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    Do Critical Audit Matter Paragraphs in the Audit Report...
    research summary posted February 16, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.01 Changes in Reporting Formats, 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement 
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    Title:
    Do Critical Audit Matter Paragraphs in the Audit Report Change Nonprofessional Investors’ Decision to Invest?
    Practical Implications:

    This paper provides the first evidence on the effect of proposed CAM paragraphs on investor decision making, thus informing the PCAOB’s proposed standard. The results indicate that including CAM paragraphs in audit reports provides useful information for well-informed, nonprofessional investors. However, regulators should also be aware that providing the resolution to the CAM seems to mute investors’ concern about the issue raised in the CAM.

    For more information on this study, please contact Professor Brant Christensen.

    Citation:

    Christensen, B. E., S. M. Glover, and C. J. Wolfe. 2014. Do Critical Audit Matter Paragraphs in the Audit Report Change Nonprofessional Investors' Decision to Invest? Auditing: A Journal of Practice & Theory 33 (4): 71-93.

    Keywords:
    Audit report, critical audit matter, nonprofessional investors, estimation uncertainty, audit assurance
    Purpose of the Study:

    Both U.S. and international standard setters have recently proposed changes to the standard audit report, including a requirement to include a critical audit matter (CAM) paragraph. These paragraphs are intended to discuss those items encountered during the audit that required significant auditor judgment or that posed difficulty to the auditor in obtaining sufficient audit evidence. However, it is unclear whether or how investors will use this additional information when making investment decisions. This paper examines how nonprofessional investors react to an audit report’s CAM paragraph that is centered on the audit of fair value estimates. Specifically, the authors examine how investors’ investment decisions are affected by 1) the inclusion of a CAM paragraph in the audit report (i.e., an information effect) and 2) the location of the CAM paragraph information in the audit report versus the footnotes (i.e., a source credibility effect). In additional analysis, the authors also examine the effect of recognizing estimation uncertainty on the face of the financial statements as well as conveying the resolution of the critical audit matter in the audit report. The findings of the paper should be of interest to regulators and standard setters as they consider the feasibility of CAM paragraphs and whether and how to convey the resolution of critical audit matters.

    Design/Method/ Approach:

    In 2013, the study used Qualtrics.com to host the experiment. The authors used alumni from a large, public university’s business school as nonprofessional investors, analyzing responses from those individuals with experience investing in individual stocks and reviewing financial statement information.

    Findings:
    • The authors find that investors who receive a CAM paragraph are more likely to change their investment decision than are investors who receive a standard audit report (an information effect) or investors who receive the same CAM paragraph information in management’s footnotes (a source credibility effect).
    • Further, the authors find that investors who receive a CAM paragraph are more likely to stop considering the company as an investment than are investors provided with the resolution of the critical audit matter in the audit report.
    • The authors also find that disclosure of estimation uncertainty through a CAM paragraph has an effect on investor decision making that is indistinguishable from the effect of formally recognizing estimation uncertainty in the income statement.
    • Finally, using path analysis, the authors find that the effect of the CAM paragraph on investor decision making emanates from ease of information assessment, thus making investors more aware of the uncertainty.
    Category:
    Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Assessing Risk of Material Misstatement, Changes in Reporting Formats, Changes in Reporting Formats