Audit team experience, audit production effort, audit fees and audit quality

Abstract

To conduct an effective and efficient audit, auditors rely on their professional judgement to recognise and respond to each client’s unique risks. Knowledge is a key factor behind good judgements. It is acquired through experience and directly impacts performance. Due to the difficulty of measuring knowledge, experience is used as its proxy. Auditors gain experience on-the-job, working in a series of hierarchical structured teams. Audit judgements are based on the information gathered, evaluated, documented and reviewed by audit team members, making audit team experience relevant to audit outcomes. This thesis investigates the association between audit team industry experience and client-specific experience on production effort, audit fees and audit quality. Auditors gain Industry experience working on different clients within an industry sector; client-specific experience from repeat audits on a client. Prior research has investigated how firm-level and individual-level experience (generally absent versus present within the Big 4) impacts audit outcomes. The thesis extends the literature. First, it constructs a direct measure of team-level experience available on each audit engagement. Second, the thesis investigates experience along a continuum from novice to expert. Third, it compares and contrasts industry and client-specific experience on three inter-related outcomes of the audit: production effort, audit fees and audit quality. Data were collected from two internationally networked non-Big 4 Australian firms. Audits conducted by non-Big 4 firms were selected, as auditors in these firms work on a diverse range of clients and industry sectors, allowing for a more nuanced level of analysis. Consistent with learning curve theory and assumptions in the literature, audit team industry experience results in a more efficient, although a marginally lower quality, audit. Audit fees are also lower but the realisation rate on individual engagements is unchanged. In contrast, audit team client-specific experience is associated with higher levels of production effort, higher audit fees and a higher realisation rate. Audit team client-specific experience is not associated with audit quality. Sensitivity analysis reveals that partner client-specific experience is the key driver of the audit team client-specific experience results. The thesis provides evidence that auditors benefit from their cumulative experience prior to obtaining expertise, and that audit team industry experience and client-specific experience do not substitute or complement each other; each has an independent impact on audit outcomes. Audit team industry and client-specific experience have an incremental effect to audit firm tenure, on production effort. By finding that variations in the extent and nature of audit team experience impact audit outcomes, the thesis provides an explanation for the inconsistent results reported in partner tenure studies. In addition to its contributions to the literature, this thesis also has practical implications. Audit firms maintain their competitive edge through the selection, development and use of their auditors. The findings are relevant to audit firms as they have some latitude to manage their auditors’ experience and purposefully construct audit teams in order to gain experience-based performance benefits. It also provides evidence of the importance of the partner-client relationship.