Have Critical Audit Matter Disclosures Indirectly Benefitted Investors by Constraining Earnings Management? Evidence from Tax Accounts

50 Pages Posted: 2 Jun 2020 Last revised: 8 Oct 2020

See all articles by Katharine D. Drake

Katharine D. Drake

University of Arizona - Department of Accounting

Nathan C. Goldman

North Carolina State University - Department of Accounting

Stephen J. Lusch

Texas Christian University - Department of Accounting

Jaime J. Schmidt

University of Texas at Austin

Date Written: October 8, 2020

Abstract

Prior research indicates that expanded audit reports, which disclose financial statement matters that involved especially challenging, subjective, or complex auditor judgment (known as critical audit matters [CAMs] in the U.S.), have fallen short of their objective to provide investors with useful information. In this study, we investigate whether the disclosure of tax-related CAMs indirectly benefits investors by constraining tax-related earnings management. Such a finding would indicate that CAM disclosure has increased auditor and/or management scrutiny of the underlying financial statement areas. We find that tax-related CAM disclosures are associated with (1) a lower likelihood that the audited company uses tax expense to meet analysts’ consensus forecasts, and (2) increases in the reported reserve for prior-period unrecognized tax benefits (UTBs). Our findings should assist the Public Company Accounting Oversight Board (PCAOB) with their post-implementation review of the new U.S. auditor reporting requirement.

Keywords: Critical Audit Matters, Earnings Management, Tax Expense, Uncertain Tax Benefits

Suggested Citation

Drake, Katharine D. and Goldman, Nathan C. and Lusch, Stephen J. and Schmidt, Jaime J., Have Critical Audit Matter Disclosures Indirectly Benefitted Investors by Constraining Earnings Management? Evidence from Tax Accounts (October 8, 2020). Available at SSRN: https://ssrn.com/abstract=3606701 or http://dx.doi.org/10.2139/ssrn.3606701

Katharine D. Drake (Contact Author)

University of Arizona - Department of Accounting ( email )

Tucson, AZ 85721
United States

Nathan C. Goldman

North Carolina State University - Department of Accounting ( email )

Raleigh, NC 27695-8113
United States

Stephen J. Lusch

Texas Christian University - Department of Accounting ( email )

M.J. Neeley School of Business
TCU Box 298530
Fort Worth, TX 76129
United States

Jaime J. Schmidt

University of Texas at Austin ( email )

Austin, TX 78712
United States

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