The Disclosure and Consequences of U.S. Critical Audit Matters

Abstract

This study uses difference-in-difference analyses to examine the consequences of adopting the U.S. critical audit matter (CAM) disclosure requirement for preparers and users of financial reports. The CAM requirement is one of the largest expansions of the U.S. audit report since the 1940s. We document significant changes to financial statement footnotes referenced by CAMs, which suggests an indirect consequence where management disclosure changes in areas that are expected to be scrutinized following auditor-provided disclosure. Results also suggest that, on average, CAM disclosures do not provide incremental information to the market. To further examine market reaction, we develop well-specified prediction models for the expected number and subject areas of CAMs. We find limited initial evidence that the market reacts negatively when unexpected CAMs are disclosed. Overall, our findings provide insights on the new CAM standard and particularly demonstrate its relevance to management disclosure decisions and to the market.

Auditors' interpretation of risk and the quality of analysts' earnings forecasts: Evidence from textual analysis of key audit matters

“…In 2017, the Public Company Accounting Oversight Board set standards for communicating critical audit matters (CAMs), which are similar to KAMs. Burke et al (2022) found that communicating CAMs does not provide incremental information for the market in the United States. These results indicate that the information value of KAMs/CAMs is limited in the developed markets.…”

“…These scholars also focused on the impact of communicating KAMs on the quality of financial statements and audits quality. Most scholars did not find evidence that communicating KAMs/CAMs affects audit quality and the quality of financial statements (Bédard et al, 2016; Burke et al, 2022; Gutierrez et al, 2018; Liao et al, 2022). Only Reid et al (2019) discovered that communicating KAMs is associated with an improvement in the quality of financial statements.…”

Disclosure of auditor risk assessments in expanded audit reports

“…They find a positive relationship between the number of items and risk-related words in auditor and management disclosures, which relationship is strengthened in firms with audit committees. Burke et al (2022) study the changes in financial statement footnote disclosures following auditors referencing footnote disclosures in their CAMs. They conclude that heightened auditor interest in the footnote disclosures prompts management changes to those disclosures.…”

“…In a US context, Burke et al. (2022, p. 1–2) acknowledge that differences in regulatory, capital markets and legal environments could lead to differences in implementing expanded audit report requirements.…”

“…There was not a lot of time for auditors to spend developing their approach to the new disclosure regulations. Burke et al. (2022, p. 9) comment that as the US was a late adopter, US auditors were aware of their affiliates' experiences in countries where the expanded audit report had been adopted and could prepare for CAM implementation.…”