The Effect of the Disclosure of Key Audit Matters on Audited Financial Statement Quality and Audit Effort: Evidence from China

Abstract

This study examines whether the disclosure of key audit matters (KAMs) in the expanded audit report in China is associated with an increase in audited financial statement quality. Specifically, we predict and find that timeliness of goodwill impairment by Chinese listed firms increased after the disclosure of KAMs related to goodwill. This finding is consistent with theory that suggests auditors have incentives to expend more effort after KAM disclosure in settings where the financial reporting quality environment is weak, such as China. In contrast, we do not find similar increases in goodwill impairment timeliness for Chinese firms that cross list in Hong Kong and for firms in the UK, where the financial reporting quality environment is strong. We also find that auditors’ disclosure of goodwill KAMs in China leads to higher auditor fees, which provides support for increased audit effort being the channel through which audited financial statement quality improves.

Keywords: expanded audit report, key audit matters, timeliness of goodwill impairment, financial reporting quality, audit effort, China

JEL Classification: M41, M42, M48