This search yields 33 studies published between 2009 and 2023. Findings The synthesis of reviewed papers suggests that studies were mainly conducted in the European countries after the mandatory adoption of international financial reporting standards (IFRS) in 2005 and the Australian setting. The first stream of research deals with the choice of fair value approach. Reported empirical findings suggest that corporate size and market-to-book ratio are negatively associated with fair value choice, whereas ownership dispersion increases the likelihood of choosing fair value approach. The empirical evidence concerning the determinants of fair value magnitude suggests the type of appraiser represents a key predictor of the extent of fair value use. The second stream of research examines the impact of fair value reporting in real estate industry. Findings suggest that empirical evidence is still limited with respect to creditors, managers and financial analysts; fair value reporting is generally associated with higher level of value relevance for investors; and the use of Level 3 inputs in fair value estimates for investment properties is associated with high degree of estimation uncertainty for external auditors leading to increased audit risk and fees. Practical implications With respect to regulators, this review emphasizes that the beneficial impacts of fair value reporting are linked to institutional characteristics (e.g. legal system, the degree of market development), the reliability concerns regarding fair value estimates and the independence of appraiser. Because real estate industry is generally characterized by the lack of active market, regulators may adopt regulations requiring the independence external appraiser. Originality/value This literature review represents a historical record and an introduction for accounting scholars, in emerging economies and other settings, where fair value accounting has gained wide acceptance among the investment community. It also offers guidance for future research avenues.