Have Critical Audit Matter Disclosures Indirectly Benefitted Investors by Constraining Earnings Management? Evidence from Tax Accounts

• In Event: Critical/Key Audit Matters

Abstract

Prior research indicates that expanded audit reports, which disclose financial statement matters that involved especially challenging, subjective, or complex auditor judgment (known as critical audit matters [CAMs] in the U.S.), have fallen short of their objective to provide investors with useful information. In this study, we investigate whether the disclosure of tax-related CAMs indirectly benefits investors by constraining tax-related earnings management. Such a finding would indicate that CAM disclosure has increased auditor and/or management scrutiny of the underlying financial statement areas. We find that tax-related CAM disclosures are associated with (1) a lower likelihood that the audited company uses tax expense to meet analysts’ consensus forecasts, and (2) increases in the reported reserve for prior-period unrecognized tax benefits (UTBs). Our findings should assist the Public Company Accounting Oversight Board (PCAOB) with their post-implementation review of the new U.S. auditor reporting requirement.

Authors

• Jaime J Schmidt, The University of Texas at Austin

• Nathan Chad Goldman, North Carolina State University

• Stephen John Lusch, Texas Christian University

• Katharine Drake, University of Arizona-Tucson