Assurance Levels, CPA Fees, and Financial Reporting Quality: Inferences from U.S. Private Firms

Are “full” audits associated with better reporting quality than “limited” reviews and “zero verification” compilations, and if so, at what cost? The answers are important because mandated financial reporting is being challenged globally and recent advances in confirmatory data analytics, the primary procedural basis for reviews, may change the economics of CPA verification services. We use a mid-size CPA firm’s fees to model verification service costs, which we then relate to financial statements of U.S. private firms. Overall, we find CPA fees approximately double for each increase in assurance level, and find that financial reporting quality is statistically indistinguishable between reviews and audits, while both reviews and audits are significantly better than compilations. Debt cost significantly decreases with each additional level of verification, although reviews capture most of the debt cost decrement between compilations and audits. We find both reviews and audits are cost-effective with respect to debt cost for larger debt ranges and we find diminishing marginal returns to full audit procedures beyond confirmatory data analytics per reviews.