Understanding Barriers to CAM Effectiveness: A Qualitative Evaluation of Auditor and Investor Views on Audit Reporting Using the Mental Models Approach

• In Event: Continental Breakfast and Research & Education Forum
  In Paper Session: Table 16: Audit Reporting

Abstract

The Public Company Accounting Oversight Board (PCAOB) has proposed inclusion of Critical Audit Matters (CAMs) in the standardized audit report to improve report usefulness. One purpose of these disclosures is to communicate areas of significant risk for the company under audit which in turn result in increased audit risk. Previous CAM research suggests investors potentially view CAM information as a disclaimer of audit opinion rather than a communication of risk about the company under audit (Christensen et al. 2014; Kachelmeier et al. 2014; Brasel et al. 2015). Applying the Mental Models Approach to risk communication outlined by Morgan et al. (2002), I use a combination of interviews and surveys with investors and auditors to specifically identify areas where auditor and investor views of CAMs and overall audit reporting diverge. Using this approach common in health hazard risk communication research, I identify gaps in what auditors believe is intended to be communicated in CAMs, their role in providing that communication, and how investors might interpret the related information. I find auditors are skeptical of the potential effectiveness of CAMs (despite some of the language in auditor comment letters to the PCAOB) and of investor ability to interpret CAM information due to their lack of knowledge about the audit process. I also find that while many investors in this study have a working knowledge of some audit terms such as reasonable assurance and materiality, most do not fully understand the concept of audit risk and how it must be addressed by auditors to issue the unqualified or “clean” opinion which will likely accompany CAM disclosures. This misunderstanding leads investors to believe CAMs serve as a disclaimer by the auditor or as a tool to highlight areas in which the auditor is not comfortable. Although investors seem to attend to CAM information, they are distracted and possibly dissuaded from investment due to their misinterpretation of the information. This misinterpretation is a significant barrier to CAM effectiveness in communicating risk specific to the company under audit. I suggest future research to evaluate the effectiveness of including clarifying language to resolve this issue and measurement of investor risk preferences as a means to clearly evaluate how well CAMs help investors make decisions aligned with those preferences.

Author

• Josette Pelzer, Florida State University