Disclosure Of Key Audit Matters Research Articles

Do key audit matters matter? Correspondence between auditor and management disclosures and the role of audit committees

This study examines whether there is a correspondence between auditor disclosures of key audit matters (KAMs) and management disclosures of significant accounting policies and estimates, following the introduction of the International Standard on Auditing (ISA) 701. In addition, we investigate how audit committees moderate the relationship. We employ a sample of Swedish listed firms (2016–2018), using measures that capture the extent and quality of management disclosures and how they relate to auditor KAM disclosures, including the number of accounting items disclosed, total number of words, and number of unique KAM-related words (via a “bag-of-word” technique). We find a positive correspondence between auditor and management disclosures, and the correlation is greater in firms with an audit committee. Additional analyses provide evidence that management disclosure quality increases after the introduction of ISA 701, but the positive effect is mostly found in firms with a separate audit committee on the board. The results are robust to alternative measures for disclosures and using a matched sample design. Our findings suggest that policymakers should consider the interplay between audit standards and audit committees.

Corporate carbon emissions management and the disclosure of key audit matters

The principle that sustainable development can foster high-quality corporate growth has gained popularity as a tool for environmental protection. Utilizing data of firms listed on Shanghai Stock Exchange and Shenzhen Stock Exchange from 2010 to 2020, this study investigates the impact of corporate carbon emissions management (CCEM) on the disclosure of key audit matters (KAMs). The findings indicate that CCEM can significantly elevate the adequacy of disclosure concerning KAMs. Tests on underlying mechanism underscore that accounting conservatism and audit quality serve as pivotal channels through which CCEM facilitates the disclosure of KAMs. Further analysis on economic consequences reveals that the disclosure of KAMs helps mitigate stock price crash risk while enhancing environmental, social, and governance performance. This study enriches research on factors influencing the disclosure of KAMs, concurrently providing valuable insights for advancing high-quality corporate development and facilitating communication between auditors and users of audit reports.

Key audit matters disclosures and informed traders

We examine whether the audit regulation of disclosing key audit matters (KAM) provides value-relevant information to short sellers as informed investors. The theoretical underpinning for examining short sellers' ability and incentives to use KAM disclosures in their stock valuation implications is based on a prediction theory and a skilled information processing theory of short sellers. Using a sample of expanded auditor's reports from UK-listed firms during the 2010–2017 period and hand-collecting a dataset of KAM disclosures, we find no evidence that the short interest is different for the period before than after the U.K.'s expanded auditor's report regulation. However, in our cross-sectional tests, we find that KAM disclosures have a marginal effect on short interest and a positive association between short interest and unexpected and severe KAM disclosures. We conclude that, except for severe KAM that is value-relevant to sophisticated investors, the disclosures in the expanded auditor's report have no valuation implications for short sellers. Our results are robust in examining the reactions of the financial market and analysts to KAM disclosures and addressing potential endogeneity concerns.

Two-tier board characteristics and expanded audit reporting: Evidence from China

AbstractThis paper investigates the relationship between the characteristics of the two-tier board structure (board of directors and supervisory board) and the disclosure of key audit matters (KAMs) in the expanded audit report. Using a sample of 10,857 firm-year observations of Chinese listed firms spanning the 2017–2020 period, we offer two main results. First, with regard to the board of directors, we find that the auditor discloses a greater number and lengthier content of KAMs when there is a CEO duality and the board meetings are more frequent. Second, conversely, we find that the size and independence of the supervisory board are related to a lower number and length of KAMs disclosure. When we distinguish between account-level KAMs and entity-level KAMs, our further analysis shows that our results are principally associated with account-level KAMs rather than entity-level KAMs. Specifically, we find that CEO duality and the frequency of board of directors meetings are positively related to account-level KAMs. We also find that the size and independence of the supervisory board are negatively related to account-level KAMs. Our further analysis also shows evidence that these two-tier board structure characteristics are associated with the tone of KAMs disclosure in a consistent fashion. Our findings are robust and address endogeneity problems. Overall, our results suggest that the characteristics of the two-tier board structure drive KAMs disclosure, which should be of interest to regulatory bodies, policymakers, auditors, multinational firms, and users of financial reports.

The effect of gender diversity on the disclosure of key audit matters: examination of dual-signature environment

PurposeThis paper aims to investigate the impact of gender diversity in the composition of engagement auditors on the disclosure of key audit matters (KAMs) in a dual-signature environment.Design/methodology/approachThe authors used the unique institutional setup of Taiwan, where the law requires that audit reports be signed by two audit partners. The authors examined the effect of gender diversity composition among engagement auditors on KAM disclosure, considering behavioral differences between female and male auditors.FindingsThe empirical results indicate that gender diversity composition in the dual-signature environment is associated with the number of disclosed KAM items (KAMIT) and the length of the explanations for each KAMIT. Furthermore, the authors found that gender diversity composition, particularly when led by female audit partners, has a more pronounced impact on the explanation of each KAMIT rather than on the disclosure of KAMIT. The authors also noted that the moderating effect of audit firm specialization does not influence the gender diversity composition of audit partners in disclosing KAMs.Originality/valueThis study’s empirical findings demonstrate that the interaction between different gender compositions in a dual-signature environment influences KAM disclosure.

The Impact of Risk Disclosure Overlaps on Auditor Liability: Evidence from China

ABSTRACT Audit disclosure requirements have increased across countries in recent years. In this study, we explore a disclosure pattern that has been adopted by approximately 23 percent of Chinese publicly listed companies and their auditors—the disclosure of up to three overlapping items both in the risk factor section of financial reports and in the key audit matters (KAM) section of the audit report. We predict and find that such disclosure overlaps increase auditor liability, using audit fees as a proxy for auditor liability, and that (1) both the magnitude and explicitness of overlapped disclosure are positively associated with auditor liability and (2) analyst following, Top 10 auditors, and auditor tenure play a moderating role in the association between overlapped disclosures and auditors’ perceived liability. Collectively, our analysis supports our hypothesis that KAM disclosure increases auditor liability when coupled with management disclosure of related risk factors. Data Availability: Data are available from the sources cited in the text. JEL Classifications: M41; M42; K41.

Audit committee-auditor interlocking and disclosure of key audit matters

ABSTRACT The key audit matters in audit report can improve the communication effect and narrow the information gap. The interlock relationship between audit committee and auditor based on cooperation and trust will affect the whole process of communication between auditor and management, and thus affect the disclosure of key audit matters. This article examines the impact of audit committee-auditor interlocking relationship on disclosure of key audit matters. The findings suggest that audit committee-auditor interlocking can improve the adequacy of key audit matters.The conclusion is still robust after controlling the selectivity bias caused by observable factors.

Does expanded disclosure in the audit report involve unintended consequences? Evidence from tax avoidance

Purpose This study aims to examine how new regulation changes for the auditor’s report, so-called key audit matters (KAMs), influence tax avoidance. Design/methodology/approach This study uses data from firms listed on the Omani capital market over the period 2012–2019 and analyzes these data using pooled panel data regression with a robust standard error. It uses two common proxies for tax avoidance and two measures for the KAMs disclosure requirement. Findings This study finds a sharp decrease in the effective tax rate following the introduction of KAMs disclosure and the issuance of more KAMs in audit reports. This result is supported by several robustness checks. In an additional analysis, the authors observe interesting results, indicating that real earnings management mediates this association, while the audit committee plays a moderating role. The authors do not find a moderating effect of Big4 on this association, but find discrepancies within the Big4 firms in relation to this moderating effect. Originality/value The results of this study indicate that although the introduction of the KAMs disclosure requirement may have positive consequences, it may also lead to unintended negative consequences. This conclusion has not been comprehensively reported in literature.

The determinants of linguistic features in key audit matters: Empirical evidence from Europe

This study investigates the determinants and dynamics of the linguistic features of key audit matters (KAMs) in European countries. Using natural language processing algorithms, including FINBERT, I quantify stylistic and content‐based text characteristics at the KAM level and find that KAM length, readability, sentiment, quantitative density, specificity, the degree of forward‐looking statements, and the extent of boilerplate language are associated with the type of KAM topics, client attributes, and audit firm characteristics. In additional analyses, I also find early empirical evidence of a time trend in these linguistic features. Since their introduction in 2016, KAMs are becoming longer, more quantitative, more specific, but also include more boilerplate phrases. Collectively, the results of the study contribute to a more nuanced understanding of the determinants and dynamics of KAM disclosures.

The effect of key audit matters and management disclosures on auditors’ judgements and decisions: An exploratory study

We investigate how disclosure of key audit matters (KAMs) and related management footnote disclosures on a subjective accounting estimate relating to fair value in the financial statement footnotes affect auditors' perceptions of their accountability and their subsequent adjustment decisions. In relation to accountability, a substitution effect is found between KAMs disclosures and footnotes. That is, auditors believe that they are less accountable either when they can report on the fair value estimates in KAMs disclosures, or when management has provided expanded fair value related footnotes. However, we find that when the fair value disclosure is considered by both KAMs and expanded footnotes it results in the auditor recommending a more conservative fair value adjustment decision. Overall, our results show that the requirement to disclose KAMs does make a real difference and interacts with management's disclosures to affect auditors' perceptions of accountability and their adjustment decisions.

The effect of expanded audit report on IPO underpricing: Evidence from China

This study investigates the impact of the expanded audit report on IPO underpricing. Using the sample of A-share listed firms in China from June 2014 to November 2021, we find that the expanded audit reports can reduce the speculative behavior of investors in the initial phase of IPOs, resulting in lower IPO underpricing and consecutive rising limits. The channel tests suggest that the disclosure of key audit matters reduces value uncertainty and alleviates investors' local bias. Our results are consistent to a series of robustness tests. Further analyses show that the negative relation between expanded audit reports and IPO underpricing intensifies when the legal environment is weak and firms' information transparency is low. Additional tests uncover positive market reaction after the mandatory disclosure rule in the long run. Overall, our study adds new insights to the information effects of the expanded audit reports in emerging markets.

Measuring and analyzing the information entropy value of key Audit matters (KAMs) disclosure at the system and reporting scale

Drawing upon information entropy theory, this study deduces a measurement formula for the information entropy for key audit matters (KAMs) disclosure, considering both system scale and audit report scale. The information entropy of an audit report within a specific system is calculated as the weighted average logarithm value of the continuous product of KAM disclosure frequencies. Subsequently, a systematic calculation of KAM disclosure information entropy is conducted using 14,837 financial statement audit reports from listed companies traded on the Shanghai and Shenzhen Stock Exchanges, covering the FY 2017-20 period. The findings indicate that: (1) The information entropy of KAM disclosure has decreased from 2017 to 2020, while the homogenization degree of KAM disclosure has increased. (2) The information entropy and evenness of KAM disclosure on the main board are significantly higher than those of the ChiNext and the STAR Market. (3) The transportation, storage and postal services, manufacturing, finance, power supply, heating, gas and water supply industries exhibit the highest overall information entropy of KAM disclosure, indicating good quality. (4) The information entropy and evenness of KAM disclosure are higher for the big 4 accounting firms compared to domestic accounting firms and big 8 accounting firms. (5) The KAMs disclosed when the Certified Public Accountant (CPA) provides unqualified opinions, emphasizing that matter paragraphs possess higher information value, and are more disorderly and balanced. The measurement method and related results of information entropy offer reference and comparative value for future research on the quality of KAMs disclosure.

Key audit matters disclosure: do they reveal construction firm’s risk of financial distress? Evidence from Ethiopia

Recent studies have provided insights into key audit matters (KAMs) disclosure content and their determinants. While conducting this study, no known study examined the relation between the type of KAMs reported and the level of clients’ financial distress (FIDT) risk in Ethiopia, which is a clear research gap. Hence, this study aimed to examine the disclosure of KAMs’ (in number and nature) usefulness in assessing a client construction firm’s FIDT risk. A quantitative method with five-year (2017–2022) secondary data of KAMs disclosure in the audited financial reports of grade one construction companies in Ethiopia was used to study the relationship. The pooled OLS regression analysis shows that KAMs reported by auditors are valuable in predicting and assessing a firm’s risk of FIDT. The number of KAMs and all account-specific KAMs were useful in assessing firms’ FIDT. However, from the company-wide KAMs, going concern was found to be significant. Results were found robust to FIDT, using alternative measures, and tests of endogeneity. Overall, this study suggests construction firms contemplate auditor disclosers (KAMs) as one of the financial health assessment approaches.

The new audit report with key audit matters: Lessons from Thailand's first implementation

AbstractUsing a mixed method research design, this study is the first to provide comprehensive evidence of the impacts of Thailand's first implementation of the new audit report with key audit matters (KAMs), which took place in 2016. Survey evidence shows that the new audit report improves the informative value and effectively narrows the deficient‐standards and deficient‐performance gaps. Nonetheless, financial statement users have made new demands for information that lie beyond auditors' traditional responsibility. Moreover, marginally significant evidence from archival data shows that although the disclosure of KAMs increases audit fees and audit delays, it improves audit quality. However, the market does not value KAMs.

How do board features and auditor characteristics shape key audit matters disclosures? Evidence from emerging economies

This study examines how corporate board features and auditor characteristics in Bangladesh influence the disclosure of key audit matters (KAM) in annual reports from 2018 to 2021. Using ordinary least squares (OLS) regressions, the study finds that factors such as chair gender, the presence of women on the board, audit committee (AC) size, auditor tenure, and client-auditor relationship significantly affect KAM disclosure. However, AC expertise, family CEO succession, and board political connections do not have significant effects. Notably, having a family member CEO with a long-tenured auditor has a negative association with KAM disclosure, while a politically connected family CEO has a positive association with such disclosures. Additionally, Big-4 auditors of important clients are negatively associated with KAM disclosure.

Key audit matters and insider trading profitability: Evidence from China

The debate as to whether or not an expanded audit report is informative to the market persists, either from experimental and empirical study perspectives. With the utilization of 4,336 firm-year Chinese observations from 2016 to 2017, this study investigates whether the mandatory disclosure of key audit matters (KAMs) restricts insider trading profitability in China. The main test and robustness tests confirm the significant and negative relationship between KAM disclosure and insider trading profitability in the Chinese capital market. The study further explores the impact of KAMs’ textual characteristics using the KAM data from 2017 to 2020. The results suggest that firm-specific KAMs, longer KAMs, more readable KAMs, and more accurate KAMs reduce the insider trading profitability. Supplementary analysis shows that this effect only exists for opportunistic insider trading. In addition, the effect of KAM disclosure on insider trading profitability is further amplified by high institutional ownership, auditor industry specialization, and KAM with goodwill impairment matter. Overall, the study presents some evidence of the communicative value of KAM disclosure and provides a practical means to restrict insiders’ opportunistic behavior, highlighting the decision-making usefulness of KAMs for external investors.

Informativeness of Key Audit Matters: Evidence from China

SUMMARY This study examines whether the key audit matters (KAMs) disclosed in expanded audit reports as a part of recent regulatory reforms are informative for investors in an emerging economy setting. Using the recent adoption of expanded audit reports for firms listed exclusively in Mainland China, we find robust evidence that the abnormal trading volume and earnings response coefficients are higher and that stock price synchronicity is lower during the postadoption than preadoption period. In additional tests, we find evidence that KAMs are more informative for non-state-owned enterprises, smaller firms, and firms with a smaller analyst following. Finally, we find that investors respond to the characteristics of KAM disclosures, providing corroborative evidence of the informativeness of these disclosures. Overall, our study provides systematic evidence that KAMs are incrementally informative for investors in an emerging economy. Data Availability: The data are available from the public sources cited in the text. JEL Classifications: M41; M42; M48.

The effect of key audit matters on the association of credit risk and earnings quality

PurposeThe purpose of this study is to examine whether the required disclosure and the high frequency of key audit matters (KAMs) are likely to moderate the effect of higher credit risk on earnings quality.Design/methodology/approachThis study uses 15,106 Taiwanese firm-year observations to explore the relationship between earnings quality and credit risk during the 2011 to 2020 period. We use the two-stage least squares method to test whether the presence of KAM disclosures moderated the association between earnings quality and credit risk and also to examine whether higher KAM frequency moderates the association between earnings quality and credit risk.FindingsOur results provide evidence that the presence of a KAM disclosure requirement moderates the impact of firms with higher credit risk on earnings quality. In addition, there is significant evidence that the higher the frequency of KAM disclosures the greater the moderation impact that is found.Originality/valueThis research investigates whether the disclosure and high frequency of KAMs moderates the effect of credit riskiness on earnings quality. This study improves our understanding of whether more KAMs disclosures would improve earnings quality of firms with higher credit risk. In addition, we also use Beneish M-SCORE, as an alternative earnings quality proxy, to reinforce our empirical results. This markedly differentiates this paper from other studies.

Determinants for disclosure of the key audit matters in non-financial companies of B3

This research analyzes the determinants of the quantity of key audit matters (KAM) reported in audit reports from 2016 to 2019 of the non-financial companies listed on B3. The longitudinal regression model for panel data - Poisson’s Log-Linear was applied to an annual sample of at least 272 companies, resulting in 1,198 reports and 3,295 KAM (dependent variable), considering as explanatory variables the aspects of the auditor, the auditee, and corporate governance mechanisms. The findings demonstrate that being audited by the big four is negatively associated with the quantity of KAM. This may be due to the big four or not reporting the same mean number of KAMs per company. Auditors of larger companies, less profitable and with greater operational risk, disclose more KAM, probably aiming to ensure their independence. The audit committees were not statistically significant, not impacting the quantity of KAM reported. The results contribute to the literature on factors that affect the disclosure of KAM in a non-European context (Bepari et al., 2022) with four years of data, and to companies, auditors, and regulatory and supervisory bodies, through Poisson’s multilevel regression, which is an appropriate approach for structured counting data in clusters of relatively similar observations (panels). This advances the studies by Ferreira and Morais (2020) and Guedes et al. (2021), who used ordinary least squares (OLS), and Colares et al. (2020), who used the Chi-square test in one- or two-year analyses of characteristics that tend to establish the quantity of KAM in Brazil.

Audit partner gender and the COVID-19 pandemic: the impact on audit fees and key audit matters

Purpose The purpose of this study is to analyze the influence of the COVID-19 pandemic on audit fees and the reporting of key audit matters (KAMs). Additionally, this study also looks into potential differences in the behavior of male and female audit partners during this period, adding to the existing research on gender's effect on different elements of the audit process. Design/methodology/approach This study used a sample of all FTSE 350 firms from before the COVID-19 pandemic and during the pandemic. It analyzed the data using Ordinary Least Squares regression analysis to test its hypotheses. Findings This paper provides early evidence on the impact of the COVID-19 pandemic on audit fees and KAM disclosures in the UK. The results of this study show an increase in audit fees during the pandemic and greater detail in the reporting of KAMs, with no significant difference between male and female audit partners. These findings will be of interest to audit firms and regulators as they assess the performance of auditors during the pandemic and evaluate the expanded audit report's effectiveness in providing sufficient information to financial statement users. Originality/value This study provides first-of-its-kind empirical evidence on how auditors in the UK reacted to the COVID-19 pandemic. The findings of this study will be of interest to audit firms, regulators, such as the Financial Reporting Council, and other stakeholders as they evaluate the performance of auditors during the crisis period. The results will help regulators assess the effectiveness of the expanded audit report in providing sufficient information during a time of heightened risk and scrutiny.