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ItemFair Value Accounting and the Cost of Debt: The Role of Auditor Expertise( 2021)This study examines the association between the use of fair value accounting and the cost of debt, as well as the impact of auditor national-level and city-level industry expertise on this association. Results suggest that more extensive use of fair value accounting measurement in the financial statements is generally associated with a higher cost of debt, primarily driven by Level 2 and Level 3 estimates, which supports the argument that fair value accounting is perceived to exhibit lower reliability. In addition, we find that national-level auditor industry expertise improves the informativeness of Level 1 and Level 3 fair value accounting information to debtholders, whereas city-level auditor industry expertise enhances the information quality of Level 3 fair value estimates to debtholders. Furthermore, we explore the effect of auditor task-specific fair value expertise and find that city-level auditor fair value expertise lowers the cost of debt for firms that use Level 3 fair value measurement. These results hold after correcting for self-selection bias, as well as controlling for the orthogonalized credit ratings and variables associated with firms’ underlying risks.
ItemA New Perspective on R&D Accounting( 2021)U.S. GAAP generally requires firms to expense R&D outlays as incurred, a requirement that many prominent stakeholders view as deficient in reflecting the value of a firm’s R&D program. Prior academic research supports this view by applying a theory for tangible capital to the issue of R&D accounting. However, tangible capital is modeled in this theory as an item that can be used immediately to generate revenues with no uncertainty. Different from tangible capital, many R&D investments can be described as uncertain multi-period ventures in which measurable progress can be made each period, but revenues can only be generated in future periods after the venture is successfully completed. I apply and extend an alternative theory that models this well documented and uncertain time lag between R&D cash outflows and inflows. Theoretical analyses predict that R&D expensing results in more value relevant accounting numbers than R&D capitalization and amortization. Empirical tests confirm these predictions in a sample of R&D intensive firms, suggesting that current accounting reflects the value of a firm’s R&D program better than R&D capitalization and amortization. This research is timely because many prominent stakeholders believe the opposite, and such beliefs have motivated the FASB to consider changing U.S. GAAP in recent years.
ItemDoes Financial Reporting for Income Tax Expense Affect the Timeliness of Goodwill Impairments?( 2021)This study examines if financial reporting for income tax expense affects the timeliness of goodwill impairments. Goodwill impairments are an important signal of expected future cash flows, yet their timing is subject to managers’ discretion. U.S. GAAP requires firms to test all goodwill for impairment, whereas tax laws generally do not permit impairment deductions but require amortization for only some goodwill. Only when an impairment includes tax-amortizable goodwill will financial statement tax benefits partially offset the impairment’s negative effect on GAAP net income. Holding the size of pre-tax impaired goodwill constant and controlling for attributes of firms’ prior acquisitions, we predict and find that managers are more likely to delay impairments when the offsetting financial statement tax benefits are smaller. We estimate goodwill impairments are 15 to 20 percent more likely to be delayed when impairments generate reduced financial reporting tax benefits. Our findings suggest financial reporting for taxes potentially distorts the timeliness of goodwill impairments, informing the current debate on goodwill accounting.
ItemManagement Engaged vs. Employed Valuation Specialist: The Effect on Evidential Planning Assessments for the Audit of Fair Value Measurements( 2021)We examine the differential effect of management engaged versus employed valuation specialists on auditor planned evidential procedures related to auditing fair value measurements (FVMs). Accounting estimates are inherently difficult to audit, and the complex finance-based modeling that underlies estimates of many financial instruments may be beyond auditor expertise. Thus, we also examine to what extent auditor fair value expertise mitigates overreliance on management’s process, rather than engaging in a critical analysis of the overall estimate. Inspection reports issued by the PCAOB consistently cite audit firms for deficiencies related to FVMs, raising concerns about auditors' application of professional skepticism and consideration of potential management bias. These deficiencies have led to the perception that auditors may not effectively evaluate FVMs or the inputs and assumptions made by management or specialists used in them. Using auditors with varying levels of fair value domain-specific expertise, we conduct a quasi-experiment to examine how management’s valuation specialists (engaged vs. employed) affects auditors’ evidential planning judgments for complex FVMs of financial instruments. We rely on psychological distance theory to predict how auditors process information and reach judgments for FVMs. We find that when the valuation specialist is management-engaged (outsourced FMV specialists), auditors with higher domain-specific expertise are more likely than auditors with lower domain-specific expertise to conduct a higher percentage of evaluative (i.e., judgment based) as compared to confirmatory audit procedures. Further, the judgment of auditors with less domain-specific expertise is influenced by the source of management provided evidence. Overall, these findings suggest that the source of FVMs impacts the perceived reliability of evidence gathered from management, resulting in differential perceptions of persuasiveness and nature of evidence gathered beyond assessments of the risk of material misstatement.