Real effects of reporting key audit matters on auditors' judgment and choice of action

Abstract

This experimental study analyzes whether reporting an accounting estimate as a key audit matter (KAM) can influence auditor judgment about the accounting estimate and the corresponding action. We find that skeptical action in the form of proposed adjustment amounts is significantly lower when the accounting estimate is reported as a KAM. Thus, the disclosure of a KAM can serve as a moral license to waive an adjustment. Taking into account that the KAM disclosure does not affect auditors' skeptical judgments in the form of a reasonableness assessment of the accounting estimate, our results indicate the existence of a judgment–action gap. Furthermore, implicit client pressure does not enlarge the moral licensing effect of the KAM disclosure. We also find evidence that audit effort is not affected by reporting a KAM. Overall, our study contributes to the current debate about the audit reporting model by showing that reporting a KAM might have unintended “real effects” on auditors' actions.

Investigating recent audit reform in the Australian context: An analysis of the KAM disclosures in audit reports 2017–2018

“…These studies support the need for investigating KAMs in audit reports by considering both auditor and client-based characteristics as the present study does when examining observable differences in reported KAMs in Australia during the initial two years of implementation (i.e., 2017 and 2018). Asbahr and Ruhnke (2019) We convey some research findings from some early reports (preimplementation) from both Australia and New Zealand on KAMs, where both countries implemented KAM reforms a few years after the United Kingdom, France, and most of Europe. In Australia, an analysis of 56 audit reports of entities listed in the Australian Securities Exchange (ASX 500), with December 31, 2016, as financial year end, by KPMG in 2017 highlights that 155 KAMs were reported before the initial year of implementation.…”

“…Their study supports the view that the forewarning effect of KAM disclosures related to measurement uncertainty could mitigate perceived auditor responsibility for KAM‐related material misstatements. Asbahr and Ruhnke (2019) argued that the auditors' adjustment decision, on which KAM disclosures to include, is not solely the result of the reasonableness assessment, as it may also be driven by the content of KAMs and other contextual factors (for example, the intention to retain an audit client). On the other hand, the reasonableness assessment is primarily determined by the auditor's judgment based on the subject matter or information and less by contextual factors (Asbahr & Ruhnke, 2019).…”

“…Asbahr and Ruhnke (2019) argued that the auditors' adjustment decision, on which KAM disclosures to include, is not solely the result of the reasonableness assessment, as it may also be driven by the content of KAMs and other contextual factors (for example, the intention to retain an audit client). On the other hand, the reasonableness assessment is primarily determined by the auditor's judgment based on the subject matter or information and less by contextual factors (Asbahr & Ruhnke, 2019). These studies help us understand why Australia, like other countries, has adopted the KAM reforms and after the first 2 years of implementation allows research to be undertaken to investigate observable differences between Australian auditors, clients of different sizes, and different industries.…”

“…Asbahr and Ruhnke (2019) examined the accounting estimates reporting in the form of KAMs and the impact of the auditors' judgment on the accounting estimate. Their study found that skeptical action related to proposed adjustment amounts is considerably lower when the accounting estimate is reported as a KAM.…”

Audit Partner Style in Key Audit Matter Reporting Decisions.

“…Experimental studies indicate that auditor liability for subsequent restatements varies in the presence and subject area of KAMs (Kachelmeier et al 2020;Brasel, Doxey, Grenier, and Reffett 2016), changes in KAMs disclosed from year to year (Vinson, Robertson, and Cockrell 2019), the nature of the misstatement (Kachelmeier et al 2020), and the precision of accounting standards (Gimbar, Hansen, and Ozlanski 2016). With respect to auditor judgment and auditor-client relationship dynamics, Asbahr and Ruhnke (2019) find that auditors propose lower adjustments to accounts discussed in KAMs, Gay and Ng (2015) show that auditors may be more likely to accept management's reported estimate balances when KAM reporting is required, and Cade and Hodge (2014) find that management is less willing to share privately known information about estimates under expanded reporting.…”