Auditors and Net Transfers Into Level 3 Fair-Valued Financial Instruments

Advances in Accounting 36: 27-39.

56 Pages Posted: 10 Sep 2018

See all articles by Mark J. Kohlbeck

Mark J. Kohlbeck

Florida Atlantic University - School of Accounting

Thomas Joseph Smith

University of South Florida

Adrian Valencia

Florida Gulf Coast University - Department of Accounting, Finance & Business Law

Date Written: September 12, 2016

Abstract

Prior research shows that managers use discretion in estimating Level 3 financial instruments to opportunistically manage capital and earnings. We investigate an earlier decision, subsequent classification changes that result in net transfers into the Level 3 classification, to examine whether firms use their discretion to engage in opportunistic transfers. We then investigate whether auditors influence the decision to transfer into the Level 3 classification and/or alter audit fees. Using a hand collected sample of public bank fair value disclosures from 2008 through 2010, we find evidence consistent with firms engaging in opportunistic transfers into the Level 3 classification. We further find evidence that high quality auditors appear to constrain this behavior, consistent with higher quality auditors mitigating some risks associated with Level 3 instruments. We also find evidence that auditors increase fees when managers transfer instruments into the Level 3 classification. Collectively, our findings suggest auditors manage risks related to Level 3 by both restricting transfers into the Level 3 classification and charging higher audit fees when transfers occur.

Keywords: Audit Quality, Fair Values, Level 3 Transfers

Suggested Citation

Kohlbeck, Mark J. and Smith, Thomas Joseph and Valencia, Adrian, Auditors and Net Transfers Into Level 3 Fair-Valued Financial Instruments (September 12, 2016). Advances in Accounting 36: 27-39.. Available at SSRN: https://ssrn.com/abstract=3234327

Mark J. Kohlbeck

Florida Atlantic University - School of Accounting ( email )

777 Glades Avenue
KH 119
Boca Raton, FL 33431-0991
United States
561-297-1363 (Phone)

Thomas Joseph Smith (Contact Author)

University of South Florida ( email )

4202 E. Fowler Avenue, BSN 3403
Tampa, FL 33620-5500
United States

Adrian Valencia

Florida Gulf Coast University - Department of Accounting, Finance & Business Law ( email )

Ft. Myers, FL 33965-6565
United States

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