Can Critical Audit Matters Be a Signal of Poor Accruals Quality?

Abstract

SUMMARY We investigate the relationship between critical audit matters (CAMs) and accruals quality. We find that companies with a higher number of CAMs in their audit reports are associated with poorer accruals quality, and this association appears to be driven by recurring rather than nonrecurring CAMs. An examination of specific CAM topics shows that revenue CAMs are associated with lower revenue-related accruals quality, and tax CAMs are associated with poorer tax-related accruals quality, suggesting that CAMs are indicators of poor accruals quality. A cross-sectional analysis shows that the CAM signal about poor accruals quality is attenuated for companies when the information environment is richer, suggesting that a rich information environment restrains the use of discretion in accruals estimation such that CAMs no longer indicate poor accruals quality. Overall, our findings suggest that CAMs can provide a relevant signal of financial reporting quality in certain circumstances. JEL Classifications: M41; M42; M48.

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