Authors: Charalampos Brilakis, Efthimios Demirakos

Title: Does Auditor Change Affect Key Audit Matters (KAMs)?

Abstract

The primary research purpose of the current study is to examine the effect of the auditor change on the number of Key Audit Matters (KAMs) in the audit report. We use a sample of 830 listed firms on the London Stock Exchange through the period 2017–2019 (2,490 firm-year observations in total). We extend prior research by examining a greater sample over a more recent period that follows the formal adoption of ISA 701. Our empirical study yields some interesting descriptive statistics: i) 251 firms out of the total number of sample firms have changed (at least once) auditor during the sample period; ii) the most frequent KAM categories are: Revenue and Other Income (863 audit reports), Goodwill and intangible assets (427 audit reports), Going concern (409 reports), Subsidiary/affiliate (354 audit reports), Other intangible assets (344 audit reports), and Business Combinations (344 audit reports); iii) the frequency of the KAM on Going concern has increased by 172% in 2019 compared to 2018, mainly due to the effects of COVID-19 pandemic on firms’ prospective financial performance and conditions; iv) the average (median) KAMs per audit report is 2.71 (3.00); v) The average KAMs per audit report is increasing during the 3 year period (2.34 for 2017, 2.71 for 2018, 3.07 for 2019); vi) the Big4 audit firms disclose 3.12 KAMs on average compared to the other smaller non-Big4 audit firms that disclose 2.16 KAMs per audit report; and vii) the percentage of sample firms audited by Big4 (non-Big4) audit firms has decreased (increased) gradually during our sample period from 59.5% (40.5%) in 2017 to 54% (46%) in 2019. Our formal multivariate empirical analysis employs three alternative regression methods (i.e., Pooled OLS, Fixed-Effects, and Linear Regression with Correlated Panel Corrected Standard Errors) to increase the robustness of our empirical results. In all three econometric model specifications, the coefficient on the auditor change variable is positive and statistically significant at conventional levels implying that the change in the audit firm leads to a greater number of KAMs in the auditor’s report. This important finding supports the argument that the change of the auditor generates a “fresh look” on the firm’s financial statements. To the best of the authors’ knowledge this is the first study that documents a positive relationship between the audit firm change and the number of KAMs in the audit report. Other statistically significant relationships of our multivariate analysis include: i) positive relationships between the number of KAMs and the amount of audit fees, the firm size, the occurrence of losses, and the amounts of revenues, goodwill, and other intangibles; and ii) a negative relationship between the number of KAMs and the return on assets ratio (in some model specifications). We believe that the study’s findings will be of interest to several constituents including auditing researchers, professional auditors, and regulators.