Audit Quality of Complex Accounting Estimates: Evidence from Audit Tests of Goodwill and Special Charges

Abstract

Because auditing complex accounting estimates are particularly challenging for the auditor, and given the PCAOB inspections reports indicating audit deficiencies with the valuation tests of goodwill and other complex estimates, we highlight the quality of audit stress tests of goodwill, and audit tests of impairments, restructuring charges and other types of special charges. We find that: (1) auditors charge a substantial fee premium for testing goodwill account balances and there is an auxiliary fee surcharge for impairments, restructuring and other types of special charges, (2) audit tests of goodwill, impairments and other special charges lead to longer audit report lags, but not for restructuring charges, (3) the likelihood of an impairment or a special charge increases with audit quality, and (4) investors react negatively to all types of complex accounting estimates but the reaction depends on audit quality for impairments only. Collectively, our results underscore the prominence and relevance of audits of complex accounting estimates, especially goodwill account balances, which helps explain why goodwill impairments and special charges are timely and informative for investors.