Abstract

This study examines whether the disclosure of critical audit matters (CAMs) in the expanded audit report in China is associated with an increase in audited financial statement quality. Specifically, we predict and find that timeliness of goodwill impairment by Chinese listed firms increased after the disclosure of CAMs related to goodwill. This finding is consistent with theory that suggests auditors have incentives to expend more effort after CAM disclosure in settings where the financial reporting quality environment is weak, such as China, which in turn leads to improved audited financial statement quality. In contrast, we do not find similar increases in goodwill impairment timeliness for Chinese firms that cross list in Hong Kong and for firms in UK, where the financial reporting quality environment is strong. We also find that auditors’ disclosure of goodwill CAMs in China leads to higher auditor fees, which provides support for increased audit effort being the channel through which audited financial statement quality improves. Taken together, these findings suggest that the efficacy of the expanded audit report depends on auditors having incentives to expend effort when enforcing the new regulations.

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• Keyword(s):
• accounting 109
• financial reporting 14