An Investigation of U.S. Critical Audit Matter Disclosures

Abstract

This study investigates the determinants, textual properties, and consequences of the newly disclosed U.S. critical audit matters (CAMs). We find that complexity, financial reporting issues, and the magnitude of accounts that require high degrees of judgment significantly determine the quantity and subject of CAM disclosures. Next, we use difference-in-difference designs to examine whether adopting the CAM disclosure requirement is associated with changes to management’s disclosures, market reaction, and audit outcomes. Using textual analysis, we document significant changes in financial statement footnotes referenced by CAMs, suggesting that management, alone or in conjunction with their auditor, change their disclosure in an apparent attempt to expand and clarify areas that may be scrutinized. Results reveal no overall market reaction or change in audit fees or quality. However, in cross-sectional analysis within CAM adopters, we find that variation in the number and textual properties of CAMs disclosed are significantly associated with abnormal returns and audit fees, suggesting they convey audit-specific risk information. In additional analysis, we utilize our well-specified determinants models to explore further outcomes of the unexpected non-disclosure of CAMs. Overall, our findings provide insights on the new CAM standard, and particularly demonstrate their relevance to management disclosure decisions and to the market.