The Effect of Auditor Size and Audit Tenure on the Value－Relevance of R&D Expenditure
Asian Tax Journal Vol. 12 No. 2 (2011), pp. 9-42
Abstract
GAAP(Generally Accepted Accounting Priciples) requires capitalization of R&D costs if they meet certain criteria. This means that GAAP alllows firms to use their discretion to capitalize the R&D expenditure which affect the firm's earnings. We examine the relative value－relevance of the expensed R&D and capitalized R&D of Korean firms. This study also examines auditor size(receiving audit services from Big 4 accounting firms) and auditor ternure affect the differences of value relevance between capitalized R&D expenditures and expensed R&D expenditures. Resutls indicate that expensed R&D expensitures are positively associated with stock price. The association is stronger for the portion of R&D expenditures that is expensed, rather than capitalized, suggesting that investors are concerned with capitalization of R&D. Second considering audit quality, we find that audit tenure(from 2 years to 5 years)increases the value relevance of capitalized R&D expenditures and decreases the value relevance of expensed R&D expenditures. This result is consistent with the prior audit quality theory. According to the auditor entrenchment hypothesis the audit quality decreases in long－term auditor tenure, because the economic dependence on the clients impair its independence. According to the auditor expertise hypothesis, the longer auditor tenure enhances the audit quality, because auditors are not familiar with the client's accounting system in the very early stage of tenure. Lastly, we find whether or not receiving audit services from Big4 accounting firms does not increase the value relevance of capitalized R&D expenditures. This is also consistent with the prior domestic research results which empirically show that auditor size does not generally affect the audit quality in Korean firms. Results of this study provide additional empirical evidence for the auditor expertise hypothesis regarding the relation between auditor tenure and audit quality, and also provides additional empirical evidence for the relation between auditor size and audit quality in Korean firms. The results imply that proper auditor tenure can increase the reliability of R&D information and thus provide practical implication that managers of firms which spend a lot on R&D should enhance the reliability of R&D expenditure information.
Keywords
- auditor expertise hypothesis
- the value relevance of capitalized R&D
- auditor size
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