Effective December 2009, FAS 132(R)-1 expands the prior disclosure requirements on pension plan assets by requiring firms to disclose the fair value inputs and measurements of pension assets. This study examines whether the different level of pension asset fair value inputs required under FAS 132(R)-1 affects audit fees, and investigates whether more expanded fair value disclosure requirements alone can have any impact on audit fees that proxy for auditors’ efforts. During our sample period from 2009 to 2010, we find supporting evidence that audit fees are an increasing function of Level 3 fair value assets that are more subjective. In addition, in a difference-in-difference test, we find evidence supporting our hypothesis that audit firms increase their audit fees after the adoption of FAS 132(R)-1, especially for the client firms that have more Level 3 pension assets. Considering that auditors have had access to the detailed fair value measurement information even before 2009, our results imply that a more detailed disclosure requirement on pension plan assets alone can affect auditors’ audit efforts and audit fees accordingly.
Pension assets in a defined benefit plan have been measured and disclosed with fair value in firms’ annual reports. However, only after the newly revised reporting standard, FAS 132(R)-1 Employers’ Disclosures about Postretirement Benefit Plan Assets, (or ASC 715), The U.S. Security Exchange Commission (SEC) registrant firms are required to expand the disclosure requirements of pension assets with fair market values effective December 15, 2009. More specifically, FAS 132(R)-1 requires plan-sponsoring firms to provide more detailed fair value information including fair value hierarchy and valuation methods in 10K filings. Taking advantage of these disclosure requirement changes, we investigate whether 1) the different hierarchy structure of pension assets has a different impact on audit fees, a proxy for auditors’ audit efforts, and 2) a more detailed disclosure requirement itself can affect audit fees. A long line of auditing research finds that client attributes, such as complexity and inherent risk, are vital determinants of audit fees because more complex clients tend to necessitate more difficult and timeconsuming audits (Charles, Glover, & Sharp, 2010; Hay, Knechel, & Wong, 2006). However, there is scant research on auditors’ response to a firm’s additional disclosure of fair value assets alone. Moreover, it is not clear whether the composition of fair value assets would affect the inherent risk of audit, and therefore require more audit work. For example, Goncharov, Riedl, and Sellhorn (2014) find that auditors charge lower fees for fair valued properties compared to properties valued at historical cost because impairment tests are required for properties valued at historical cost, but not for those valued at fair values. Therefore, fair value accounting does not necessarily increase auditors’ efforts or audit fees. On the other hand, some prior studies document that compared to the fair value of assets using quoted prices in the active market (Level 1) and significant other observable inputs (Level 2), fair value measurements using unobservable inputs (Level 3) are more susceptible to managerial discretion (Jaggi, Winder, & Lee, 2010; Song, Thomas, & Yi, 2010). In addition, Ettredge, Xu, and Yi (2014) also argue that Level 3 assets rely more on subjective assumptions and estimates, and therefore audit fees increase with fair value assets with more Level 3 inputs in bank holding company audits.