The Economic Consequences Of Key Audit Matters Standard

The audit report is an important link between auditors and the users for information communication,which plays an important role in reducing information asymmetry and improving the efficiency of capital market operation.After the financial crisis,traditional audit repor model is controversial: users expect to obtain information about the audited entity and audit process through audit reports,however,the traditional audit reports with fixed format,unified content and homogenization of opinion types,not only lack individualized disclosure of the audited entity,but also present audit results only,without mentioning audit process,which brings out an information gap between the information needs of users and the information supply of audit reports,and the call for reform of audit reports has become increasingly strong.In order to response to the information needs of users and to reduce the information gap,the new round of audit report reforms has being carried out worldwide.The UK took the lead in implementing audit report reforms since 2013;the International Accreditation and Auditing Standards Board issued revised auditing standards to reform the traditional audit reporting model in 2015;the US Public Company Accounting Oversight Board also launched audit report reform process in 2017.In order to follow up the international trend of audit report reform,and achieve international convergence of the audit standards continuously,Chinese Ministry of Finance issued 12 new auditing standards,including ?Chinese CPA Auditing Standard No.1504 – Communicating Key Audit Matters in Audit Reports?(hereinafter referred to as ?KAM standard?)on December 23 th in 2016.The new audit standards have been piloted by A and H shares listed companies since January first 2017,and have been fully implemented in other listed companies from the beginning of 2018.The core change of new audit standards is that auditors are required to disclose KAM in audit reports,describing the most important matters and the corresponding audit procedures,in order to increase the transparency of audit process and improve the communication value of audit reports.With the advancement of the audit report reform,how is the implementation of Chinese KAM standard? What are the economic consequences of the implementation of the KAM standard? In particular,as the executor of the auditing standards,the supplier of the audit report information,do auditors change their behavior after the implementation of the KAM standard;as the caller of this reform,the demand side of the audit report information,do investors obtained incremental information for decision-making through new audit reports? A series of questions are worthy of systematic analysis and empirical testing.So this paper chooses the perspectives of auditors‘ behavior and investors‘ decision-making to study the economic consequences of the implementation of KAM standard,based on the institutional background of Chinese audit report reform,aiming to provide empirical evidences for comprehensive evaluation of the audit report reform effect and response to the original intention of the reform.Combining the theories of auditing,economics and psychology,using the methods of normative analysis and empirical testing,this thesis study the implementation and its impact of KAM standard.Specifically,the existing literature on economic consequences of audit standards changes and the disclosure of KAM are reviewed firstly,to grasp the research dynamics and development trends,and clarify the entry points of this study.Secondly,the international dynamics and Chinese practice of the audit report reform is introduced,and the theoretical basis and logical framework of the impact of KAM standard implementation on auditors‘ behavior and investor‘ decision-making is expounded using expectation gap theory,information gap theory,signal transmission theory,insurance theory and guilty control theory.Then,a statistical analysis and a questionnaire about the KAM standard implementation is carried out,and the economic consequences of the KAM standard implementation and the impact mechanisms are empirically tested,from the perspectives of auditors‘ behavior and investor‘ decision-making,based on the date of Chinese listed companies during the period of 2016-2017.Finally,policy recommendations to improve the KAM standard implementation are presented,based on research findings.The main conclusions are as follows:First,the implementation situation of Chinese KAM standard.A statistical analysis about the KAM disclosure status of Chinese listed companies during the 2016-2017 is carried out,the results show that:(1)the KAM is mainly disloused in the form of text,supplemented by forms;(2)the number of KAM is mostly no more than 3,which is generally small;(3)the types of KAM cover a wide range of areas,but highly concentrated on asset impairment and revenue recognition,and the industry characteristics are very obvious;(4)the content elements of KAM are relatively complete,but the length of the text varies,the accuracy of the description of the matters,the logic of the audit process,the clarity of the audit results are different,and the level of disclosure is uneven;(5)compared with the UK,the quantity and types of KAM disclosed in China diverse less;(6)the KAM of A and H share listed companies repeated frequently.The questionnaire about KAM standard implementation and public‘s evaluation of KAM disclosure shows that:(1)the principle-oriented KAM standard increases the difficulty of writing new audit reports;(2)many auditors are cautious and learn from each other or imitate,when disclosing KAM;(3)regulatory risk and customer termination risk are important factors that auditors take into consideration;(4)audit firms have played an active role in the application of KAM standard;(5)the disclosure of KAM has received attention and recognition of the public,however,the number and types of KAM are lower than users‘ expectations,and also the gap between users‘ information require and the content of KAM that describe matters and audit response procedure is also exist.Second,the impact of KAM standard implementation on auditors‘ behavior.For the perspective of audit quality,it reveals that:(1)compared with control companies,the accrued earnings management of A and H share listed companies is significantly inhibited,after the implementation of KAM standard,which means the disclosure of KAM prompted auditors to be more cautious in their practice,reduce tolerance for earnings management,and significantly improve audit quality;(2)the impact of KAM standard implementation on audit quality is mainly existed in non-industry specialties and firms that rely heavily on customers,that is to say,auditor industry expertise and customer importance are important factors affect the relationship between the KAM standard implementation and audit quality;(3)when auditors focus on the impairment of accounts receivable and revenue recognition,the audit quality is higher,indicating that the risk of material misstatement in matters of impairment of accounts receivable and income recognition are high,paying more attention to these matters can help to control the detective risks and improve audit quality.For the perspective of audit fee,it shows that:(1)audit fees have increased significantly after the implementation of KAM standard,which means the disclosure of KAM increases auditors‘ legal liability risk,so that auditors add audit costs and inputs,improve audit quality,and raise risk premiums in order to deal with potential losses,thereby promoting audit fees;(2)the impact of KAM standard implementation on audit fees is mainly reflected in the cases of non-big4 firms and a better legal environment,indicating that the impact of KAM standard implementation on audit fees varies from the types of firms,and depend on a good legal environment;(3)the audit fees are higher,when more matters and more complex text is disclosed,that is to say the specific disclosures of KAM affect audit fees;(4)when auditor focuses on the impairment of accounts receivable,impairment of fixed assets,impairment of goodwill and income recognition,the audit fees are higher,which means the types of KAM have an influence on audit fees.This may be related to the higher added audit costs or an additional risk premium of these matters.Third,the impact of KAM standard implementation on investors‘ decision-making.From the perspective of value relevance of earnings,this thesis tests the impact of KAM disclosure on the usefulness of accounting earnings assessed by investors and finds that:(1)compared with control companies,the value relevance of earnings decrease significantly,after A and H share listed companies disclose KAM,which means the KAM disclosure enhances the level of corporate risk and earnings uncertainty perceived by investors,attracts parts of investors‘ attention from earnings,and reduces the dependence on earnings in investor stock pricing decisions;(2)the impact of KAM disclosure on investors‘ decision-making is more significant in the case of a high degree of information asymmetry,indicating that the decision value of KAM is higher in the poor information environment than a better information environment.(3)the value relevance of earnings decrease significantly when KAM are disclosed with more items,longer paragraphs,poorer readability,and higher accuracy,that is to say the quality and textual characteristics of KAM affect its communication value;(4)when impairment of fixed assets,impairment of goodwill and impairment of inventories are disclosed as KAM,the value relevance of earnings decrease significantly,meaning that the disclosure of above matters in KAM can attract investors‘ attention,guide investors to pay attention to the high-risk areas of financial statements,improve the level of risk and uncertainty of earnings perceived by investors,thus reduce the usefuless of earnings in stock pricing decisions.The conclusions of the thesis indicate that the implementation of KAM standard significantly affects auditors‘ behavior and investors‘ decision-making in China.On one hand,the disclosure of KAM increases transparency of audit process,prompting auditors to be more cautious in their practice,thereby improving audit quality and audit fees;on the other hand,the disclosure of KAM provides incremental information related to investors‘ decision-making,which improve the communication value of the audit reports significantly.The effect of Chinese audit report reform has begun to appear.However,there are still some difficulties and problems in the application of Chinese KAM standard,which limits the continuous improvement of information content of audit reports.To this end,it is recommended that the standards-setting institution should improve relevant provisions of KAM standard;the regulatory authorities should pay close attention to the auditors‘ practice and the implementation of KAM standard;the audit firms should provide more guidance,supervision and review of information disclosure on KAM;auditors should try to improve the disclosure of KAM,and investors should interpret KAM rationally.The contributions of this thesis are as follows:(1)the worldwide evaluation about effectiveness of the audit report reform has been supplemented with important empirical evidences from the Chinese market.(2)the research perspective in related fields has been expanded through testing the impact of the KAM standard implementation on auditors‘ behavior and investors‘ decision-making.Researches about the economic consequences of KAM disclosure mainly focus on investors‘ decision-making,such as cumulative abnormal returns and stock price synchronicity,however,few literature choose the perspective of auditors‘ behavior to discuss.This paper examines the impact of the KAM standard implementation on audit quality and audit fees,and selects the value relevance of earnings as an entry point to test the impact of the KAM standard implementation on investors‘ decision-making,which expands the research perspective of the economic consequences of KAM disclosure.(3)the existing research content is enriched through exploring the KAM standard implementation and its impact mechanism as well as the role path of auditors‘ behavior and investors‘ decision-making.Distinguishing the characteristics of audit firms,legal environment,information environment,and the specific disclosure of KAM,this paper examines the impact of the KAM standard implementation on auditors‘ behavior and investors‘ decision-making,which not only helps to systematically evaluate the economic consequences of the implementation of KAM standard,facilitate the participants of capital market to interpret KAM thoroughly,but also provides a useful reference for better advancing audit report reform.