Using abnormal audit fees to capture any added charges associated with incremental audit effort beyond the effort level needed under normal or expected circumstances, we find that the incremental audit effort is positively associated with goodwill to total assets. Additionally, when goodwill is impaired, auditors exert incrementally more effort for testing the magnitude of a goodwill impairment loss than when goodwill is not impaired. Further, we document predictable temporal and cross-sectional variations in audit effort with goodwill. As the standards on accounting for goodwill became more (less) stringent, there is a corresponding increase (decrease) in audit effort. The effort also varies cross sectionally with auditor quality (Big 4 versus non-Big 4). Using audit delay as an alternative proxy for audit effort, we find that only a goodwill impairment loss is associated with longer audit delays. Finally, we provide corroborating evidence based on survey responses obtained from expert auditors. Our results contradict the perception that auditors do not exert incrementally more effort when testing goodwill for impairment.
SYNOPSIS The controversy over Chinese reverse mergers has led to concerns about the audit quality of all U.S.-listed Chinese companies. Because a sizeable number of foreign firms cross-list their shares as American Depositary Receipts (ADRs) issued by U.S. depositary banks (as opposed to direct listings), we study how auditors have managed their audits of Chinese ADRs. Our motivation for examining Chinese ADRs is based on the findings that cross-listing via the ADR process is beneficial for U.S. shareholders. We find that relative to ADRs from countries other than China, and relative to directly listed Chinese companies, Chinese ADRs are more likely to be associated with a Big 4 auditor and are less likely to restate prior-period financial statements. We also find that Chinese ADRs pay significantly higher fees than other emerging market ADRs and Chinese direct-listings. Collectively, these results suggest high audit quality for Chinese ADRs, which is in sharp contrast to the Chinese direct-listing results. Using Tobin's Q as a measure of market value, we find that the stock market rewards Chinese ADRs, indicating that investors incorporate the benefits of higher audit quality when evaluating Chinese ADRs.