The Importance of Topical Content in Understanding Expanded Audit Reporting: Evidence from Tax-Related Key Audit Matters
62 Pages Posted: 29 Oct 2020 Last revised: 26 Jan 2021
Date Written: September 8, 2020
This study examines determinants and consequences of auditors’ tax-related key audit matter (KAM) disclosures. We argue that to investigate whether KAMs provide information and affect firm behavior it is important to examine determinants and consequences that map into the specific topic of the KAM. Tax KAMs provide an excellent setting for such investigation because tax expense is material to most firms’ financial statements, there is substantial risk associated with the tax function, and tax KAMs are prevalent and discuss a diverse range of issues. Consistent with tax complexity increasing the difficulty of auditing tax expense, we find that firms with greater tax avoidance, more volatile effective tax rates (ETRs), and larger deferred tax asset (DTA) balances with greater estimation uncertainty (market discounting) are more likely to receive tax-related KAMs. With respect to the consequences of tax KAMs, we find that firms that stop receiving tax KAMs increase their future purchases of auditor-provided tax services, consistent with economic bond incentives threatening auditor independence. We find that, in general, firms do not change their tax avoidance in response to receiving tax KAMs, but that firms that stop receiving tax KAMs increase their tax avoidance in subsequent years. Overall, we provide evidence that tax KAMs contain information about the tax activities of the firm and that firms and auditors significantly change their behavior in response to tax-related KAMs.
Keywords: Tax, Key Audit Matters, Critical Audit Matters, KAM, CAM, Disclosure, Expanded Audit Reporting, Auditor Independence
JEL Classification: H20, H25, M41
Suggested Citation: Suggested Citation