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Key audit matter and auditor Key audit

matter and
liability: evidence from auditor auditor liability

evaluators in Thailand
Thanyawee Pratoomsuwan 741
Business Administration Division, Mahidol University International College, Nakorn
Pathom, Thailand and Received 21 October 2019
Revised 20 April 2020
Thammasat Business School, Thammasat University, Bangkok, Thailand, and Accepted 24 May 2020

Orapan Yolrabil
Thammasat Business School, Thammasat University, Bangkok, Thailand

Abstract
Purpose – This study examines the effects of key audit matter (KAM) disclosures in auditors’ reports on
auditor liability in cases of fraud and error misstatements using evaluators with audit experience.
Design/methodology/approach – The experiment is conducted using 174 professional auditors as
participants.
Findings – The participating auditors assess higher auditor liability when misstatements are related to errors
rather than when they are related to fraud. In addition, the results also demonstrate that KAM disclosures
reduce auditor liability only in cases of fraud and not in cases of errors. Together, the results support the view
that KAM reduces the negative affective reactions of evaluators, which in turn, reduce the assessed auditor
liability.
Research limitations/implications – This study did not analyze the setting in which auditors who act as
peer evaluators had an opportunity to discuss the case among their peers, which may have affected their
judgments.
Practical implications – The results of KAM disclosures on auditor liability in cases of error and fraud
misstatements inform auditors that, different from the auditors’ concern that disclosing KAM may increase
auditors’ legal risk, it tends to decrease or at least have no impact on the liability judgment.
Originality/value – This study contributes to the accounting literature by adding findings on another aspect
of KAM in different audit settings, particularly, in the Thai legal environment with different types of
undetected misstatements. The current conflicting results on how KAM disclosures affect auditor liability
warrant further investigation of this issue in other audit contexts in different countries.
Keywords Disclosure, Thailand, Auditor liability, Counterfactual theory, Key audit matter, Misstatements
Paper type Research paper

1. Introduction
The concern about the usefulness of auditor reports has prompted a change to the content of
the standard auditor’s report. The current pass/fail audit report has long been criticized for
having low informational and communication values. In response to this concern, global
audit standard setters, such as the Public Company Accounting Oversight Board (PCAOB) in
the United States and the International Auditing and Assurance Board (IAASB), agreed that
one way to enhance the transparency of the audit process and make audit reports an effective
means of communication is to mandate the audit-specific “Key Audit Matters” [1] (hereafter
referred to as KAM) to communicate those matters that auditors perceive to be the most
important to the users. Specifically, the KAM should address areas that the auditor feels are
complex or subjective, where it is difficult to obtain and evaluate evidence, or that require
Journal of Applied Accounting
significant judgments. Research
In the recent literature, several academic studies have investigated the effect of KAM Vol. 21 No. 4, 2020
pp. 741-762
disclosures on investors’ willingness to invest (e.g. Christensen et al., 2014; Kachelmeier et al., © Emerald Publishing Limited
0967-5426
2014), and another stream of research has attempted to examine its effect on auditor liability DOI 10.1108/JAAR-10-2019-0147
JAAR (e.g. Gimbar et al., 2016; Gimbar et al., 2015; Backof, 2015; Backof et al., 2014; Brasel et al., 2016;
21,4 Brown et al., 2014; Gimbar et al., 2016; Kachelmeier et al., 2014). The conflicting findings are
generally evidenced when investigating the impact of KAM on auditor liability. Most of the
evidence tends to be aligned with the argument that KAM reduces auditor liability. However,
some studies (e.g. Gimbar et al., 2016) have reached the opposite conclusion. These conflicting
results warrant a further investigation on how KAM disclosures affect auditor liability in
different audit settings and legal environments. In support of this notion, Bedard et al. (2016)
742 suggested that more research on whether the findings hold for users with greater levels of
financial and audit expertise will be important and the question of whether the assessed
auditor liability differs for fraud-related versus error-related misstatements remains an issue
worth further investigation (Brasel et al., 2016; Bedard et al., 2016). To fill this gap, this study
attempts to demonstrate whether different types of misstatements (fraud and error) and the
use of evaluators with audit expertise alter the impact of KAM on the assessment of auditor
liability. As opposed to the US legal system that allows for the use of undergraduates as a
proxy for jury-eligible evaluators, Thailand provides a unique legal setting, where auditor
liability judgments are made by an ethical committee that is comprised of professional
auditors with audit experience, not a juror. Expanding KAM works that have focused largely
on the Western context, this paper seeks to widen the debate to an Asian context and to gauge
Thai accounting professionals’ attitudes towards KAM. To the best of our knowledge, this is
among the first studies in Thailand that investigates the effect of KAM on auditor liability in
the context of fraud and error misstatements.
Unlike most studies on KAM, this study provides evidence from auditor evaluators
regarding auditor liability based on publicly available information. Therefore, rather than
focusing on the results of legal litigation, this study investigates the perceptions of auditors of
how KAM may lead to the initiation of litigation against auditors in fraud and error
misstatement settings in Thailand. The results indicate that the assessed auditor liability is
lower when the misstatement is related to fraud rather than when it is related to an error. In
addition, when a KAM disclosure is present in an auditor report, the assessed auditor liability
is even lower. Unfortunately, the disclosure of KAM has no impact on lowering auditor
liability when the misstatement is related to an error, which implies that, from the auditor
evaluators’ point of view, KAM disclosure should not only be viewed as a “disclaimer” for an
auditor’s responsibility (Kachelmeier et al., 2014). The extant research on KAM disclosure
provides conflicting results. In fact, there is no single study that can provide definitive
conclusions. This study does not intend to reconcile these conflicting results. The findings of
this study, at least, provide some evidence to strengthen the previous findings that the
disclosure of KAM is unlikely to increase and, in certain circumstances, could even decrease
auditor liability.
The remainder of this paper is organized as follows: Section 2 discusses the relevant
literature and develops the study’s theory and hypotheses, the methodology is discussed in
Section 3, Section 4 reports the findings with a discussion, and the conclusions and limitations
are provided in Section 5.

2. Literature review
The concern about the effects of auditors’ reports and the wider communication gap that
exists between financial statement users and auditors has led to changes in the auditors’
reporting model (IAASB, 2013). One of the changes is the inclusion of a key audit matter
section in auditors’ reports to increase the information and its relevance and usefulness for
financial statement users. Although auditors believe that KAM will improve users’
understanding of audits, they also have some concerns on whether increased litigation risk
would follow the disclosure of KAM (Katz, 2014; PCAOB, 2011).
2.1 Auditor liability Key audit
Auditors operate in a litigious environment, and auditors who fail to detect material matter and
misstatements are more susceptible to litigation (Brasel et al., 2016). Auditors’ performance
judgments are always difficult to perform since there are no criteria for certain types of audit
auditor liability
tasks (Peecher et al., 2013). Peecher et al., (2013) further noted that, by law, auditors should be
evaluated based on their audit quality rather than the audit outcome. Different from the law,
the outcomes of audit failures, such as a plaintiff’s losses, are highly weighted in liability
judgments (Charron and Lowe, 2008; Hawkins and Hastie, 1990; Jennings et al., 1998). The 743
overreliance on the audit outcome is particularly concerned when judges lack audit
knowledge. As noted in Kadous (2000), lay evaluators have insufficient knowledge and
understanding of the responsibilities of auditors; thus, they rely on the severity of the
consequences of audit failures rather than the quality of the audit work that was performed.
With this limitation, Palmrose (2006) proposed the use of an experienced auditor as the
evaluator in the case of auditor negligence. Reffett et al. (2012) later stated that an auditor
evaluator’s judgments significantly differ from a lay evaluator’s judgments in cases of
alleged auditor negligence. The Thai legal environment allows this study to investigate how
evaluators with audit experience evaluate auditor liability.

2.2 Audit profession and environment in Thailand

The Accountant Association of Thailand was originally established in 1948 and then
renamed the Institute of Certified Accountants and Auditors of Thailand in 1975, prior to
assuming its current name, the Federation of Accounting Professions (FAP), in 2004. For the
past 50 years, the accounting profession has tremendously changed due to the expansion of
the Thai economic environment. Moreover, since the establishment of the Stock Exchange of
Thailand (SET), accounting standards and procedures in Thailand have been profoundly
influenced by the US GAAP and/or the International Accounting Standards (the Stock
Exchange of Thailand Act B.E, 1980). Following the financial crisis in 1997, together with
financial scandals such as those of Unicord, Aphatec Electronics, and the Bangkok Bank of
Commerce, in which irregularities were found in their accounts, the quality of accounting and
auditing standards in Thailand has come under extensive scrutiny (Kuasirikun, 2005).
International organizations such as the World Bank have expressed concern about the
quality of auditing as well as the accounting profession in general. In particular, it is
suggested that Thailand establish an independent organization that has the authority to
draft accounting regulations and monitor and control the behavior of qualified accountants
and auditors (Krungthep-thurakit, 1998). This has led to the proposal of a new Accounting
Professional Act B.E. 2004 for regulating the accounting profession. Under the Accounting
Professions Act B.E. 2547 (2004), the FAP is the only professional accountancy organization
in Thailand and is responsible for regulating the accounting profession under oversight from
the Accounting Professions Regulatory Commission. The main responsibilities of the FAP
include, for example, establishing professional development, setting accounting and auditing
standards, establishing ethical requirements for professional accountants and monitoring the
behavior and operation of registered members in accordance with professional ethics (the
Accounting Professions Act B.E., 2004). Such an outline of the development of Thai
accounting indicates the substantial mainstream economic influence that is exerted upon the
development of the accounting profession in Thailand. Hence, Thai auditors contribute
tremendously to the development of the Thai economy.
In the legal environment of auditors in Thailand, when allegations are made against
auditors, the ethical committee that is appointed by the Federation of Accounting Professions
(FAP) investigates, considers the results of the investigation and penalizes the auditors
accordingly or dismisses the allegation (Code of Ethics Charter, 2017). However, in some
cases, class-action lawsuits may also occur when Thai auditors are accused of negligence.
JAAR Under the Thai Accounting Profession Act B.E. 2547, auditors are not only liable to their
21,4 clients but also to nonclient third parties. This is because the law is intended to increase the
credibility of the auditing profession by showing the auditors’ responsibility to all users of
accounting information. Therefore, the laws and regulations relating to auditors seem to
increase their potential exposure to litigation (Tosakulwan, 2004; Phusitpokai, n.d.). In
Thailand, since most cases are settled out of court, there are very few negligence cases that
are brought to court, and they include the Thai-American Education Foundation
744 (Tosakulwan, 2004) and PricewaterhouseCoopers, the Thanathai Trust Public Company
Limited and Arthur Andersen, and Global One Asset Management and Karin Audit.
Similarly, Donelson et al. (2014) also noted that legal actions against auditors in the US are
often settled out of court and auditors should also be more concerned about public opinion
since this could affect the arbitration process and result in reputational harm. In addition,
Kadous and Mercer (2012) also argued that the study of auditor liability is essential despite
the low percentage of court trials because auditors and plaintiffs consider anticipated trial
outcomes when making settlement decisions.

2.3 Key audit matter in Thailand

The Federation of Accounting Professions (FAP) of Thailand, as a member of the IFAC, has
adopted new audit reports for financial statements issued after December 31, 2016, with the
aim of communicating an informative message, especially in regard to companies’ risks to
investors and to urge management and those charged with governance to pay attention to
risk disclosure Federation of Accounting Professions (FAP) (2015). However, only companies
listed on the Stock Exchange of Thailand are required to use the new audit reports. After the
new auditor reports of listed companies were announced, one of the Thai listed companies
became the “talk of the town.” Its stock price decreased from 69 to 12 Thai Baht (83%).
Financial analysts and investors criticized that the KAMs issued to that company by one of
the Big 4 caused the decline in the stock price (Boonyanet and Promsen, 2018). After the
implementation of KAM, several studies regarding the consequences of KAM, for example,
informational value and firm performance, in Thailand emerged. For example, Srijunpetch
(2017) and Boonyanet and Promsen (2018) used an event study to investigate the effect of
KAM announcements on changes in stock prices and trading volume. The findings indicated
that KAM had no significant impact on stock prices but had a significant and positive impact
on trading volume. Additionally, a recent study from Boonlert-U-Thai et al. (2019) examined
how KAM affects firm performance, audit fees, audit report days, and earnings management.
The results indicate that the number of KAMs is negatively associated with firm performance
and positively associated with audit fees, auditors’ report lead time, and earnings
management. In addition to the investigation on the consequences of KAM, Kitiwong and
Srijunpetch (2019) used Hofstede’s cultural dimensions to explain the characteristics of the
disclosure of KAM in three different countries: Thailand, Malaysia and Singapore. They
particularly focused on two cultural dimensions, namely, uncertainty avoidance and
masculinity. The results show that countries with strong uncertainty avoidance and less
masculinity, such as Thailand, tend to disclose industry-common KAMs rather than entity-
specific KAMs. A possible explanation for their findings is that auditors are more reluctant to
disclose specific KAMs because the consequences of disclosing KAMs remain unclear.

3. Hypotheses development
3.1 The effect of the types of misstatements on the assessment of auditor liability
To develop theoretical support for the hypotheses, counterfactual reasoning, Decision Affect
Theory and the Culpable Control Model (hereafter, CCM) are used. Counterfactual reasoning
postulates how evaluators’ negative feelings are enhanced by an adverse outcome. The Key audit
content of counterfactual thinking is generally expressed in the following sentence: “If X were matter and
different, then the outcome would have been avoided” (Roese and Olson, 1996, p. 201).
Counterfactually, this implies that X causes the outcome. In contrast, if the counterfactual
auditor liability
condition is “Even if X were different, the outcome would have been the same” (Roese and
Olson, 1996, p. 201), then X, in this case, cannot undo the adverse outcome. Therefore, the
causality of X toward the outcome is expected to decrease. In relation to counterfactuality,
decision affect theory (DAT), which is also known as expectation-consistency theory, should 745
predict that the level of counterfactual intensity depends on the outcome of surprise (i.e.
expectation inconsistency), leading to a strong negative response.
The intensity of counterfactual thinking may vary with different degrees of
outcome-expectation inconsistency. The application of counterfactual thinking to the audit
context means that in the case of undetected misstatement, the thought of what auditors
could have done differently to detect the misstatement indicates that it should not have
occurred if auditors performed well during the audit. This causal counterfactual thought
implies that audit failure is somehow caused by auditors. In most cases, intense
counterfactual thought should produce an extreme negative affective response when the
counterfactual alternative is “better” than reality (i.e. it should have been better than it
actually is). However, these two theories do not link the evaluation of the affect and the blame.
The CCM complements this theory since it suggests that individuals spontaneously evaluate
their affective reactions to harmful events and that the people who are involved could
influence their attribution of blame (Alicke, 2000). Regardless of their audit experience,
because liability judgments are frequently biased by evaluators’ affects or emotions (Kadous,
2001), the CCM provides an appropriate base theory that models the emotional factor in the
blame assessment. Taken together, when the counterfactual thought of what the agent
should have done or known is activated by the negative outcome, evaluators tend to not be
able to eliminate the negative affect from their judgments (Alicke, 2000; Alicke et al., 2008;
Alicke and Rose, 2012). As a result, this negative affect should increase the assessed auditor
liability. Figure 1 below illustrates the line of argument for the first hypothesis.
This study argued that, due to their audit knowledge, evaluators are supposed to
understand that fraud barely occurs and is more difficult to detect than errors when they
attempt to conceal them (ISA, 240). As a result, the counterfactual alternative to undoing
fraud-related misstatements is less mutable because evaluators find it to be more difficult to
think of a “better alternative outcome.” Low outcome mutability creates less intensity in their
counterfactual thinking and restricts the further development of counterfactual thinking that
could arouse negative feelings. On the other hand, errors could occur due to, for example,
weak internal control. In this case, it is expected that misstatements due to errors are more
controllable and involve less complicated audit procedures when compared to fraud. This
pattern of thought should result in a higher counterfactual intensity such that a better
outcome could be obtained, which in turn, would generate stronger negative feelings. This
leads to the following hypothesis.
H1. The effect of misstatements related to fraud on auditor liability is lower than that of
misstatements related to errors.

3.2 The effect of KAM on the assessment of auditor liability

Despite the fact that the association between counterfactual thinking and the CCM activates
the identification of the causes of harmful outcomes and affective reactions in the blame
judgment, the evidence of control – for example, an agent taking reasonable precautionary
actions to prevent the harmful outcome – should be taken into account in an evaluator’s
spontaneous evaluation in which it should moderate the negative emotional response and the
JAAR Material misstatement

21,4

Error Fraud

746
Expectation Expectation Counterfactual and
inconsistency consistency Decision Affect
Theory

High counterfactual Low counterfactual

intensity intensity

More negative Less negative

feeling feeling

Culpable Control
Model
Figure 1.
Higher auditor Lower auditor
Line of argument for
liability liability
Hypothesis 1

blame judgment (Heider, 1958; Weiner, 1995; Mandel and Lehman, 1996; Alicke et al., 2008;
Alicke and Rose, 2012). KAM disclosure is argued to represent the objective evidence of the
transparency of the audit procedure and an auditor’s intention to perform a quality audit by
forewarning the public about the difficult matters in the audit (Kachelmeier et al., 2014). In
other studies, it was found that KAM could demonstrate an auditor’s precaution in certain
issues (Backof et al., 2014) and also help to reduce the counterfactual intensity (Brasel et al.,
2016). Therefore, this study predicts that KAM disclosure will reduce the effects of an
auditor’s underlying behaviors that might arouse an evaluator’s negative feelings. The
moderating effect of KAM on the relationship between misstatements and the assessed
auditor liability is separately hypothesized as follows:
H2. The effect of fraud and error misstatements on auditor liability is moderated by
KAM disclosures.

4. Experimental design and methods

4.1 Experimental design
To test the hypothesis, this study employed a 2 3 2 (KAM 3 types of misstatements)
between-subject experimental design. The participants assumed the role of peer evaluators to
determine the liability of an auditor who failed to detect financial misstatements. The
misstatements involve overstated revenues in which the third party relies upon this
information when making decisions. Long-term revenue recognition was selected as the
subject of the KAM in the auditor’s report because it was the most common KAM in the UK
and Thailand (Financial Reporting Council (FRC), 2016; Pratoomsuwan and Yolrabil, 2018) Key audit
and was also frequently noted as having a high risk of litigation (Bonner et al., 1998; matter and
Demirkan and Fuerman, 2014). The manipulation involved different types of misstatements,
specifically fraud- or error-related misstatements. The second manipulation was whether
auditor liability
KAM addressing revenue was present or absent from the auditor’s report. Each of them was
randomly given to the participants in one of the four conditions: (1) NO KAM – ERROR, (2)
NO KAM – FRAUD, (3) KAM – ERROR and (4) KAM – FRAUD.
747
4.2 Participants
The experiment used professional auditors as participants to proxy for the members of the
ethics committee that are responsible when auditors are accused of misconduct. The total
number of participants in this experiment was 195. After excluding the participants who
failed the manipulation check questions, 174 participants were included in the analysis. A
discussion of the manipulation check is included in the results and discussion section.

4.3 Materials and experimental procedures

All participants received the three envelopes. In front of each envelope, the instructions about
how to do the experiment were given. The participants were informed that they had to strictly
read and follow the instructions. The experiment begins with the participants reading the pre-
experiment questions regarding the information in the auditor’s report and their initial
perceptions of the detection risk of misstatements that are related to fraud and errors. The
experimental materials are publicly available information that were adapted from the case
that was used in Kachelmeier et al. (2014), which include (1) the auditor’s report and (2) the
news that was published in a newspaper. Unlike other KAM studies in which the materials
that are used are based on actual court transcripts, the assessment of auditor liability in this
study is an initial judgment rather than the result of litigation. The experimental case
material has three main sections and they were included in three respective envelopes. The
first envelope contains the pre-experimental questions concerning the audit viewpoint and
differentiating between fraud and errors. The second envelope includes the general business
environment, the auditor’s report on the company, the published news, and the main
experiment questions. The manipulation check, demographic and post-experimental
questions were in the third envelope. The participants were instructed to assume the role
of a peer evaluator on the ethics committee. They were asked to record judgments regarding
the likelihood of negligence and auditor liability for misstatements.
While rendering the liability judgment, participants were also informed that they were
allowed to revisit the case material since reviewing documents is common practice in a
liability judgment. Finally, the participants answered several post-experimental questions
regarding their counterfactual thoughts, affective feelings, demographics and a manipulation
check. While answering the questions in the last envelope, the participants were strictly
asked not to review the case material. They were compensated 500 baht in cash for their
participation. The case material was pretested on final-year undergraduate students who
were accounting majors. In addition, the case was also completed and amended according to
the recommendations of two manager-level professional auditors from two of the Big 4 audit
firms. The case material was also back translated and read by accounting faculty members.

4.4 Independent variable

There are two variables that were manipulated in this study. The first manipulation is the
presence and absence of KAM information. In the condition in which the KAM is disclosed,
the participants will see the KAM section in the auditor’s report describing the long-term
JAAR revenue contract and addressing how auditors responded to this matter. In the NO KAM
21,4 condition, the KAM section stated that there was no identified KAM. The first manipulation
aims to examine the differences between the presence and absence of KAM in terms of the
perceived level of professional care and the precautionary actions of the auditors during the
audit. The second manipulation is whether the subsequent material misstatement is fraud or
an error. The information in the news should instruct the participants whether the financial
misstatement is error- or fraud-related. In the fraud condition, participants were informed by
748 the news article that the firm misstated its revenues due to collusive fraud by the
management, subordinates, and customers. In the error condition, the news article reported
that the misstated revenues occurred because management erroneously misinterpreted its
long-term revenues. In addition, fraud and errors were also defined for the participants so that
they would have the same basic understandings of them.

4.5 Dependent variable

The dependent variable of interest is the assessment of auditor liability. Prior studies, such as
Kadous (2000) and Reffett et al. (2012), measured auditor liability using (1) the likelihood of
auditor negligence and (2) monetary damages compensating for plaintiff losses. Many studies
have measured auditor liability by only using the negligence judgment (Grenier et al., 2015;
Brasel et al., 2016; Brown et al., 2014; Backof et al., 2014; Kachelmeier et al., 2014). In this study,
the dependent variable includes both the likelihood of negligence and auditor liability. The
auditor liability measurement was intended to confirm the strength of their responses on the
level of negligence. The first question asks the participants to rate the extent to which the
auditors were likely to be found to be negligent on an 11-point scale. The second question
aimed to measure the liability using an 11-point scale by asking the participants to indicate
how liable the auditors should be for the third-party losses.
Because these two questions are highly correlated since that they pertain to the same
general construct, the composite score was computed to reduce these two questions into one
overall auditor liability variable. The untabulated results show that the correlation between
the likelihood of auditor negligence and the liability for third-party losses is 0.82 and
significant at the 99% confidence level. Therefore, the dependent variable in this study
should measure the overall liability for negligence, which is referred to as “auditor liability.”
The reduction into one dependent variable is calculated by computing the composite score
using the unit weight approach. The literature suggests that when the original variables are
continuous, the unit weight can be used in two ways: by averaging the (unstandardized) raw
scores across variables or by averaging the standardized scores. The latter approach
involves converting all component variables into “z-scores” before applying the unit weight to
prevent the composite from being dominated by a component score with large variances
(Bobko et al., 2007). However, after performing the test using the z-scores as the dependent
variable, the results were not significantly different from those using the original composite
score as the dependent variable. Therefore, the original composite score was used to enhance
the interpretation in this study.

5. Results and discussion of the experiment

5.1 Participants
The participants were 174 professional auditors. The participating professional auditors
represented evaluators with auditing knowledge and expertise. The average audit experience
for the participating auditors was 5 years, with a maximum of 20 years and a minimum of 0.5
years. The average age of the participants was 29 years old. To confirm that the participants
have different perceptions of fraud and error misstatements in terms of the detection risk, a
pre-experimental question asked them to indicate whether fraud is more or less difficult to Key audit
identify in an audit than an error. The result from the pre-experimental questions suggested matter and
that approximately 92% of them believed that fraud is more difficult to detect than an error.
auditor liability
5.2 Manipulation check
To ensure the salience of the manipulations, the manipulation check questions were included
in the post-experiment survey. The manipulation check questions included these: (1) “What
role were you assuming?” (2) “The material misstatement was caused by. . .” and (3) “Does the 749
auditor’s report contain KAM?”
Eighty-nine percent (174 of 195) could correctly identify either the cause of the material
misstatement, the presence of KAM or both. The twenty one unsuccessful participants who
failed the second and third manipulation check questions were removed from the full sample.
The 174 questionnaires that were included in the analysis consisted of participants who failed
either the misstatement question or the KAM manipulation question and participants who
passed all questions. All participants were able to correctly identify their role in the
experiment. To verify that the responses by the participants who failed one of
the manipulation check questions were not systematically different from those who passed
the manipulation check, the analysis was reperformed to include the responses from those
questionnaires. When included, the experimental results were not significantly different.
Table 1 demonstrates the demographic statistics of the sample.

5.3 Hypotheses tests

The planned contrast results that are presented in panel A of Table 2 support the prediction
of H1 that the evaluators perceived misstatements due to errors (Mean 5 6.47) to be more
severe than misstatements due to fraud (Mean 5 4.85), resulting in a higher assessment of
auditor liability (p < 0.001). Thus, the results are consistent with the prediction of H1.

Number of participants
Professional Auditors 195
Less: Participants who incorrectly answered the manipulation check questions (21)
Total useable participants in the analysis 174
Assignment of useable participants to conditions
Fraud/KAM 43
Fraud/ NO KAM 42
Error/KAM 44
Error/NO KAM 45
Total useable participants in the analysis 174
Demographic statistics for the participants
Gender
Male 62 (35.63%)
Female 112 (64.36%)
Years of experience
Mean 6.24
Standard deviation 5.97
Age
Mean 29.00
Standard deviation 6.84
Education
Bachelor degree 149 (85.63%) Table 1.
Master degree 25 (14.37%) Demographic statistics
JAAR Panel A: Mean (Standard deviation) of auditor liability
21,4 KAM NO KAM Total

ERROR 6.14 (1.44) n 5 44 6.79 (1.49) n 5 45 6.47 (1.49) n 5 89

FRAUD 3.88 (2.66) n 5 43 5.85 (1.68) n 5 42 4.85 (2.29) n 5 85
Total 5.00 (2.42) n 5 87 6.31 (1.65) n 5 87 5.66 (2.17) n 5 174

750 Panel B: ANOVA results

Source of variation df F p-value one-tailed

Misstatement 1 30.37 <0.001

KAM 1 20.16 <0.001
Misstatement * KAM 1 18.04 0.013

Panel C: Planned contrast

Contrast t p-value one-tailed

H1 – Error > Fraud 5.20 <0.001

Table 2. H2 – Error/KAM < Error/NO KAM
1.58 0.06
Professional auditor H2 – Fraud/KAM < Fraud/NO KAM
4.77 <0.001
decision regarding Note(s): KAM is the treatment manipulated at two levels: presence of KAM (KAM) and absence of KAM (NO
auditor liability KAM). Misstatement is the treatment manipulated at two levels: error and fraud

H2 involves the prediction of the interaction role of KAM on auditor liability. It is expected
that the presence of KAM in an auditor’s report will reduce the assessment of auditor liability
in both the error and the fraud cases. The results indicated that the interaction term in the
ANOVA result in panel B of Table 2 is significant (p 5 0.013). However, when testing the
fraud and error cases separately, the results from panel C of Table 2 showed that the KAM
reduced auditor liability only in the case of misstatements related to fraud (p < 0.001).
Therefore, the failure to detect fraud results in less blame being attributed to the auditor when
KAM is present than when it is absent.
In the case of misstatements related to errors, the results suggested that although it was in
the predicted direction, the presence of KAM did not lead the evaluators to view auditors as
less liable for error-related misstatements than in the case of no KAM (p 5 0.06). Therefore,
H2 is partially supported. A possible explanation for the insignificant result is that auditors
could generally view misstatements that were caused by errors as more common and
frequent than misstatements that were caused by fraud; thus, the errors should have been
detected during audits. To auditors, a misstatement due to an error might essentially be so
salient that they disregard the additional information from the KAM in the auditor’s report.
As a result, having KAM in the auditor’s report yields no significant difference in the assessed
liability when a material misstatement that is due to an error is subsequently uncovered,
which implies that KAM disclosure does not necessarily have a disclaimer effect for auditor’s
responsibility, at least for the error misstatement case.
Figure 2 demonstrates that the presence of KAM is more sensitive in the case of fraud
misstatements than in that of error misstatements since there is a very minor shift in the
graph for the error case, indicating that KAM is insensitive to the auditor liability judgment in
the error case. The evaluators appear to be more sensitive to KAM disclosure in fraud than in
error cases. In particular, the presence of KAM is more impactful in fraud cases than in error
cases. To test whether this sensitivity is significant, Buckless and Ravenscroft (1990) suggest
that a more effective technique, contrast coding, should be used to test the form of the ordinal
interaction, as depicted in Figure 2.
 8 Key audit
Assessment of auditor liability
7 6.79 matter and
6 6.14 5.84
auditor liability
5
KAM
4
3.88
NO KAM 751
3

1
Error Fraud

Misstatement is a type of undetected misstatement manipulated at two levels – fraud and Figure 2.
error Effect of misstatement
Auditor liability is a composite score of the likelihood of negligence and the liability for type and presence of
third-party losses using the unit weight (average) method. KAM on Auditor
KAM is the disclosure of KAM in the auditor’s report manipulated at two levels – presence liability
of KAM and absence of KAM

In addition to the statistical evidence that was offered by the significant interaction term from
the ANOVA results, the sensitivity of KAM was further examined using contrast coding to
test the interaction between different types of misstatements and KAM. The contrast weights
were assigned as follows: 3,
1, 2 and
4 [2]. The 3 and 2 codes represent the auditor liability
assessments in the error-related misstatement case with the absence and presence of KAM,
respectively, indicating that having KAM in the error case could slightly lower the assessed
liability compared to having no KAM. The
1 and
4 codes represent the liability
assessments in the fraud-related misstatements in the absence and presence of KAM,
respectively. The codes indicate that the liability for fraud misstatement with KAM is lower
than that for misstatement without KAM. The overall contrast test is significant
(t-value 5 7.10, p < 0.001).

5.4 Discussion of results

The presence of KAM in the auditor’s report is expected to reduce the assessment of auditor
liability for both error and fraud misstatement. Using counterfactual theory and decision
affect theory, it could be argued that the evaluator perceives KAM as (1) a warning of
information presented on the financial statements and/or (2) evidence that could be inferred to
the audit process (Kachelmeier et al., 2014) and standard of care (Backof, 2015) taken by the
auditor, including certain precautions during the audit. In this study, KAM tends to reduce
expectation-outcome inconsistency and the intensity of counterfactual thought. Therefore, in
some way, KAM should limit evaluators’ thoughts regarding actions that the auditor could
have taken to avoid unwanted outcomes. Low counterfactual thought should lead to more
positive affective feelings toward the auditor, thus reducing the auditor’s assessment of
liability. As a result, auditor evaluators are expected to rate auditor liability lower when KAM
is present. Surprisingly, only in the fraud case does KAM disclosure reduce the assessed
auditor liability. The results are consistent with the outcome effect phenomenon, which
suggests that individuals usually judge audit quality, in part, based on the adverse outcome
information (i.e. fraud and error misstatements) rather than the quality of the audit. Since
overreliance on audit outcomes is problematic in auditor negligence trials, prior accounting
research has attempted to improve liability judgment by reducing overreliance on outcome
JAAR information (Brown and Solomon, 1987; Kinney and Nelson, 1996; Kadous, 2001; Tan and
21,4 Lipe, 1997; Lowe and Reckers, 1994; Peecher and Piercey, 2008). This outcome information
would not completely influence judgment if the complete set of information about the
auditor’s decision processes is certain or known. However, such conditions are rare in audit
environments. Even the auditors themselves sometimes cannot accurately recall the
information set used to make judgments (Peecher and Piercey, 2008). Therefore, evaluators
should use the outcome information together with other diagnostic signals to assess the
752 quality of auditors’ decision processes (Baron and Hershey, 1988).
Furthermore, it is also noted from Kadous (2001) that in addition to using it as information
to make judgments, the adverse outcome information in the audit setting is at least the result
of an affect-driven process. This implies that evaluators may use their feelings or affect
arising from negative outcomes as heuristically relevant information (Schwarz and Clore,
1983). To the extent that evaluators focus on outcome information, it may dilute the effect of
more relevant information (i.e. audit quality) on evaluation of the auditor. As soon as
evaluators understand that the affect is not the diagnostic of auditor blameworthiness, the
outcome effect should be eliminated. Consistent with this phenomenon, the results of this
study demonstrate that the outcome effect decreases with the presence of KAM, especially
when the misstatement relates to fraud. This implies that the overreliance on outcome
information is mitigated when KAM is present. In this case, the evaluators are willing to
conduct an additional search for more information to explain the adverse outcome, in this
case, the fraud misstatement, and re-adjust the weight they assigned to the outcome
information while making liability judgments. Therefore, KAM causes evaluators to realize
that their affect is not an appropriate basis for judgment about auditor liability. In contrast,
for error misstatements, the inconsistency of evaluators’ expectations and outcomes is
believed to cause evaluators to disregard other diagnostic signals (i.e. KAM disclosure).
Hence, their liability judgments are mainly based on negative audit outcome information.
Taken together, the results demonstrate that the extent to which KAM can reduce auditor
liability is also dependent on the degree of negative affect generated from the consistency
between the evaluator’s expectation and actual outcome. KAM can only play its role in the
fraud case, where the degree of negative feeling is expected to be lower than in the error case.
This pattern of judgment might not be optimal, but whether it should be considered a biased
judgment is beyond the scope of this study.

5.5 Robustness test

The performance judgments are generally determined based on experience and ability
(Libby and Tan, 1994). However, the effect of experience on audit judgments is mixed.
Several prior studies found no experience effect in their studies (Ashton and Brown, 1980).
To avoid the possibility of a confounding effect in which audit experience also influences
the liability judgment, the experience variable was included in the analysis to test whether
the results are robust when controlling for the participant’s audit experience. After
controlling for audit experience, the ANCOVA result (untabulated) shows that audit
experience had no significant impact on the assessment of auditor liability (F 5 1.27,
p 5 0.131, one-tailed. In addition to audit experience being added as a covariate, Grenier
et al. (2018) also suggested that the demographic data of the participants, such as gender,
education and age, should be considered to ensure that they do not significantly vary across
experimental conditions. Although some studies found that demographic information had
no relationship to the decision in liability cases (Lowe and Pany, 1993), other studies
ascertained that some demographics affected liability decisions (e.g. Lower et al., 2002). In
this research context, only gender and age are added as potential covariates because all the
participants tend to have similar educational backgrounds. In addition, prior studies on
auditor liability judgments generally used age and gender as demographic data that could
affect information processing (Chung and Monroe, 2001; Gimbar et al., 2016; Lower et al., Key audit
2002). The ANCOVA was conducted again with the age and gender variables added into the matter and
model. After age and gender were controlled, they did not affect the liability judgment
(p 5 0.117 and 0.241, one-tailed, respectively), while the interactive effect between the
auditor liability
misstatement types and KAM remained significant (p 5 0.018, one-tailed). Overall, these
results suggest that the observed effect on the liability judgment resulted from the auditors’
evaluation of the misstatement type and KAM rather than their experience and
demographic differences. 753

5.6 Additional analysis

The overall results in the previous section indicate that the auditor evaluators in a case of an
error are more likely to hold the auditor liable as opposed to a case of fraud. Fraud-related
misstatements with the presence of KAM in the auditor’s report result in the lowest
assessment of liability. However, these results do not show how the evaluators process KAM
information, which helps to reduce liability. The CCM predicts how the affective reaction to a
harmful outcome influences the blame evaluation. Our study was similar to the study by
Shaver (1985), who used CCM theory to argue that the attribution of blame is not only based
on causal control but also on culpable control or the “deservedness of blame,” which involves
a more subjective evaluation of the agent’s behavior than the arousal of the evaluator’s
negative feelings. Accordingly, the effect of the misstatement type in the evaluation of auditor
liability could be mediated by the affective reaction. However, this mediation effect is
expected to be moderated by the presence of KAM. Since KAM disclosure is argued to reduce
counterfactual intensity, the extent to which the negative feelings could influence the
assessment of auditor liability should decrease.
To test the moderated mediation effect of KAM, the PROCESS macro for SPSS was used
(Hayes, 2012, 2013, 2018). The PROCESS macro is a versatile modeling tool and an add-on
function for SPSS. This macro integrates many functions of existing statistical tools for the
mediation, moderation, and conditional process model (i.e. moderated mediation and
mediated moderation) analysis. To test for moderated mediation, the following steps were
performed: (1) the analysis of the simple mediation effect of the affective reaction on the
relationship of the misstatement type and auditor liability, (2) the analysis of the simple
moderation effect of KAM on the relationship between the misstatement type and the
affective reaction and (3) the analysis of the moderated mediation effect of KAM. Figure 3
illustrates the moderated mediation model. The model depicts the conditional effect of KAM
on the relationship between the misstatement type and affective feelings. To measure their
affective reactions, participants were asked to indicate their feelings towards the auditors and
investors suffering from audit failures on a Likert scale from
10 to 10. For the overall
affective score, feelings towards investors were subtracted from those towards the auditor.
This measure ranged between
20 and 20, where
20 indicated a very pro-plaintiff affective
reaction, 0 indicated a neutral overall affective reaction, and 20 indicated a very pro-auditor
affective reaction (Reffett, 2010). A value of 1 was assigned to fraud-related misstatements
and 0 was assigned to error-related misstatements. For KAM, the variable took the value of 1
in the presence of KAM and 0 otherwise.
The statistics in panel A of Table 3 indicate that the indirect effect of the affective reaction
is significant since the bias-corrected bootstrap confidence intervals based on 10,000 samples
are all below zero (LLCI 5
1.13, ULCI 5
0.47). Additionally, the Sobel test to establish the
mediation effect is also statistically significant (z 5
4.12, p < 0.001). Consistent with the
expectation, the effect of the misstatement type on auditor liability is mediated by
the affective reaction. Panel B of Table 3 reports the simple moderation effect of KAM on the
relationship between the misstatement type and affective reaction. The results show a
positive and significant association between the interaction of the misstatement and KAM on
JAAR
21,4 KAM

754
Misstatement Affective Auditor
type reaction liability

Misstatement refers to the type of undetected misstatement, manipulated at two levels: fraud
and error.
KAM refers to the disclosure of KAM in the auditor’s report, manipulated at two levels: the
presence and absence of KAM.
Affective reaction refers to the participant’s overall affective reaction to the case by
subtracting his/her feelings towards the plaintiff from those towards the auditor ranging from
Figure 3. -20 = very strong pro-plaintiff reaction, 0 = neutral overall reaction, 20 = very strong pro-
Moderated auditor reaction.
mediation model Auditor liability refers to the composite score of the likelihood of negligence and liability
for third-party losses using the unit weight (average) method.

the affective reaction (p 5 0.013). To analyze the moderation effect of KAM, the conditional
effect of a misstatement on the auditor liability assessment for different levels of KAM
suggests that the presence of KAM increases the affective feelings towards the
auditor (p < 0.001).
Panel C of Table 3 reports the results, which includes the moderated mediation model. In
the analysis of the moderated mediation, the findings show indirect conditional effects for
KAM on the affective reaction and misstatement type towards auditor liability. The
moderated mediation results suggested that the lower-and-upper limits of the confidence
intervals for the presence of KAM are all below zero (LLCI 5
1.19, ULCI 5
0.09),
indicating a statistically significant indirect conditional effect for misstatements on auditor
liability through affective reaction. Therefore, it is suggested that KAM moderates the
affective reaction of the evaluator. For the path where the KAM moderates the misstatement
type and affective reaction, the indirect effect of the misstatement type on auditor liability
through KAM is (4.64 þ 3.14KAM)*(
0.16). Specifically, when KAM is 1 (i.e. the presence of
KAM), the assessment of auditor liability in the case of fraud was statistically lower by 1.24 in
comparison to the error case. In the absence of KAM, a fraud-related misstatement decreased
auditor liability by 0.74 compared to an error-related misstatement.

6. Conclusion and implication

In this study, the model and hypotheses were developed using counterfactual reasoning and
the CCM to inform the debate regarding the impact of KAM disclosures on assessments of
auditor liability. The results of this study provide an understanding of KAM disclosure and
test hypotheses about how professional auditors will assess auditor liability given fraud and
error-related material misstatements. The experiment was conducted with participants who
acted as members of an ethics committee. They decided whether an auditor who failed to
detect a material error or fraud is negligent and therefore liable for losses. The results are
essentially consistent with the predictions. When the material misstatement was caused by
fraud, evaluators were likely to assess lower auditor liability than when the misstatement
Panel A: Simple mediation effect
Key audit
Coefficient t-value p-value one-tailed matter and
auditor liability
Dependent variable: Affective reaction
Misstatement 4.66 5.53 <0.001
Dependent variable: Auditor liability
Affective reaction
0.16
6.27 <0.001 755
Misstatement
0.86
2.83 0.003
Dependent variable: Auditor liability
Misstatement
1.62
5.19 <0.001

Effect LLCI ULCI

95% bootstrap CI*

Indirect effect of misstatement on auditor liability through affective reaction

Affective reaction
0.75
1.13
0.47
Sobel test for indirect effect z 5
4.12, p-value < 0.001

Panel B: Simple moderation effect

Coefficient t-value p-value one-tailed

Dependent variable: Affective reaction

Misstatement 4.64 5.81 <0.001
KAM 3.14 3.93 <0.001
Misstatement * KAM 3.60 2.25 0.013
The R-square increase due to interaction (F 5 5.07, p 5 0.013)

KAM Effect t-value p-value one-tailed

Conditional effect of misstatement on affective reaction towards the value of KAM (moderator)
Presence of KAM 6.43 5.71 <0.001
Absence of KAM 2.83 2.49 0.006

Panel C: Moderated mediation analysis on the relationship between misstatement, KAM, and assessment of
auditor liability
Coefficient t-value p-value one-tailed

Dependent variable: Affective reaction

Misstatement 4.64 5.81 <0.001
KAM 3.14 3.93 <0.001
Misstatement * KAM 3.60 2.25 0.013
Dependent variable: Auditor liability
Misstatement
0.86
2.83 0.003
Affective reaction
0.16
6.27 <0.001

Mediator Moderator Effect LLCI ULCI

95% bootstrap CI*

Conditional indirect effect of misstatement on auditor liability towards the value of KAM (moderator)
Affective reaction Presence of KAM
1.04
1.51
0.67
Absence of KAM
0.45
0.88
0.07 Table 3.
Index of moderated mediation
1.19
0.09 Results of moderated
Note(s): *Percentile bootstrap CI based on 10,000 samples mediation analysis
JAAR was caused by an error. However, the KAM reduced liability only when the misstatement was
21,4 related to fraud, not an error. In addition, the evaluators appeared to be more sensitive to the
presence of KAM disclosure given a fraudulent misstatement than an error-related
misstatement. Overall, this study indicates that the effect of KAM on auditor liability is
likely to vary as a function of the characteristics of misstatements. The findings of this study
contribute to the accumulated body of evidence regarding the role of KAM in auditor liability
assessments in different audit and legal settings. This study provides broader evidence by
756 testing KAM from a real KAM disclosure. The results of the experiment suggest that auditors
should not disclose KAM only because of its “disclaimer effect” on their assessed liability as
suggested in Kachelmeier et al. (2014).
In terms of theoretical implications, substantial research has been conducted with the
objective of examining the consequences of KAM disclosure on various stakeholders.
However, much of the previous research showed mixed results, indicating that further
investigations are needed to bring more clarity to the topic. Nevertheless, the effect of KAM
on auditor liability was examined in different stakeholders, for example, investors, financial
analysts, and jurors, but the “auditor” has not been included in previous studies. Particularly
in cases of investigations of “fraud and error misstatements”, to the best of the researchers’
knowledge, few studies have examined the consequences of KAM using two different types
of misstatements: fraud and error. Therefore, our research has filled the gaps in the previous
literature by demonstrating the following.
First, this research elaborates the results in the Thai context, which has the unique
characteristic of having a legal system that allows audit experts to make liability judgments.
The paper, therefore, examines the impact of KAM on auditors and the audit profession. The
findings add to and widen the Western-focused work on KAM and auditor liability by
suggesting that when evaluated by an auditor, KAM can reduce liability only in cases of
fraud but not for error misstatements.
Second, this is among the first papers to examine the impact of auditor liability based on
different types of misstatements: fraud and error. The new findings suggest that different
types of misstatements contribute to the differences in auditor liability judgments, especially
when evaluated by evaluators with auditing knowledge.
For managerial implications, our work significantly benefits auditors, the audit
profession, and standard setters. This study helps alleviate the key concerns of auditors
as to whether KAM practices will affect liabilities that potentially occur after undetected
misstatements. Our findings particularly provide better insight in cases of error, showing
that KAM disclosures will not help reduce auditor liability. Therefore, auditors should be
aware that KAM disclosures have attention-directing impacts on auditors’ liability
assessment, and auditors should carefully decide how many or what matters they disclose
as KAMs in their report.
Moreover, as noted by Peecher et al., (2013), the current process of liability judgment
primarily depends on the audit outcome rather than the audit judgmental process,
especially during a fraud investigation. The findings from this study inform the current
debate concerning the effect of KAM on auditor liability by documenting that the use of
KAM and audit experts as evaluators for liability judgments helps reduce the evaluator’s
overreliance on the outcome, at least in the case of fraud misstatement. With KAM
disclosures, auditor evaluators incorporate the KAM information while making a liability
judgment. However, the nonsignificance of KAM disclosures in the error-related
misstatement continues to suggest that the outcome effect may be difficult to eliminate
in the audit litigation setting. This study confirms that having KAM disclosure as
additional information in terms of the audit process does not reduce the reliance on outcome
information in the performance evaluation, especially when the evaluator’s expectations
and audit outcomes are highly inconsistent. However, whether the outcome effect is
considered “biased” is contextual depending on many factors, for example, an individual’s Key audit
Bayesian probability (Peecher and Piercey, 2008). matter and
Despite its contributions, this study is not without limitations. First, the design of this
study did not incorporate a setting in which the auditors had the opportunity to
auditor liability
communicate with peers, which could affect their judgments. 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.
Second, this research relies on a relatively small sample of subject experts and may not 757
provide a complete view of all audit professionals regarding the KAM reports. Therefore,
the findings only provide the analysis of the impact of KAM from the preparers’
perspective. Last, the results from this study do not imply any possible effects of multiple
KAM disclosures in the same auditor’s report. Future research could examine whether
auditors would have legal incentives to disclose more, as opposed to fewer, KAM. If
multiple KAM disclosures are issued, the question of whether this undermines the intent of
the proposed standard by diluting the impact of more KAM disclosures remains
under-researched.

Notes
1. The Key Audit Matter is referred to as Critical Audit Matter (CAM) in the US Generally Accepted
Accounting Principles (GAAP).
2. The contrast code was assigned based on a contrast code in which the code for error-related
misstatements did not vary much between the absence and the presence of KAM. For the robustness
of the result, a contrast code of 2,
1, 2, and
4 was also tested. The results remained
significant (p < 0.001).

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Appendix 1 Key audit
Primary dependent variable used in the experiment
Measures used in the auditor liability construct: matter and
auditor liability
(1) In your opinion, what is the level of negligence you would assign to the auditor of BB public
company limited in performing audit?
(2) If investors sue the auditor of BB public company limited for the loss from the misstatement,
how liable should the auditor be for that loss? 761
Measures used in the counterfactual thinking construct:
(1) You believe that the other auditor (not related to BB Public Company Limited) could have
detected the revenue misstatement of BB public company limited.
Measures used in the affective reaction construct:
(1) Please indicate your feeling toward the other investors of BB Public Company Limited
(2) Please indicate your feeling toward the other investors of BB Public Company Limited

Appendix 2
Experimental materials
[The following information appeared in all conditions]
Information about BB public company limited
BB public company limited is large technological company engaged in selling electronic equipment
to industrial customers. The company is publicly traded on the Stock Exchange of Thailand and its
financial statements were audited by a certified audit firm. Regarding the financial performance, BB
performance is about average for companies in its industry. However, from your review of management
discussion and analysis and company’s financial statements, the following items caught your attention
(in no particular order). Please note that these items might also be sensitive to the auditors to perform the
audit.
(1) Revenue recognition for long-term contract: Revenue recognition for long-term contract is
highly subjective to the judgment.
(2) Inventory valuation: The BB public company limited must evaluate the obsolescence in
inventory and a subsequent impairment of the asset account because they may have
overestimated their ability to market a new product.
(3) Goodwill: The BB public company limited must evaluate the amount recorded for goodwill to
ensure that the goodwill is not overvalued.
The financial statement of BB public company limited is certified by the auditor and received the
unqualified auditor’s opinion. More than 90% of financial statement of firms traded in Thailand stock
exchange commonly received the unqualified auditor’s opinion.
Extract BB Public Company’s auditor report
Key Audit Matters
[In the “KAM” condition, the KAM disclosure was presented with the following wording]
Key audit matters are those matters that, in our professional judgment, were of most significant in
the audit of the financial statements of the current period. These matters were addressed in the context
of my audit of the financial statements as a whole, and in forming my opinion thereon, and I do not
provide a separate opinion on these matters. The key audit matters and how the matters were addressed
in the audit are described below.
JAAR Key audit matter
21,4
Long-term revenue contract
During the year 2016, the company recognized
revenue from sales under long-term contract totaling
875 million Baht or equivalent to 90 percent of
company’s total revenue. This has the direct impact
762 on profit and loss of the company. With different
conditions of service contracts, there might be the
concern regarding the revenue recognition from this
long-term contract.
I considered this matter as the key audit matter due to
the high value of long-term contract. The provision of
the penalty for the delay and estimated potential
losses are subject to the management consideration.
How the matter was addressed in the audit
I have assessed and tested the company’s internal
controls concerning the sales transactions under bill
and hold arrangement. I read the long-term contract,
make enquiry of responsible executives to gain an
understanding of the specific conditions and examine
supporting documents. I also analyzed the revenue
account using the disaggregate data to observe
whether there was any unusual transaction of
revenue.
Based on the audit procedure above, I found no
material issues arising from my work. The
management interpretation of accounting treatment
for revenue recognition is appropriate.

[In the “NO KAM” condition, the KAM disclosure was replaced with the following wording]
Key audit matters are those matters that, in our professional judgment, were of most significant in
the audit of the financial statements of the current period. These matters were addressed in the context
of my audit of the financial statements as a whole, and in forming my opinion thereon, and I do not
provide a separate opinion on these matters. I have determined that there are no key audit matters to
communicate in the report.
Material misstatement discovered later
(In addition to the auditor’s report, the following information appears in fraud and error
misstatement condition)
A few months after the financial statement and the auditor’s report was issued, an SEC (Security and
Exchange Commission) investigation indicated that the financial statement of BB public company
limited was significantly misstated. The SEC concluded that the company overstated their revenue
pertaining to long-term revenue contract transaction, causing the overstatement of net income.
The misstatement of revenue was caused by the “fraud”. The management together with their
customer and personnel intentionally conceal some information about long-term contracts
[OR the misstatement of revenue is caused by the unintentional “error” in making assumptions and
interpretation of long-term revenue contract].
This revenue overstatement causes the highest BB stock price drop in the last 5 years. More than
200 investors suffered from losing all of their savings from the investment. This group of investors now
plans to sue the management and the auditor of BB public company limited to compensate for their
losses.

Corresponding author
Thanyawee Pratoomsuwan can be contacted at: thanyawee.pra@mahidol.ac.th

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