Investigating recent audit reform in the Australian context: An analysis of the KAM disclosures in audit reports 2017–2018

• Author: Michael Kend,Lan Anh Nguyen
• Date: 01 November 2020
• Published date: 01 November 2020
• DOI: http://doi.org/10.1111/ijau.12205

ORIGINAL ARTICLE

Investigating recent audit reform in the Australian context: An

analysis of the KAM disclosures in audit reports 2017–2018

Michael Kend | Lan Anh Nguyen

RMIT University, Australia

Correspondence

Michael Kend, School of Accounting, RMIT

University, Melbourne VIC 3000 Australia.

Email: michael.kend@rmit.edu.au

Funding information

Accounting and Finance Association of

Australia and New Zealand, Grant/Award

Number: Research Grants Scheme 2018;

AFAANZ; CPA Australia, Grant/Award

Number: Global Perspectives Research Grant

Scheme 2018

The aim of this study is to explore the new Australian auditing regulations around

Key Audit Matters (KAMs), fully adopted since 2017, by reporting on matters publi-

shed in over 3,000 Australian statutory audit reports from 2017 to and including

2018 reports. The study provides the first evidence on whether auditors used the

same or different disclosures related to audit procedures when reporting on the same

KAM in the second year in Australia. The findings suggest the most common KAM

disclosures are related to “impairments of goodwill and intangible assets,”“revenue

recognition,”“asset valuation,”“acquisitions,”and “exploration and evaluation.”

Around 70% of Australian auditees had the same KAMs disclosed in both years 2017

and 2018. The study found differences between large and small audit practitioners

related to the average number of KAMs disclosed and the average number of audit

procedures undertaken per KAM. There were also differences found between indus-

tries and auditee size.

KEYWORDS

Audit Firms, Audit Markets, External Audit, Key Audit Matters

1|INTRODUCTION

The traditional audit report was considered to contribute to the audit

expectation gap, and its standardized form and language detracted

from its usefulness (Humphrey, Loft, & Woods, 2009). Users viewed

the audit report as a pass/fail document of little relevance (Mock

et al., 2012) or as a symbol with little communication value (Almulla &

Bradbury, 2019). Regulators such as the International Auditing and

Assurance Standards Board (IAASB) and the Public Company

Accounting Oversight Board (PCAOB) in the United States identified

user demand for more information in the auditor's report instead of

the established “pass”or “fail”opinion (Li, Hay, & Lau, 2018). The most

notable feature of the new form reports is a section termed key audit

matters (KAMs). The purpose of KAMs is to disclose financial

reporting risks, thereby enhancing the communication value of the

audit report. KAMs are financial reporting matters that, in the

auditor's professional judgment, require significant auditor attention

during the audit (Auditing Standard ASA/ISA (701), 2015). KAMs are

determined from the same pool of matters communicated to those

charged with governance (ISA 701, para. 7) and require auditors to

consider issues where there is a high risk of misstatement, where

there is significant management judgment, and where the effect of a

transaction is significant. When disclosing KAMs, the standard

requires the auditor to explain why the matter is important, how it

was addressed, and to reference any relevant financial statement

disclosures. Some researchers and commentators believe that the

new audit reporting requirements are likely to increase auditor's

accountability and professional skepticism, which should result in

improved audit quality (IAASB, 2013; Peecher, Solomon, &

Trotman, 2013). Others suggest that the new audit reporting

requirements may impose additional pressure on auditors, and thus

have an adverse effect on audit quality (KPMG, 2015). These mixed

views ensure (and the uncertainty they create) research is needed to

explore the informational value of KAMs, their impact on audit quality

and whether any further reforms are required to audit reports.

The new auditing standard ISA 701 applies to audits of complete

sets of general purpose financial statements of listed entities and

when the auditor otherwise decides to communicate KAMs in the

auditor's report (Pratt, 2016). KAMs are selected from matters

communicated with those charged with governance and are

Received: 10 January 2020 Revised: 10 July 2020 Accepted: 27 August 2020

DOI: 10.1111/ijau.12205

412 © 2020 John Wiley & Sons Ltd Int J Audit. 2020;24:412–430.wileyonlinelibrary.com/journal/ijau

determined by considering areas of higher risk; significant auditor

judgments; and the effect on the audit of significant events or trans-

actions (Pratt, 2016). In describing KAMs in the auditor's report, the

auditor is required to include the reason a matter was considered a

KAM and how the auditor dealt with the matter. The overall objective

of these expected improvements in audit reporting (i.e., the reporting

of KAMs) was to respond to calls for auditors to provide more

relevant information to users based on the audit that was performed.

Accordingly, the new requirements and layout are aimed at enhancing

the informational value of the auditor's report to shareholders in

Australia (Pratt, 2016).

The aim of the study is to explore the new Australian auditing

regulation around KAMs, fully adopted since 2017, by reporting on

matters published in over 3,000 Australian statutory audit reports

from both years 2017 and 2018. We employ textual analysis (specifi-

cally partial latent semantic analysis) at the word level by initially run-

ning a frequency test for large and small auditors and then using

concept links for KAMs. Then we conduct a topic extraction analysis

in order to examine whether there are systematic differences

between large and small auditors regarding the KAMs and audit pro-

cedures they use. By investigating the changes in the audit proce-

dures (2017 and 2018), after the initial year of implementation (of the

KAMs reform) and in the second year, the study will provide initial

evidence on whether auditors used the same or different disclosures

related to audit procedures when reporting on the same KAM in the

second year. The main research questions developed for this study

are:RQ1 What are the observable differences between larger/smaller

auditors, different industries and larger/smaller-sized audit clients

when investigating reported KAMs in Australia during the initial two

years of implementation (i.e., 2017 and 2018)?

RQ2 In the initial two years of implementation in Australia, do

reported KAMs (that are repeated in both years) convey any changes

in the accompanying disclosed audit procedures?

The data was analyzed to find differences between auditors of

similar or different sizes, different industries, and among similar-sized

audit clients. Around 70% of Australian auditees had the same KAMs

disclosed in both years 2017 and 2018. The study found differences

between large and small audit practitioners related to the average

number of KAMs disclosed and the average number of audit proce-

dures undertaken per KAM. There were also differences found

between industries and auditee size. This investigation has implica-

tions for stakeholders impacted by new Australian audit reforms, as

our findings will help them to understand if the disclosure and

reporting of KAMs has improved the usefulness and relevance of

audit reports. This present study will help regulators, standard setters,

and other stakeholders understand what observed changes in audit

reporting had occurred in 2017 and 2018.

Thus, the in-depth level of analysis of this study should help

inform regulators and standard setters on the informational value of

KAMs. It will assist them in determining whether more regulatory

intervention is required. For the audit report preparers, the study has

the potential to inform auditors on the overall outcomes of this

reform in Australia. The study would allow auditors to reevaluate their

implementation of the KAMs reform given the new knowledge that

will be provided by our research findings. Our study will make contri-

butions such as indicating that Australian audit firms have complied

with the recommendations from the IAASB (2013), and ISA 701. Our

findings can also be compared with prior studies, such as Bédard,

Coram, Espahbodi, and Mock (2016), that examine the extent of

KAMs disclosures in the audit report to determine whether KAMs are

very much dependent on the audit firms' approach to the audit pro-

cess and on the auditors' judgment. This present study will have policy

implications by contributing to the debate on auditors' reforms in the

wake of the corporate collapses of the early 2000s, the Global Finan-

cial Crisis (GFC), and the Hayne Royal Commission into Banking and

Financial Services (2019) in Australia.

In the next section, we provide a review of prior research, on

KAMs specifically. The description of the sample and research meth-

odology adopted in the study is then presented, including a discussion

of the study's research questions. This is followed by an analysis of

the findings. The final part of the article concludes and discusses the

implication of the research including limitations.

2|LITERATURE REVIEW AND

THEORETICAL FRAMEWORK

2.1 |Research on KAM disclosures: Their positive

and negative impacts on auditing

Prior research conducted in the auditing field conveyed concern about

the quality of the audit reports and labeled disclosures within those

reports as inadequate (Church, Davis, & McCracken, 2008; Guiral-

Contreras, Gonzalo-Angulo, & Rodgers, 2007; Vanstraelen,

Schelleman, Meuwissen, & Hofmann, 2012). Further research

highlighted the need to enhance the quality of those reports by pro-

viding higher quality information (Dobija, Cie

slak, & Iwu

c, 2013;

Kranacher, 2011; Turner, Mock, Coram, & Gray, 2010). In response to

these calls, regulators and standard setters (such as the International

Auditing and Assurance Standards Board - IAASB) developed new

standards. In December 2015, the new standard (ISA 701), on Key

Audit Matters in the Independent Auditor's Report, was released.

According to IAS 701, the inclusion of key audit matters in the audit

report is an important concept that extends the auditor's role and

requires the disclosure of the most significant risks facing the client in

the audit opinion. It is expected that KAMs will “increase the promi-

nence of potentially valuable information”(PCAOB, 2013, para. 16;

Sirois, Bédard, & Bera, 2018) in the auditor's report and enhance the

users' “ability to navigate and better understand increasingly complex

financial reports”(IAASB, 2012, para. 9).

Christensen, Glover, and Wolfe (2014) consider KAM disclosures

as concise and more easily accessible disclosures more so than any

other underlying financial statement disclosures. The introduction of

KAM disclosures in audit reports potentially increase the transparency

of the auditors' report (Reid, 2015). Another study, Cordos¸ and

Fülöp (2015), concluded that KAM disclosures are an important

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