Weathering the Weather: Does Extreme Weather Affect the Cost of an Audit?

Abstract

We examine the impact of extreme weather on the cost of an audit. We measure the impact as the number of extreme weather days, namely, how many days per year a firm experiences an extreme weather event (e.g., drought, flood, storm, wildfire) in its metropolitan statistical area (MSA). We first find that auditors charge significantly higher fees for firms with more extreme weather days in the past, suggesting that auditors consider previous extreme weather exposure a material business risk. No single weather type dominates this finding. Second, auditors charge higher fees when firms experience abnormal increases in extreme weather days contemporaneous with the audit. Fees increase even more when firms experience unanticipated weather events in the audit season (after the fiscal yearend but before the audit report date). Third, audit fees are higher when the auditor and the firm reside in the same MSA, suggesting that local auditors act conservatively in assessing the impact of extreme weather on a client audit. Lastly, as evidence of a channel linking extreme weather and audit fees, we find that firms with more extreme weather days in the audit season record more asset write-downs and are likelier to report a financial restatement.

Keywords: Audit cost, audit risk, audit effort, extreme weather, audit fees, metropolitan statistical area

JEL Classification: Q54, Q56, M42