The Consequences of Expanded Audit Reporting: Evidence from Tax-Related Key Audit Matters

63 Pages Posted: 29 Oct 2020 Last revised: 17 Aug 2023

See all articles by Dan Lynch

Dan Lynch

University of Wisconsin - Madison - Department of Accounting and Information Systems

Aaron Mandell

University of Wisconsin - Milwaukee - Sheldon B. Lubar School of Business

Linette M. Rousseau

University of Houston, Bauer College of Business

Date Written: November 9, 2021

Abstract

This study examines the consequences of tax-related key audit matters (KAMs) to the valuation of clients’ tax attributes and to the auditor-client relationship. Existing literature on expanded audit reporting finds that KAMs are not associated with investor or audit outcomes. This creates an impetus to identify whether, in specific circumstances or for especially sensitive topics, KAMs are more consequential. Tax KAMs are an ideal setting for this investigation because they are prevalent, taxes are economically important, and auditors can provide tax services to their clients. We begin our analysis by developing an expectations model of tax KAM disclosure, finding that companies with greater tax avoidance and larger deferred tax asset balances are more likely to receive tax KAMs. In consequences analyses, we find that investors discount the tax avoidance and deferred tax assets of companies receiving tax KAMs. Furthermore, companies that are expected to receive tax KAMs, but do not, can avoid some of these undesirable valuation effects. These results illustrate significant consequences of tax KAMs, suggesting managers have incentives to avoid tax KAMs. Consistent with self-interest threats to auditor independence, we find that companies that stop receiving tax KAMs increase their purchases of auditor-provided tax services (APTS) in the future, while companies that continue to receive tax KAMs decrease APTS. Further, clients with unexpectedly low levels of tax KAM disclosure purchase more APTS. Our results are strongest for uncertain tax position and deferred tax asset KAMs, where the auditor has the most discretion in issuing the KAM. These results reveal previously unknown consequences of tax KAMs to the valuation of companies’ tax positions and to the auditor-client relationship.

Keywords: tax, key audit matters, critical audit matters, KAM, CAM, disclosure, auditor-provided tax services

JEL Classification: H20, H25, M41

Suggested Citation

Lynch, Dan and Mandell, Aaron and Rousseau, Linette, The Consequences of Expanded Audit Reporting: Evidence from Tax-Related Key Audit Matters (November 9, 2021). Available at SSRN: https://ssrn.com/abstract=3689349 or http://dx.doi.org/10.2139/ssrn.3689349

Dan Lynch (Contact Author)

University of Wisconsin - Madison - Department of Accounting and Information Systems ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States

Aaron Mandell

University of Wisconsin - Milwaukee - Sheldon B. Lubar School of Business ( email )

P.O. Box 742
3202 N. Maryland Ave.
Milwaukee, WI 53201-0742
United States

HOME PAGE: http://uwm.edu

Linette Rousseau

University of Houston, Bauer College of Business ( email )

Bauer College of Business
4800 Calhoun Road
Houston, TX 77204
United States

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