Auditing trade credit risk: Evidence from BAPCPA and COVID-19

Abstract

We examine how auditors assess trade credit risk. While trade credit is an increasingly common financing tool, it is not uncommon for trade credit to become past due, increasing a supplier's own financial risks. We use two events reflecting regulatory and global sources of variation in trade credit risk: BAPCPA's strengthening of creditor protections and the COVID-19 pandemic's supply chain disruptions. Using a difference-in-difference design, we find that post-BAPCPA auditors levy lower audit fees on suppliers whose customers exhibit greater trade credit risk, reflecting the greater certainty surrounding regulatory enhancement of creditor protections. We further find that post-COVID-19 auditors levy higher audit fees on suppliers whose customers exhibit greater trade credit risk. We then investigate the role of supply chain risks in addition to audit effort and audit quality implications. Overall, we find evidence that auditors account for trade credit risk in audit pricing.