Review Procedures and Financial Reporting Quality: Inferences from U.S. Private Firms

57 Pages Posted: 11 Aug 2017 Last revised: 5 May 2020

See all articles by Brad A. Badertscher

Brad A. Badertscher

University of Notre Dame

Jaewoo Kim

University of Oregon - Department of Accounting

William Kinney

University of Texas at Austin - McCombs School of Business

Edward Owens

University of Utah - David Eccles School of Business

Date Written: May 4, 2020

Abstract

Are “full audits” cost-effective in improving financial reporting quality compared to “reviews,” which are based primarily on analytical procedures and inquiries? The answer is important because independent verification cost-effectiveness is being challenged globally and recent advances in confirmatory data analytics may change the economics of reviews and audits. We obtain financial statement data for U.S. private firms having financial statements compiled, reviewed, or audited. We examine four accounting-based financial reporting quality proxies and, to reflect broader economics, we examine cost of debt. We find financial reporting quality for both reviews and audits is significantly better than for compilations, but is statistically indistinguishable between reviews and audits, on average. Cost of debt significantly decreases with each additional level of CPA firm verification service, although reviews capture most of the cost of debt benefit increment between audits and compilations. We estimate incremental CPA service fees and find that, when compared to compilations, reviews are associated with less than half the fee increment for an audit. Overall, our tests are consistent with enhanced reporting quality from both reviews and audits, and diminishing marginal returns to “full” audit procedures beyond a review for both financial reporting quality and cost of debt.

Keywords: economics of auditing, financial reporting quality, cost of debt, confirmatory data analytics

JEL Classification: G21, M41, M42, M48

Suggested Citation

Badertscher, Brad A. and Kim, Jaewoo and Kinney, William and Owens, Edward, Review Procedures and Financial Reporting Quality: Inferences from U.S. Private Firms (May 4, 2020). Simon Business School Working Paper No. FR 17-17. Available at SSRN: https://ssrn.com/abstract=3016422 or http://dx.doi.org/10.2139/ssrn.3016422

Brad A. Badertscher (Contact Author)

University of Notre Dame ( email )

Mendoza College of Business
Notre Dame, IN 46556-5646
United States

Jaewoo Kim

University of Oregon - Department of Accounting ( email )

Lundquist College of Business
1208 University of Oregon
Eugene, OR 97403
United States

William Kinney

University of Texas at Austin - McCombs School of Business ( email )

1 University Station B6400
Austin, TX 78712
United States

Edward Owens

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States
8015815732 (Phone)

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
240
Abstract Views
1,174
rank
137,817
PlumX Metrics