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    The Effects of Critical Audit Matter Paragraphs and...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 12.0 Accountants’ Reports and Reporting, 12.05 Changes in Reporting Formats 
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    Title:
    The Effects of Critical Audit Matter Paragraphs and Accounting Standard Precision on Auditor Liability
    Practical Implications:

    These results provide new insight into conflicting results in contemporaneous studies that investigate the relationship between CAMS and auditor liability. The results will also be informative to the PCAOB and SEC because they highlight a potential unintended consequence of the proposed audit reporting model and reinforce the importance of the two oversight bodies considering the relationship between their regulatory actions. 

    Citation:

    Gimbar, C., B. Hansen and M. E. Ozlanski. 2016. The Effects of Critical Audit Matter Paragraphs and Accounting Standard Precision on Auditor Liability. The Accounting Review 91 (6): 1629 – 1646.

    Keywords:
    PCAOB, audit reporting, auditor litigation, critical audit matter (CAMs), and accounting standard precision
    Purpose of the Study:

    The PCAOB is currently considering substantial changes to the audit reporting model that would require auditors to disclose critical audit matters (CAMs) in the audit report. CAMs discuss areas of the audit that required a significant amount of professional judgment to evaluate appropriately or that posed the most difficulty in obtaining and evaluating evidence. Although this additional disclosure is expected to increase the information content of the audit report for investors, several interest groups have expressed concerns that CAMs will also increase the audit profession’s liability risks. In addition, the SEC, FASB and IASB have the potential to make sweeping changes to accounting standards in the coming years. These changes have the potential to significantly impact assessments of auditor liability. The purpose of this study is to investigate how jurors’ perceptions of auditor liability are affected by CAMs, accounting standard precision, and the interaction between CAMs and accounting standard precision. 

    Design/Method/ Approach:

    The authors use an experiment in which participants, acting the role of jurors, evaluate auditor liability for an alleged misstatement of financial statements due to inaccurate lease reporting and the subsequent bankruptcy of an audit client.  Following the experiment, the authors use mediation analysis to provide additional evidence regarding participants’ decision making underlying the hypothesized and observed significant association between auditor liability under precise accounting standards and both related and unrelated CAMs. 

    Findings:
    • The authors find that when no CAM is present, the participants have a lower propensity to issue verdicts against the auditor when the client’s accounting conforms to a precise standard than under an imprecise standard with the same accounting treatment.
    • The authors find that under precise standards and an accounting treatment that meets the letter of the law, both related and unrelated CAMs increase auditor liability.
    • The authors observe an interaction between standard precision and CAMs such that CAMs increase auditor liability by a lesser amount under imprecise standards than precise standards.
    • The authors find that, under precise accounting standards, related CAMs increase jurors’ assessments of the auditor’s control over financial reporting, and this increased level of perceived control mediates the relationship between related CAMs and jurors’ assessments of the auditor’s liability.
    • The authors find that unrelated CAMs are significantly associated with a decrease in participants’ evaluation of the audit performed, and this result mediates the relationship between unrelated CAMs and auditor liability under precise standards. 
    Category:
    Accountants' Reporting, Standard Setting
    Sub-category:
    Changes in Reporting Formats, Impact of PCAOB