Informativeness of Key Audit Matter (KAM) Disclosures: An exploratory study of ISA 701 in Sweden

Abstract

In this study, we examine whether Key Audit Matter (KAM) disclosures are informative in the Swedish setting. Financial stakeholders have long criticized the audit report for being too standardized and neither conveying entity-specific nor relevant information. Stakeholders have pointed out that information, with respect to complex issues, such as accounting estimates associated with estimation uncertainty and management judgment should be communicated by auditors. In response, the International Auditing and Assurance Standards Board (IAASB) in 2015 issued several changes to the audit report. At heart of these changes is the inclusion of KAM, that is supposed to convey information about entity-specific risks, to improve the informativeness of the audit report. By using textual analysis, we (i) measure tone to capture the sentiment and specificity of KAM disclosures and (ii) use a binary index to quantify the specificity level of KAM disclosures. We explore potential determinants that drive variations in the tone and specificity of KAM disclosures in the audit report which in turn yield an indication of whether KAM disclosures are informative. We document that determinants associated with audit firm characteristics and firm financial characteristics drive variations in the tone and specificity of KAM disclosures. Other determinants associated with estimation uncertainty constituting underlying economics such as Total accruals, Number of segments and Industry are not reflected in KAM disclosures. Further, we find that the KAM disclosures do not hold a high level of specificity. Together, these findings suggest that KAM disclosures are limited informative as they do not reflect estimation uncertainty and are only entity-specific to a lesser extent.