Does Tax Enforcement Inform Auditors’ Risk Assessment? Evidence from Key Audit Matters

Contemporary Accounting Research (forthcoming)

60 Pages Posted: 12 Jan 2023 Last revised: 11 Feb 2025

See all articles by Jessica Filosa

Jessica Filosa

University of Alabama

Jing Huang

Virginia Polytechnic Institute & State University - Pamplin College of Business

Lijun (Gillian) Lei

University of North Carolina at Greensboro

Sarah E. Stein

Virginia Tech

Date Written: February 11, 2025

Abstract

International standards encourage auditors to consider regulatory factors and external parties during the risk assessment process. One such external party is the taxation authority, which monitors corporate conduct and uses the threat of tax audits to constrain managerial opportunism. This study examines whether tax enforcement influences auditors’ perception of the risk of material misstatement on their engagements. Using a sample of companies listed on European exchanges, we assess the strength of tax enforcement at the country level based on the number of full-time equivalent (FTE) employees in the tax audit and verification function relative to the size of the economy. Since auditors of these European listed companies must publicly disclose key audit matters (KAMs), we use the number of KAMs to capture auditors’ perceptions of client-level misstatement risk. Our results indicate that auditors report fewer KAMs in the presence of more FTEs in the tax audit and verification function. In cross-sectional tests, we find that this negative association is stronger in settings where auditors are more inclined to incorporate the monitoring potential of the tax authority into their risk assessment, such as in countries with high book-tax conformity and for auditors with greater exposure to complex tax issues. These findings offer new insights into the role of tax enforcement in auditors’ decision-making and have timely implications for accounting regulators and academics studying the determinants of KAMs.

Keywords: risk assessment, key audit matters, tax enforcement, monitoring

JEL Classification: M41, M42, M48, H25, H26

Suggested Citation

Filosa, Jessica and Huang, Jing and Lei, Lijun and Stein, Sarah E., Does Tax Enforcement Inform Auditors’ Risk Assessment? Evidence from Key Audit Matters (February 11, 2025). Contemporary Accounting Research (forthcoming), Available at SSRN: https://ssrn.com/abstract=4322782 or http://dx.doi.org/10.2139/ssrn.4322782

Jessica Filosa

University of Alabama ( email )

101 Paul W. Bryant Dr.
Box 870382
Tuscaloosa, AL 35487
United States

Jing Huang

Virginia Polytechnic Institute & State University - Pamplin College of Business ( email )

250 Drillfield Drive
Blacksburg, VA 24061
United States

Lijun Lei

University of North Carolina at Greensboro ( email )

P.O.Box 26170
Greensboro, NC 27412
United States

Sarah E. Stein (Contact Author)

Virginia Tech ( email )

250 Drillfield Drive
Blacksburg, VA 24061
United States

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