The Effects of Key Audit Matters and Audit Materiality Disclosures on Auditors' and Investors' Fair Value Related Judgments and Decisions

Abstract

The audit reporting model has undergone significant changes to now include additional audit disclosures. Key Audit Matters (KAMs) and audit materiality are two important additional disclosures among these. My PhD dissertation consists of three independent, but closely related experimental studies on effects of these disclosures. The research designs employed focus on fair value estimates, one of the most significant areas of accounting information suggested as a potential reporting issue for KAMs by standard setters. Study One examines how the KAMs disclosures and management disclosures in the financial statement footnotes affect auditors’ perceptions of their accountability to users of financial statements and their fair value decisions. I find that auditors believe that they are less accountable when they have the opportunity to report on the fair value estimates in KAMs disclosures or when management has provided fair value related footnotes. Drawing on discounting and augmentation principles from psychology research, I also find that when both KAMs and footnotes are reported concurrently, auditors behave more conservatively by requiring greater fair value adjustments. Study Two investigates the impact of audit materiality and management uncertainty disclosures on auditor perceptions of accountability and fair value decisions. Drawing on discounting and augmentation principles, I expect that auditors’ perceived accountability and their tendency to require fair value adjustments would be affected by these two types of disclosures. I find that auditors feel more accountable and are more likely to require their client to correct detected fair value misstatements when audit materiality and uncertainty disclosures are provided concurrently. I also find that these disclosures interactively increase auditors’ tendency to disclose a fair value issue as a KAM. Finally, taking a user’s perspective, Study Three investigates the impact of additional audit disclosures, such as KAMs and audit materiality, on investors’ investment risk perceptions, confidence and willingness to invest. I predict and find that investors perceive heightened investment risk due to KAM disclosures, but that disclosing audit materiality information reduces this effect. I also find that these two disclosure types can increase investor confidence that there are no material misstatements. Further, I find evidence that these disclosures interactively affect nonprofessional investors’ investment decisions, and this interaction effect is fully mediated by investors’ perceptions of misstatement risks. Overall, these three studies provide empirical evidence concerning the ways in which auditors’ and users’ judgments and decisions may be influenced by the new audit disclosures. The findings offer important insights for regulators and standard setters in implementing and improving standards, as well as for practitioners for evaluation and compliance purposes.