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The Forewarning Effect of Critical Audit Matter Disclosures Involving Measurement Uncertainty

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  • Steven J. Kachelmeier
  • Dan Rimkus
  • Jaime J. Schmidt
  • Kristen Valentine

Abstract

We present experimental evidence suggesting that critical audit matter (CAM) disclosures in the auditor's report involving areas of high measurement uncertainty forewarn users of misstatement risk. Specifically, in our first study with MBA students, financial analysts, and attorneys, we find that CAMs (i) lower premisstatement assessments of confidence in the financial statement area disclosed as a CAM, and (ii) lower assessments of auditor responsibility for a subsequently revealed misstatement in a CAM‐related area. In our second study with student participants proxying as mock jurors, we find that the responsibility‐mitigating effect of CAM disclosure is driven by CAM disclosures involving measurement uncertainty, as opposed to CAM disclosures involving categorical determinations. Combined, our findings help reconcile mixed evidence from prior research, supporting the view that the forewarning effect of CAM disclosures involving measurement uncertainty could mitigate perceived auditor responsibility for CAM‐related material misstatements. Valeur indicative de la communication de questions critiques de l'audit faisant intervenir l'incertitude relative à la mesure Les auteurs présentent des données expérimentales selon lesquelles la communication dans le rapport d'audit de questions critiques de l'audit (QCA) faisant intervenir des sections dans lesquelles l'incertitude relative à la mesure est élevée est, pour les utilisateurs, indicative d'un risque d'anomalie. Plus précisément, les résultats d'une première étude, menée auprès d'étudiants MBA, d'analystes financiers et d'avocats, amènent les auteurs à constater que les QCA 1) diminuent l'évaluation, préalable à l'anomalie, de la confiance dans la section des états financiers soulevant une QCA et 2) diminuent l'évaluation de la responsabilité de l'auditeur quant à une anomalie subséquemment mise au jour dans un domaine lié à la QCA. Les résultats d'une seconde étude auprès de participants étudiants jouant le rôle de jurés, mènent les auteurs à constater que l'effet atténuateur de responsabilité de la communication des QCA est attribuable au fait qu'elles se rapportent à une incertitude relative à la mesure plutôt qu'à des décisions de classement. Ces résultats conjugués contribuent à rapprocher les résultats divergents des recherches antérieures, ce qui confirme le point de vue selon lequel la valeur indicative de la communication de QCA faisant intervenir l'incertitude relative à la mesure pourrait atténuer la responsabilité perçue de l'auditeur en ce qui a trait aux anomalies significatives liées aux QCA.

Suggested Citation

  • Steven J. Kachelmeier & Dan Rimkus & Jaime J. Schmidt & Kristen Valentine, 2020. "The Forewarning Effect of Critical Audit Matter Disclosures Involving Measurement Uncertainty," Contemporary Accounting Research, John Wiley & Sons, vol. 37(4), pages 2186-2212, December.
    • Handle: RePEc:wly:coacre:v:37:y:2020:i:4:p:2186-2212
    DOI: 10.1111/1911-3846.12583
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    1. Aronow, Peter M. & Baron, Jonathon & Pinson, Lauren, 2019. "A Note on Dropping Experimental Subjects who Fail a Manipulation Check," Political Analysis, Cambridge University Press, vol. 27(4), pages 572-589, October.
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    1. Li, Valerie & Luo, Yan, 2023. "Costs and benefits of auditors' disclosure of critical audit matters: Initial evidence from the United States," Advances in accounting, Elsevier, vol. 60(C).
    2. Hien Hoang & Robyn Moroney & Soon‐Yeow Phang & Xinning Xiao, 2023. "Investor reactions to key audit matters: Financial and non‐financial contexts," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(3), pages 3325-3349, September.
    3. Duboisée de Ricquebourg, Alan & Maroun, Warren, 2023. "How do auditor rotations affect key audit matters? Archival evidence from South African audits," The British Accounting Review, Elsevier, vol. 55(2).
    4. Clive S. Lennox & Jaime J. Schmidt & Anne M. Thompson, 2023. "Why are expanded audit reports not informative to investors? Evidence from the United Kingdom," Review of Accounting Studies, Springer, vol. 28(2), pages 497-532, June.
    5. Chambers, Valerie A. & Reckers, Philip M.J., 2022. "Auditor interventions that reduce auditor liability judgments," Advances in accounting, Elsevier, vol. 58(C).
    6. Ma, Jin & Coram, Paul & Troshani, Indrit, 2024. "The effect of key audit matters and management disclosures on auditors’ judgements and decisions: An exploratory study," The British Accounting Review, Elsevier, vol. 56(2).
    7. Chen, Lihong & Xiao, Tingting & Zhou, Jia, 2023. "Do auditor changes affect the disclosure of critical audit matters? Evidence from China," Economic Modelling, Elsevier, vol. 122(C).
    8. Efrat Dressler & Yevgeny Mugerman, 2023. "Doing the Right Thing? The Voting Power Effect and Institutional Shareholder Voting," Journal of Business Ethics, Springer, vol. 183(4), pages 1089-1112, April.
    9. Maroun, Warren & Duboisée de Ricquebourg, Alan, 2024. "How auditors identify and report key audit matters - An organizational routines perspective," The British Accounting Review, Elsevier, vol. 56(2).
    10. Elsayed, Mohamed & Elshandidy, Tamer & Ahmed, Yousry, 2023. "Is expanded auditor reporting meaningful? UK evidence," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 53(C).
    11. Saeed Rabea Baatwah & Ehsan Saleh Almoataz & Khaled Salmen Aljaaidi, 2022. "Tightened it and ruined it: Earnings management trade-off as a consequence of key audit matters disclosure," Economics Bulletin, AccessEcon, vol. 42(2), pages 678-693.
    12. Song, Jie & Liang, Shangkun & Zhen, Yuhan, 2023. "Does CEO-auditor dialect sharing affect stock price crash risk? Evidence from China," Finance Research Letters, Elsevier, vol. 57(C).
    13. Liu, Hui & Chang, Yufan & Zuo, Man, 2023. "Key audit matters and insider trading profitability: Evidence from China," Journal of Contemporary Accounting and Economics, Elsevier, vol. 19(3).
    14. Chan-Chuan Ting, 2023. "The Association Between Changes in Key Audit Matters and Earnings Management Behavior in Companies," Advances in Management and Applied Economics, SCIENPRESS Ltd, vol. 13(6), pages 1-3.
    15. Yan Luo, 2021. "Determinants and consequence of critical audit matter disclosure: early evidence," International Journal of Disclosure and Governance, Palgrave Macmillan, vol. 18(4), pages 336-345, December.
    16. Ma, Qianqun & Zhou, Jianan & Wang, Qi & Wang, Kongwen, 2024. "The impact of key audit matters on goodwill accounting and investment behavior: Evidence from China," International Review of Financial Analysis, Elsevier, vol. 93(C).

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