Article2019

The Forewarning Effect of Critical Audit Matter Disclosures Involving Measurement Uncertainty*

Steven J. Kachelmeier · Dan Rimkus · Jaime J. Schmidt · Kristen Valentine

195 citations0/0 files storedContemporary Accounting Research

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Auditing, Earnings Management, Governance Accounting Theory and Financial Reporting Corporate Governance and Financial Management

Abstract

ABSTRACT We present experimental evidence suggesting that critical audit matter (CAM) disclosures in the auditor's report involving areas of high measurement uncertainty forewarn users of misstatement risk. Specifically, in our first study with MBA students, financial analysts, and attorneys, we find that CAMs (i) lower premisstatement assessments of confidence in the financial statement area disclosed as a CAM, and (ii) lower assessments of auditor responsibility for a subsequently revealed misstatement in a CAM‐related area. In our second study with student participants proxying as mock jurors, we find that the responsibility‐mitigating effect of CAM disclosure is driven by CAM disclosures involving measurement uncertainty, as opposed to CAM disclosures involving categorical determinations. Combined, our findings help reconcile mixed evidence from prior research, supporting the view that the forewarning effect of CAM disclosures involving measurement uncertainty could mitigate perceived auditor responsibility for CAM‐related material misstatements.

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References

2013Inside the 'Black Box' of Sell-Side Financial Analysts 1996What might have been: the social psychology of counterfactual thinking 2014Do Critical Audit Matter Paragraphs in the Audit Report Change Nonprofessional Investors' Decision to Invest?2016Risk Disclosure Preceding Negative Outcomes: The Effects of Reporting Critical Audit Matters on Judgments of Auditor Liability 2012Extreme Estimation Uncertainty in Fair Value Estimates: Implications for Audit Assurance 2016The Effects of Critical Audit Matter Paragraphs and Accounting Standard Precision on Auditor Liability 1997When doing better means feeling worse: The effects of categorical cutoff points on counterfactual thinking and satisfaction.

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