The Role of Key Audit Matters in Assessing Auditor Liability: Evidence from Auditor and Non-auditor Evaluators

Abstract

Abstract Manuscript type: Research paper Research aims: This study examines the effects of key audit matter (KAM) disclosures in the auditor’s report on auditor legal exposure in cases of fraud and error misstatements. Design/Methodology/Approach: The experiment is conducted with the 133 professional auditors from Big 4 audit firms and 134 MBA students as the participants. Research findings: This KAM effect manifests in different ways for different groups. Specifically, auditor participants assess higher auditor liability when misstatement relates to error than when it is connected to fraud. KAM reduces assessed auditor liability only in cases of fraud but not of error. For nonprofessional investor participants, the auditor liability is rated higher in the case of fraud than for error misstatement. Unfortunately, KAM appears to have a nonsignificant impact on auditor liability. Together, the results support the view that instead of increasing legal exposure, as audit practitioners fear, KAM disclosures could actually mitigate and at least do not change auditors’ risk of legal exposure. Theoretical contribution/originality: This study contributes to accounting literature by adding the findings another aspect of KAM in different audit settings: fraud and error misstatements. Moreover, the conflicting evidence on how KAM affect auditor liability warrants further investigation of other audit settings that could alter the impact of KAM disclosures on the assessment of auditor liability. Practitioner/Policy implications: The findings of this study, especially, the nonsignificance of KAM disclosures as evaluated by nonprofessional investors should inform policymakers and related parties that investors need to be educated and better informed about the KAM disclosure and its objectives. Research limitations/Implications: The design of this study did not accommodate setting where the auditors had the opportunity to communicate with peers, which could affect their judgment. This is a general limitation of the experiment, which could be considered somewhat unrealistic because discussions are encouraged among committee members or in a courtroom when making judgments.