Do Firms Respond to Auditors’ Red Flags? Evidence from the Expanded Audit Report

54 Pages Posted: 28 Jul 2020 Last revised: 6 Dec 2021

See all articles by Ionela Andreicovici

Ionela Andreicovici

Frankfurt School of Finance & Management

Anne Jeny

IESEG School of Management

Daphne Lui

ESSEC Business School

Date Written: June 24, 2020

Abstract

We investigate the impact of the expanded audit report on firms’ financial disclosure
decisions, focusing on auditors’ mentions of goodwill impairment as a key audit matter (KAM).
Drawing on a sample of UK Premium Listed companies with goodwill on their balance sheets
during 2013-2019, we identify instances where goodwill impairment is flagged as a KAM and
contrast firms’ disclosure level on goodwill impairment using textual measures constructed from
information in their annual reports. We find that managers increase (decrease) disclosure on
goodwill impairment when auditors start (stop) mentioning goodwill impairment as a KAM. The
increase in disclosure is more pronounced in the presence of stronger external information demand
and better internal governance. Finally, firms are more likely to impair goodwill in the next period
when auditors flag goodwill impairment as a KAM. Overall, this paper establishes the role of the
expanded audit report as a trigger of enhanced corporate disclosure.

Keywords: disclosure, goodwill impairment, expanded audit report

JEL Classification: M41, M42, M48

Suggested Citation

Andreicovici, Ionela and Jeny, Anne and Lui, Daphne, Do Firms Respond to Auditors’ Red Flags? Evidence from the Expanded Audit Report (June 24, 2020). Available at SSRN: https://ssrn.com/abstract=3634479 or http://dx.doi.org/10.2139/ssrn.3634479

Ionela Andreicovici (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee, 32-34
32-34
Frankfurt am Main, 60322
Germany

Anne Jeny

IESEG School of Management ( email )

Socle de la Grande Arche
1 Parvis de la Defense
Puteaux, Paris 92800
France

Daphne Lui

ESSEC Business School ( email )

Av Bernard Hirsch
Cergy-Pontoise 95021
France

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