The Importance of Topical Content in Understanding Expanded Audit Reporting : Evidence from Tax-Related Key Audit Matters

This study examines determinants and consequences of auditors' tax-related key audit matter (KAM) disclosures. We argue that to investigate whether KAMs provide information and affect firm behavior it is important to examine determinants and consequences that map into the specific topic of the KAM. Tax KAMs provide an excellent setting for such investigation because tax expense is material to most firms' financial statements, there is substantial risk associated with the tax function, and tax KAMs are prevalent and discuss a diverse range of issues. Consistent with tax avoidance and tax risk increasing the difficulty of auditing tax expense, we find that firms with greater tax avoidance, more volatile effective tax rates (ETRs), and larger deferred tax asset (DTA) balances are more likely to receive tax-related KAMs. With respect to the consequences of tax KAMs, we find that the market discounts the DTAs of tax KAM firms, and that firms that stop receiving tax KAMs increase their purchases of auditor-provided tax services and increase their tax avoidance, consistent with an improvement in the firm's tax function. Overall, we provide evidence that tax KAMs contain information about firms' tax avoidance and that markets and firms significantly change their behavior in response to tax-related KAMs