The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1321-7348.htm

Measurement uncertainty and Measurement

uncertainty and
management bias in accounting management
bias
estimates: the perspective of key
audit matters reported by Chinese
firms’ auditors Received 9 July 2020
Revised 16 September 2020
3 November 2020
Chee Kwong Lau 24 November 2020
Accepted 24 November 2020
University of Nottingham Malaysia, Semenyih, Malaysia

Abstract
Purpose – This study examines (1) the extent of key audit matters (KAMs) reported by auditors is related to
accounting estimates, (2) whether measurement uncertainty and management bias affect auditors to do so and
(3) whether the use of accounting estimates, given the measurement uncertainty and management bias reported
in KAMs adversely affects the decision usefulness of accounting information.
Design/methodology/approach – Data on key audit matters, accounting estimates, measurement
uncertainty, management bias, etc. were collected from the auditor’s reports of 351 sample Chinese listed
firms. It employs regression analyses to assess the hypotheses on issues affecting the report of these key audit
matters and the impacts on the decision usefulness of accounting information.
Findings – Fair value and impairment loss estimations make up of 2.6 and 44.1% of the 606 KAMs identified,
respectively. Measurement uncertainty is positively, while management bias is negatively, affecting auditors
report KAMs related to accounting estimates. The use of accounting estimates in firms where their auditors
reported the KAMs related to accounting estimates does not enhance the value and predictive relevance of
reported earnings. The assurance works on, and reporting of, KAMs served as a “red flag” about the accounting
estimates.
Practical implications – The use of accounting estimates does not always lead to enhanced decision-useful
accounting information. Auditors, in their stewardship role, shall ensure that the measurement uncertainty
issue is appropriately identified, addressed and verified. In addition, they shall provide an effective check-and-
balance to the accounting discretion managers have in providing decision-useful information from
opportunistic reporting.
Originality/value – This study examines the proposition that while the use of estimates can enhance the
decision usefulness of accounting information, it can also induce measurement uncertainty and management
bias into financial reporting.
Keywords Accounting estimates, Measurement uncertainty, Management bias, Decision usefulness,
Key audit matters
Paper type Research paper

1. Introduction
Accounting estimates are becoming increasingly important in financial statements and are
expected to enhance the decision usefulness of accounting information (see Griffin et al., 2015;
IASB, 2018). However, their use is associated with two fundamental issues: measurement
uncertainty and management bias. This study seeks to examine the two fundamental issues
concerning the use of accounting estimates in practice from the auditors’ perspective, as
reported in key audit matters (KAMs). The recent requirement for auditors to report KAMs
creates a natural experiment (see Perez-Gonzalez and Yun, 2013) to examine the two
fundamental issues. The first question, which this study addresses, is to what extent the
KAMs identified and reported by auditors are related to accounting estimates. If so, the
second question is whether measurement uncertainty and management bias affect auditors Asian Review of Accounting
in identifying and reporting these KAMs related to accounting estimates. These lead to the © Emerald Publishing Limited
1321-7348
third question, that is whether the use of accounting estimates, given the measurement DOI 10.1108/ARA-07-2020-0109
ARA uncertainty and management bias reported in KAMs, adversely affects (or enhances) the
decision usefulness of the accounting information.
If managers are given discretion to estimate, auditors need to provide assurance that these
estimates are “true and fair”. In their statutory role, auditors possess private information
about the firms they audit. They are expected to be professional, unbiased and independent
and hence in a fair position to identify and address financial reporting issues. Past studies
provide empirical evidence that the quality of audit work and assurance services positively
contributes to the quality of accounting information (see Watkins et al., 2004). In fact, Gaynor
et al. (2016) propose a comprehensive recursive relation between audit quality and accounting
quality from the perspectives of people, task and environment. Ewert and Wagenhofer (2018)
show that auditing complements (and supplements) enforcement in curbing earnings
management efforts among firms. Hence, the perspective of auditors should therefore be a
good basis for identifying direct empirical evidence to gauge the extent to which measurement
uncertainty and management bias are significant financial reporting issues. This provides
motivation to address the first question, that is to what extent the KAMs identified and
reported by auditors are related to accounting estimates, and second question, that is whether
measurement uncertainty and management bias affect the auditors in doing so.
According to the IASB’s Conceptual Framework of Financial Reporting 2018 (CFW 2018),
measurement uncertainty refers to uncertainty that arises when monetary amounts in
financial reports cannot be observed directly and must instead be estimated (IASB, 2018).
Bratten et al. (2013) define measurement uncertainty as the ambiguity in the valuation of an
item or in the estimation of a discrete number. Hence, accounting estimates such as fair
valuation and impairment loss estimation require management judgment and assumptions
and hence are subject to measurement uncertainty and estimation errors. Nonetheless, the
CFW 2018 states that the use of reasonable estimates is an essential part of the preparation of
financial information and even a high level of measurement uncertainty does not necessarily
prevent estimates from providing useful information (IASB, 2018). However, there is little
empirical evidence of the presence of measurement uncertainty in the use of accounting
estimates. The limited relevant literature that exists has been largely opinion-based (see
Whittington, 2008) and focused on the auditors’ perspective, such as the challenges in auditing
fair values (see Bell and Griffin, 2012; Bratten et al., 2013; Joe et al., 2017). In brief, the concept of
measurement uncertainty is prescriptive, and empirical evidence of its presence is limited.
Managers possess private information about the firms they manage and so giving them
discretion to estimate and report their firms’ financial position and performance shall
improve the decision usefulness of accounting information (see Dechow et al., 2010). For
instance, managers are well placed to judge how much their assets should be marked down in
order to determine the estimated current value of these assets and to charge estimated
impairment losses to reported earnings. The practical problem is, however, that managers
are, in some cases, opportunistic in using the discretion given – bias in making accounting
estimates. Unlike measurement uncertainty, management bias has not been explicitly
prescribed in the CFW 2018. However, past studies document significant management bias
and earnings management opportunism around the discretionary inputs of estimates (see
Chen et al., 2004; Capkun et al., 2016; Joe et al., 2017). In contrary to measurement uncertainty,
the concept of management bias has been extensively studied in the domain of earnings
management literature, but it has not been explicitly prescribed in the CFW 2018.
In terms of decision usefulness, there is no clear empirical evidence that measurement
uncertainty adversely affects the decision usefulness of accounting estimates, as prescribed
by the CFW 2018. In contrary, past studies show that markets discount accounting
information, specifically accounting accruals and estimates, from firms that have
opportunistically managed their reported earnings (Beaver, 2002; Dechow et al., 2010;
Fiechter and Farkas, 2017). While the earnings management literature has been well-
established, earnings management measures are often associated with misspecification Measurement
issues (see Dechow et al., 2010). Hence, using KAMs reported by auditors to identify possible uncertainty and
management bias in accounting estimates provides direct evidence of earnings management.
This provides motivation to explore the third question, that is whether the use of accounting
management
estimates, given the associated measurement uncertainty and management bias as reported bias
in the KAMs, adversely affects (or enhances) the decision usefulness of the accounting
information.
This study addresses the research questions in the context of Chinese listed firms. Two
recent developments in the accountancy and auditing profession in China provide an excellent
context for this study. First, the stop-start of fair value measurement in China with effect from
2007 has reintroduced measurement uncertainty in fair value estimation (and hence,
additional opportunity for management bias) into the financial statements of Chinese firms.
This has led to a large amount of the literature dealing with the use of fair value measurement
and reactivated the debate on the use of accounting estimates in China (see Zhang et al., 2012).
Second, the past decade has also seen a structural change to the accountancy and auditing
profession in China (see Huang et al., 2019; Hao et al., 2019; Yeung and Lento, 2020), which
aimed to bring about a convergence with international standards. In 2016 and 2017, the
CICPA (2018) issued 12 auditing standards and released 16 practice guidelines for audit
reports based on the reform of the International Standards of Auditing (ISA).
This study finds that, despite pervasive recent debate, fair value estimation represents
only a small proportion, while impairment review and loss estimation makes up the major
portion of the total KAMs related to accounting estimates. This study concludes that
measurement uncertainty is, while management bias is not, the determinant of auditors
reporting KAMs related to accounting estimates. It, however, finds that the use of accounting
estimates enhances the value relevance of net assets, but not the value and predictive
relevance of reported earnings. The assurance work and reporting of KAMs send adverse
signals (like a “red flag”) with respect to the accounting estimates on reported earnings.
This study contributes as follows. First, the IASB’s move to include the use of current
values in the revised CFW 2018 on one hand acknowledges the decision usefulness of
accounting estimates, and on the other hand, accommodates the associated measurement
uncertainty. The use of such a measurement base is, therefore, normative – and this study
provides currently lacking empirical evidence relevant to this use. Second, this study
provides evidence about the role of auditors and their assurance work (audit quality) in
contributing to the informational role of accounting estimates (accounting quality).
Furthermore, reporting KAMs in an auditor’s report is a new requirement, and this study,
therefore, also contributes to the limited studies relevant to this emerging topic. Lastly, given
the issues of measurement uncertainty and management bias, this study provides evidence
that the use of accounting estimates impairs, rather than enhances, the decision usefulness of
the accounting information among the sample firms. In practice, more work is needed to
ensure that the use of accounting estimates enhances the decision usefulness of accounting
information.
The remainder of this paper is organized as follows. The next section discusses the
relevant literature on measurement uncertainty and management bias in the context of
financial reporting and auditing. The third section focuses on the research design and data
analysis. The fourth section presents the findings and discussion, while the final section
contains the conclusions.

2. Theoretical background and hypothesis development

The agency theory states that firms operate in an environment with uncertainties, which
leads to potential information asymmetries between managers and external investors
ARA (see Walker, 2013). These potential information asymmetries in turn underpin the need for
financial reporting and accounting information to play an informational role. Against this
background, this study is grounded on two theoretical perspectives.
On one perspective, managers, who possess private information about the firms they
manage, are given discretion under the accrual reporting system which enable them to
provide more decision useful information, consistent with the informational role of
accounting information (Beaver, 2002; Walker, 2013). In practice, however, the information
quality is subject to measurement uncertainty arising from incomplete information and
future uncertainties, which require judgments and assumptions about future transactions or
events for reporting. On the other perspective, some managers may misuse or aggressively
use this discretion to manage reported earnings for personal or corporate gain, consistent
with the opportunistic contracting hypothesis (Beaver, 2002; Walker, 2013). This can lead to
uncertainties about the financial position and performance of reporting entities. If so,
accounting information including estimates and reported earnings will clearly not provide
decision useful information to markets.
A fundamental area where managers are given discretion is accounting measurement,
which in most cases involves accounting estimates – estimate values in the recognition and
measurement of assets and liabilities. For instance, managers value the assets and liabilities
for the purpose of subsequent measurement from one financial period to another – by
determining the carrying amounts of these items. A common example is the estimation of
impairment losses of tangible and financial assets (see Zhang et al., 2010). Table 1 presents a
list of common sources of accounting estimates and the associated accounting standards,
both international and Chinese.

2.1 Accounting estimates, measurement uncertainty and management bias

The CFW 2018 acknowledges that the use of accounting estimates gives rise to measurement
uncertainty (IASB, 2018). However, it argues that even a high level of measurement
uncertainty does not necessarily prevent estimates from providing useful information,

Key source Accounting estimates ASBE (CAS) IFRS

Fair valuation
Property plant and equipment Revalued amount, being the fair value ASBE4 IAS16
Intangible assets Revalued amount, being the fair value ASBE6 IAS38
Financial instruments Fair value ASBE22 IFRS9
Investment property Fair value ASBE3 IAS40
Assets and liabilities in acquiree Fair value ASBE20 IFRS3
Impairment of assets
Inventory Net realizable value ASBE1 IAS2
Property plant and equipment Recoverable amount ASBE8 IAS36
Trade receivable Expected future cash flows ASBE22 IAS39/IFRS9
Revenue Fair value of consideration ASBE14/15 IAS11/18,
IFRS15
Other estimates
Deferred tax assets Future taxable income ASBE18 IAS12
Table 1. Pension liabilities/assets Pension expense/income ASBE9/10 IAS19
Key sources of Provisions Estimated settlement amount ASBE13 IAS37
measurement Note(s): IFRS denotes International Financial Reporting Standards. IFRS has two sets of codes (IFRS and
uncertainty and IAS). ASBE denotes Accounting Standards for Business Enterprises (also known as the Chinese Accounting
management bias Standards)
provided that the estimates in question are clearly and accurately described and explained. In Measurement
practice, commentators have expressed concern that estimations in financial reporting are uncertainty and
associated with high uncertainty (see Whittington, 2008). Bratten et al. (2013) define
measurement uncertainty as ambiguity in the valuation of an accounting item (e.g. trade
management
receivables) or in the estimation of a discrete value to be included in financial statements (e.g. bias
impairment loss). In addition, measurement uncertainty also arising from availability of
alternative estimation models, judgment in model selection, the use of multiple models and
giving appropriate weigh to each model (see Bratten et al., 2013). Bell and Griffin (2012)
propose that management’s estimation processes, assumptions and historical estimation
accuracy contribute to measurement uncertainty and are key attributes to the decision useful
of accounting estimates.
However, empirical evidence of the presence of measurement uncertainty in accounting
estimates has been limited, has tended to focus on fair value measurement and in most cases
has expressed concerns from the auditors’ perspective. For instance, Griffin (2014) finds that
the big-4 auditors, in an experiment, are more concerned over fair value estimates which
contain both input subjectivity and outcome imprecision. Similarly, Christensen et al. (2012)
examine estimates reported by public firms and find that fair value based on subjective
models and inputs from management can produce extreme estimation uncertainty in
measures such as net income and earnings per share.
Unlike measurement uncertainty, the CFW 2018 does not explicitly prescribe
management bias as a concern in the use of accounting estimates (IASB, 2018). The CFW
2018 only addresses the concept of bias as a construct of neutrality, when defining the
qualitative characteristics of decision useful information. A neutral depiction means there is
no bias in the presentation of financial information (IASB, 2018). In addition, the disclosure
requirement of the CFW 2018 for a clear and accurate description and explanation of
accounting estimates may lead to a moral licensing of management bias. Griffin (2014)
concludes that disclosure requirements often exacerbate management bias, as firms are more
comfortable in providing biased estimates with the expectation that financial statement users
are forewarned about the estimates’ potential inaccuracy. These may adversely affect the
informational role of accounting estimates.
Unlike measurement uncertainty, there is a large amount of empirical evidence to indicate
the presence of management bias in the use of accounting estimates, consistent with the
opportunistic contracting hypothesis. For instance, Bratten et al. (2013) report that recent
studies have examined management’s discretion in developing fair value estimates; the
results generally suggest that managers use this discretion opportunistically. This is
especially so in the case of level-3 fair value estimates, which uses unobservable inputs
developed by management (see Lilien et al., 2020). Joe et al. (2017) also report that past studies
document widespread of management bias and opportunism around the subjective inputs
(e.g. discount rates, model assumptions and model selections) to complex fair value
estimations. Li and Sloan (2011) conclude that managers use their discretion to delay goodwill
impairments, as these impairments are related to past declines in operating performance and
stock returns. Jackson and Liu (2010) find that firms use discretion when estimating the bad
debt expense accrual to meet or beat analysts’ forecasts, an evidence of management bias in
accounting estimates. Capkun et al. (2016) identify IFRSs which likely provide earnings
management opportunities, including those applicable to deferred tax assets, employee
benefits, inventories, goodwill and intangible asset impairments, tangible and financial
assets impairment and provisions.

2.2 The auditors and the informational role of accounting estimates

Auditors play an important role in contributing to financial reporting quality and the
informational role of accounting estimates. Past studies provide empirical evidence that audit
ARA quality, which positively contributes to information quality (see Watkins et al., 2004). A
number of researchers find various audit-related determinants that can affect financial
reporting quality, including audit firm quality (e.g. Big-4 or non-Big-4), prior audit work,
auditor expertise, auditor rotation and audit tenure (see Gaynor et al., 2016). Specifically,
researchers find that auditors play an important role in mitigating earnings management by
firms. Ewert and Wagenhofer (2018) show that auditing complements (and supplements)
enforcement in curbing earnings management efforts among firms. Chen et al. (2011) find that
earnings management level is significantly lower for non-state-owned firms which audited by
top-8 auditors in China than that of those similar firms audited by non-top-8 auditors. Yeung
and Lento (2020) find that audit quality is negatively associated with earnings opacity and
thereby, improves reporting quality among Chinese listed firms.
In their statutory role, auditors possess private information about the firms they audit and
are required to provide assurance services to these firms’ financial statements and accounting
information. They are expected to be professional, unbiased and independent and hence in a
fair position to identify and address the issues of measurement uncertainty and management
bias in the use of accounting estimates. Specifically, they are required to obtain reasonable
assurance for accounting estimates involving high levels of inherent measurement
uncertainty (i.e. Bell and Griffin, 2012), more input subjectivity and more outcome
imprecision (i.e. Griffin, 2014). They are also required to test accounting estimates in the
context of significant management bias and opportunism around the discretionary inputs of
audited complex estimates (Joe et al., 2017). Therefore, auditors and the quality of audit work
and assurance services can identify the measurement uncertainty and management bias in
the use of accounting estimates. Auditors should audit any material items pertaining to
accounting estimates and report them, if any, as KAMs in accordance with CSA1504/ISA701,
Communicating key audit matters in the independent auditor’s report. Accordingly, this study
hypothesizes as follows.
H1. Measurement uncertainty is positively affecting key audit matters related to
accounting estimates
H2. Management bias is positively affecting key audit matters related to accounting
estimates

2.3 Decision usefulness of accounting estimates and key audit matters

The literature on how measurement uncertainty can affect the informational role of
accounting estimates which is limited, although the informational role of accounting
information in general has been extensively studied. For instance, researchers examine the
value relevance of the book value of equity and reported earnings (see Barth et al., 2008) and
the persistence of current reported earnings in predicting future earnings (see Dechow et al.,
2010; Beaver et al., 2012). Moreover, there have been some studies into more specific aspects of
the informational role of accounting estimates, such as impairment loss (Xu et al., 2011), fair
value (Fiechter and Farkas, 2017) and pension information (Hann et al., 2007). These studies,
however, have not focused on measurement uncertainty in accounting estimates. When
auditors report accounting estimates as KAMs and provide the necessary descriptions and
explanations about the KAMs with the assurance work rendered, this may enhance the
informational quality of the accounting estimates. Moroney et al. (2020) find that the reporting
of KAMs improves the perceived value of an audit by a non-Big-4 firm (though not in the case
of a Big-4 firm). However, if the KAMs are reported because of auditors’ concerns about the
issue of measurement uncertainty in the accounting estimates, the decision usefulness of
accounting information will be adversely affected.
In practice, some managers may exercise their accounting discretion in order to report
accounting information, which will favor either personal or corporate gains, as motivated by
various incentives, consistent with the opportunistic contracting hypothesis (see Chen et al., Measurement
2004; Capkun et al., 2016; Joe et al., 2017). Accounting estimates and hence the consequential uncertainty and
reported earnings prepared with management bias have low information quality and are less
decision useful. Unlike measurement uncertainty, past studies show that markets discount
management
accounting information, specifically accounting accruals and estimates, from firms that have bias
opportunistically managed their reported earnings (Beaver, 2002; Dechow et al., 2010;
Fiechter and Farkas, 2017). Furthermore, the disclosure requirement of KAMs may lead to a
moral licensing of management bias. Griffin (2014) concludes that disclosure requirements
often exacerbate management bias, as firms are more comfortable in providing biased
estimates with the expectation that financial statement users are forewarned about the
estimates’ potential inaccuracy. This study therefore hypothesizes as follows.
H3. Measurement uncertainty and/or management bias, as reported in key audit matters,
impairs the decision usefulness of accounting estimates and of the consequential
accounting information.

3. Research methodology
Since KAM disclosures is a recent requirement, the related data are not readily available in
the major databases and need to be hand-picked. This constrains the use of entire population
and limits the sample size for study. In fact, the limited pioneer studies involving KAMs are
mostly experimental and collecting views from students as a proxy to non-professional
investors (i.e. Moroney et al., 2020). Some other studies that use sample firms consist of major
index constituents, which the sample size is relatively small (i.e. Sierra-Garcia et al., 2019).
Furthermore, the use of index constituents, i.e. FTSE100 likely introduces self-selection bias.
Hence, this study selects samples from the population of Chinese listed firms on the Shanghai
Stock Exchange (SSE) based on a stratified random sampling basis. This stratification is
based on the Industry Classification Benchmark (ICB) system, which partitions firms into 41
industries (level 4), by DataStream. In line with this, the firms in each stratum were randomly
selected based on the randomized list generated from Microsoft Excel.
While mitigating any potential self-selection bias using index constituents, stratified
random sampling allows all the firms in an industry stratum to have an equal chance of being
selected. Hence, random sampling ensures that results obtained from the sample should
approximate what would have been obtained if the entire population had been measured
(Shadish et al., 2002). The final sample that consists of 351 Chinese listed firms represents
approximately 26.2% of the total SSE listed firms as at 31 December 2018. 47.7% of these
sample firms have some kind of state ownership (central, provincial or local government), and
firms with their shares traded on dual or multiple stock exchanges were not included. As
presented in Table 2, the mean values of market capitalization (firm size), debt-to-equity
(leverage) and return on equity (profitability) of the sample firms are statistically indifferent
from those of the population firms. These statistics indicate that the sample firms are
appropriate representative of the population firms in size, leverage and profitability from
which they are drawn.
This study employs a content analysis of the auditor’s reports on these sample firms for
the financial year ended 2017. According to CSA1504/ISA701, an auditor shall determine
those KAMs which require significant auditor judgments relating to areas in the financial
statements that involve significant management judgment (including accounting estimates
that have been identified as having high estimation uncertainty). In communicating these
KAMs, an auditor shall provide descriptions of each individual KAM covering why the
matter was considered to be significant and therefore a KAM, and how the KAM was
addressed in the audit.
ARA Table 3 presents the descriptions of the KAMs which provide the variables needed for this
study from the content analysis. A KAM is related to accounting estimates when the
measurement of a financial statement item involves an estimated amount since this requires
management discretion, judgments and assumptions in the estimation (see Bratten et al.,
2013). Some common examples include estimations of fair value, recoverable amounts in
asset impairment reviews (PPE, purchased goodwill, trade receivable, etc.), the net realizable
values of inventory and future taxable income (deferred tax asset recognition). In order to
collect more precise evidence, a dummy variable was used to denote the presence of each of
the following KAMs in the auditor’s reports collected: fair valuation, impairment of assets and
other estimates (KAMs related to accounting estimates).

Mean S. deviation Maximum Median Minimum

Sample firms (n 5 351)

Market capitalization (CNY billion) 24.29 (
0.754) 91.45 1481.00 9.91 1.49
Debt-to-equity ratio 1.101 (1.149) 3.273 42.65 0.580
11.46
Return on equity ratio
0.020 (
1.335) 1.441 6.929 0.069
19.03
Population firms (N 5 1,340)
Table 2. Market capitalization (CNY billion) 27.12 117.26 2209.72 7.24 0.99
Descriptive statistics of Debt-to-equity ratio 0.947 3.624 106.30 0.310
11.46
sample and Return on equity ratio 0.059 1.498 30.50 0.087
32.19
population firms Note(s): Values in the parentheses are the t statistics for one-sample t-test (all t statistics are insignificant)

Variable Measure

Dependent (see Appendix)

Key audit matters A dummy variable, equals 1 if a key audit matter relates to accounting estimates – fair
valuation, impairment loss and other estimates; otherwise 0 if the key audit matter
relates to other matters (non-accounting estimates)
Three separate dummy variables, each equaling 1 if the key audit matters relate to fair
valuation, impairment loss estimation, and other estimates, respectively; otherwise 0
Explanatory (see Appendix)
Environment Measurement uncertainty, equals 1 if an item involves management estimation,
judgment, assumptions or methods used; otherwise 0
Macroeconomic risks, equals 1 if such risks are mentioned; otherwise 0
Task Task structure, equals 1 if financial reporting standards give discretion to managers in
measurement, in other words estimation is required (flexibility and ambiguity);
otherwise 0
Management bias, equals 1 if the auditor is concerned over management manipulation
and bias; otherwise 0
Auditor’s specific Auditor’s specialization, equals 1 if the auditor uses in-house expertise in valuation or
estimation; otherwise 0
Big five audit firms, equals 1 if the auditor belongs to the big-5; otherwise 0
Control
Firm size Logged market capitalization of equity
Leverage Total debt over total equity (debt-to-equity)
Profitability Net income over total equity (return on equity)
State State-ownership dummy equals 1 if state ownership is present; otherwise 0
Table 3. Specialized Specialized industry dummy – if the firm is involved in such industries as utility,
Variables and Industry pharmaceutical and biotechnology, banks and financial services, and real estate,
measures equals 1; otherwise 0
Analogously with Bratten et al. (2013), this study proposes three groups of determinants for Measurement
auditors to identify and report the KAMs related to accounting estimates: environment, task- uncertainty and
related and auditor-specific factors, as presented in Table 3. The environment group refers to
measurement uncertainty and macroeconomic risks. The task-related group consists of task
management
structure and management bias. Finally, this study uses two auditor-specific factors: auditors bias
use of in-house specialist in estimation and auditors are Big-5 audit firms. In the year 2017, the
top 5 auditors in China, ranked in accordance with their reported revenue, were PwC, Deloitte,
BDO, EY and KPMG (CICPA, 2018; Huang et al., 2019). The key words and phrases in the
descriptions of KAMs, as described above, were handpicked to indicate the presence of the
environment, task-related and auditor-specific factors, in order to provide inputs to the dummy
variables presented in Table 3. Appendix provides further details about these variables and
how they were constructed from KAM disclosures. This study uses the following model for
estimations:
Key audit matter dummies ¼ f ðmeasurement uncertainty; microeconomic risks;
task structure; management bias; in-house specialist;
big-5 audit firms; firm size; leverage; profitability;
state-owned; specialized industryÞ
(1)

The KAM dummies include those related to accounting estimates, fair value estimation,
impairment review and loss estimation and other estimates, respectively. Like Sierra-Garcia
et al. (2019), this study includes three firm characteristics into the model as control variables:
firm size, leverage and profitability (see Table 3 for definitions and measures). Equation (1) is
estimated on logit regressions to test H1 and H2.
This study employs two established models from the relevant literature to assess the
decision usefulness of information related to the accounting estimates identified in the KAMs.
The first model, an adopted price model in the value relevance studies, examines the
relationship between the share price of equity, the book value of equity and reported earnings
(see Barth et al., 2008). The second model studies the earnings persistence, i.e. the
predictability of future earnings, using current reported earnings (see Dechow et al., 2010;
Beaver et al., 2012). The equations for the models are as follows:
Pit ¼ α0 þ α1 BVit þ α2 Eit þ α3 Dt þ α4 Dt *BVit þ α5 Dt *Eit þ εit (2)
Eitþ1 ¼ γ 0 þ γ 1 Eit þ γ 2 Dt þ γ 3 Dt *Eit þ εit (3)

Pjt is the market price of firm j at four months after time t; BVjt is the book value of equity (net
assets) of firm j at time t. Ejt, and Ejtþ1 are the reported earnings of firm j for the periods
ending at time t (current period) and tþ1 (future period), respectively. All variables are on a
per share basis and denominated in Chinese Yuan (CNY).
Analogously with Tucker and Zarowin (2006), this study incorporates a dummy variable
into these equations for interactions with the accounting variables, namely book value of
equity and reported earnings. These interactions allow a clear segregation of the incremental
effect of accounting information which contained the accounting estimates identified in the
KAMs from accounting information not related to these accounting estimates. Dt is the
dummy variable which represents firm-year observations of treatment sample (those related
to the accounting estimates, impairment review and loss, KAMs reporting measurement
uncertainty and management bias, respectively), equals to 1, otherwise 0 for control sample.
These interactions allow the decision usefulness effect of book value and reported earnings in
the treatment sample to be distinguished from those in the control sample. If α4, α5 and γ 3 are
ARA negative and statistically significant, this means that the decision usefulness of accounting
variables for the treatment sample is lower/poorer than that for control sample.

4. Empirical results and discussion

4.1 Key audit matters related to accounting estimates
Table 4 presents the 606 KAMs identified in the auditor’s reports of the sample firms. 334
(55.1%) of these KAMs identified are related to accounting estimates, i.e. fair valuation,
impairment losses or other estimates. Overall, measurement uncertainty is positive,
significant at 0.01, in explaining KAMs related to accounting estimates, presented in
column 1 Table 5. This indicates that auditors are concerned over the measurement
uncertainty in accounting estimates and hence reported these as KAMs, consistent with H1.
In contrast, management bias is negative, significant at 0.01, in explaining KAMs related to
accounting estimates, not supporting H2. The result does, however, provides evidence that
management bias is not a concern of auditors for KAMs related to accounting estimates but to
non-accounting estimates. The estimates for task structure is positive, while Big-5 audit firms
is negative, respectively significant at 0.01 and 0.05, in explaining KAMs related to
accounting estimates. The estimates for microeconomic risks and in-house specialist are
statistically insignificant.
While the topic of fair valuation has been aggressively debated in recent financial
reporting and auditing literature, only 16 (2.6%) of the 606 KAMs are identified related to fair
value estimation, as presented in Table 4. This provides descriptive evidence that, fair
valuation has not been an issue of concern in practice. A reason to this observation is that,
while an investing entity is required to fair-value its investments in the equity shares of other
entities as financial assets, it is however not required to do so but rather to consolidate the
assets and liabilities of other entities, as these are likely its subsidiaries. Another reason could

Key audit matters Sub-total Total

Fair valuation 16
Financial assets (non-derivatives) 11
Derivative contracts 7
Business combinations 5
Investment properties 4
Impairment review and loss estimation 267
Property plant and equipment 25
Purchased goodwill and other intangible assets 72
Inventory 77
Trade receivable and other financial assets 91
Other non-current assets (including natural resources) 22
Other estimations 51
Deferred tax assets 9
Pension liabilities 5
Provisions 17
Capitalization of development costs and PPE 13
Depreciation/amortization 3
Tax liabilities 4
Related to accounting estimates 334
Not related to accounting estimates 272
Total 606
Note(s): The sub-totals may not tally with the respective totals due to the fact that some key audit matters
Table 4. relate to more than one sub-area; for example, impairment review and loss estimation may include both PPE
Key audit matters and intangible assets
Dependent [1] Accounting [2] Fair value [3] Impairment of
Measurement
variable estimates measurement assets [4] Other estimates uncertainty and
management
Constant
6.076 (
2.123**)
12.336 (
2.716***)
5.073 (
2.162**)
6.040 (
2.247**)
Measurement 5.839 (11.39***) 2.194 (2.045**) 5.608 (7.677***) 2.165 (3.435***) bias
uncertainty
Macroeconomic 0.470 (0.629) 0.169 (0.154) 0.567 (1.044)
0.506 (
0.665)
risks
Task structure 2.593 (3.234***)
1.068 (
0.946) 2.837(2.586***) 0.190 (0.177)
Management
1.450 (
3.194***)
0.528 (
0.461)
0.458 (
1.097)
1.844 (
1.780*)
bias
In-house 1.171 (1.360) 2.180 (2.802***) 0.386 (0.694)
0.310 (
0.396)
specialist
Big-5
0.756 (
2.118**)
1.313 (
1.621)
0.549 (
2.029**) 0.488 (1.433)
Firm size 0.001 0.006) 0.526 (1.946*)
0.150 (
1.211) 0.115 (0.758)
Leverage
0.226 (
1.849*)
0.185 (
0.705)
0.102 (
1.047)
0.102 (
0.819)
Profitability
0.169 (
0.428)
0.237 (
0.379) 0.341 (1.036)
0.308 (
1.105)
State-owned 0.095 (0.289)
0.803 (
1.336) 0.350 (1.426)
0.265 (
0.838)
Specialised 0.686 (1.917*)
0.199 (
0.339) 0.280 (1.090) 0.205 (0.626)
industries
Chi-square 527.89*** 22.17** 377.08*** 41.51***
N 593 593 593 593
Note(s): Key audit matter dummies 5 f (environment, task, auditor-specific, control variables), where the key
audit matter dummies include accounting estimates, impairment review and loss estimation and other
estimates, as presented in Columns [1], [2], [3] and [4], respectively. See Table 3 for the definitions and measures Table 5.
of all variables. N denotes number of firm-year observations; ***, ** and * denote significant at 1%, 5% and Key audit matters and
10%, respectively key determinants

be the relatively lower frequency of transactions/events which involving fair valuation, i.e.
business combinations and/or generally smaller material amounts involved, i.e. derivative
contracts. In addition, investment properties, which fair value option is available, normally
have observable market inputs, which enable reporting entities to reliably measure their fair
values.
As presented in column 2 Table 5, the estimate for measurement uncertainty is positive,
significant at 0.05, which indicates the auditors’ concern over the measurement uncertainty of
fair value estimation and hence their inclusion as KAMs, supporting H1. However,
management bias is statistically insignificant and not the reason for their inclusion as KAMs,
inconsistent with H2. In addition, in-house specialist is positive, significant at 0.01, which
supports the proposition that, due to concern over measurement uncertainty and task
structure, auditors involve in-house specialists and consultants to assess their clients’ fair
value estimations. Knechel and Leiby (2016) believe that providing more specialist expert
advice can reduce the uncertainty surrounding a specific accounting judgment.
The largest number of KAMs related to accounting estimates are impairment review and
loss estimation – 267 (44.1%) out of 606 KAMs. The key concern of auditors is the estimations
of the recoverable amount of assets. These estimations include value to sell (fair value less
cost to sell) and value in use (present value of projected cash flows) of PPE; the estimated
selling price, which is a key input to estimate the net realizable value of inventories and the
expected recoverable amount of financial assets, in particular trade receivables. When the
carrying amount of an item of asset is larger than its estimated recoverable amount or net
realizable value, the excess is recognized as an impairment loss to the profit or loss account (or
revaluation surplus). The recognition of impairment losses, therefore, erodes reported
earnings and is thus a potential source of measurement uncertainty and management bias
(see Chen et al., 2004).
ARA Column 3 Table 5 presents the estimates on KAMs related to the impairment review and
loss estimation. Measurement uncertainty is positive, significant at 0.01, consistent with H1.
Task structure too is positive, significant at 0.01, reflecting the fact that task complexity,
difficulty and ambiguity are significant determinants of auditors reporting the impairment of
assets of the sample firms as KAMs. In fact, further scrutiny of the descriptions in the KAMs
shows that the impairment review and loss estimation of PPE and purchased goodwill are
highly complex and involving judgmental processes: assessment of impairment indicators,
projection of future cash flows and the reasonableness of assumptions, all of which rely
substantially on management discretion. The described assurance works performed in these
areas include the assessment of the relevant internal control systems established and
impairment indicators identified by management. This is clearly an area which challenges the
auditors with complexities, ambiguities and management bias (see Bell and Griffin, 2012;
Bratten et al., 2013; Joe et al., 2017).
Another 51 (8.4%) of the 606 KAMs related to other estimates include the estimation of
deferred tax assets, pension liabilities, provisions, development costs, PPE costs and
depreciation and other tax liabilities. As presented in column 4 Table 5, measurement
uncertainty is positive, significant at 0.01, in explaining KAMs related to other estimates.
Besides, management bias is negative, significant at 0.10, inconsistent with H2. This is despite
the fact that literature on earnings management provides evidence that a number of these
estimates do involve management opportunistic behavior. For instance, in remeasurement of
deferred tax valuation allowance (Christensen et al., 2008) and pension assets and liabilities
arising from post-employment employee benefits (Comprix and Muller, 2011; Hwang and
Sarath, 2018).

4.2 Decision usefulness of accounting estimates and key audit matters

Table 6 present the estimates based on the price and earnings persistence models. The net
assets (equity) of sample firms where the auditors have reported KAMs related to accounting
estimates (estimate firms) are more value relevant than those of sample firms, where their
auditors have not reported any such KAMs (non-estimate firms). As presented in panel A
column 2, the coefficient of net assets D*BVjt, α4 is positive, significant at 0.10. The reported
earnings of estimate firms, however, are less value relevant than those of the non-estimate
firms. The coefficient of D*Ejt, α5 is negative, significant at 0.05. Similarly, their reported
earnings are also less predictive relevant than those of the non-estimate firms, where the
coefficient of D*Ejt, γ 3 is also negative, significant at 0.10, as presented in panel B. These
mixed observations suggest that, while the use of accounting estimates may be good for
reporting the financial position of a firm, they are not so for reporting financial performance.
This indicates that the disclosure of the use of accounting estimates in an auditor’s report
does not enhance the decision usefulness of reported earnings; rather, it signals the auditor’s
concern over such use.
This study duplicates the same estimation solely on sample firms with KAMs related to
impairment review and loss – as these represent the largest number of items involving
accounting estimates. As presented in column 3, the coefficient of α4 net assets is positive,
significant at 0.01 and the coefficients of α5 and γ 3 are negative, significant at 0.01. In fact, the
incremental value in the coefficient of net assets in the impairment review and loss estimation
is larger than that in the accounting estimates estimation. In contrast, the decrement values in
the coefficients of reported earnings in the impairment review and loss estimation are larger
than that in the accounting estimates estimation.
This study hypothesizes that measurement uncertainty and management bias, as
reported in KAMs, impair the decision usefulness of accounting estimates and accounting
information (H3). Therefore, it is fundamental to ascertain that whether with (without) KAMs,
investors might (might not) be able to identify the effect of measurement uncertainty and
 KAM-MU-MB
Measurement
Treatment Accounting Impairment of assets Accounting estimates uncertainty and
sample (Dt) None (1) estimates (2) (3) (4) management
Panel A: Price model bias
α0 7.663 (23.04***) 9.845 (12.14***) 9.752 (14.65***) 8.108 (20.76***)
a1BVjt 0.435 (5.628***)
0.004 (
0.015)
0.059 (
0.293) 0.251 (2.457**)
a2Ejt 6.981 (10.85***) 10.233 (5.961***) 10.092 (7.618***) 7.984 (8.818***)
a3D –
2.529 (
2.879***)
2.688 (
3.538***)
5.842 (
4.200***)
a4D*BVjt – þ0.506 (1.881*) þ0.609 (2.869***) 1.004 (3.133***)
a5D*Ejt –
4.118 (
2.241**)
4.220 (
2.795***)
4.360 (
1.877*)
Adjusted R2 0.194 (158.09***) 0.205 (68.27***) 0.208 (69.37***) 0.168 (44.01***)
N 1,306 1,306 1,306 1,067
Panel B: Earnings persistent model
γ0 0.061 (7.556***) 0.064 (3.259***) 0.066 (4.334***) 0.077 (9.009***)
γ 1Ejt 0.895 (55.22***) 0.952 (26.53***) 0.958 (31.49***) 0.766 (36.09***)
γ 2D –
0.001 (
0.044)
0.004 (
0.248) 0.008 (0.320)
γ 3D*Ejt –
0.078 (
1.894*)
0.097 (
2.610***) 0.117 (1.888*)
Adjusted R2 0.667 (2612.8***) 0.669 (876.2***) 0.671 (883.5***) 0.591 (514.6***)
N 1,302 1,302 1,302 1,067
Note(s): See the specification and variable definitions for the Price model in Equation (3) and the Earnings
Persistence model in Equation (3), Research Design section. Dt is the dummy variable represents firm-year
observations of treatment sample equals to 1, otherwise 0 for control sample. The treatment sample consists of
firm-year observations as follows: key audit matters related to accounting estimates in Column (2), impairment
review and loss estimation in Column (3), and accounting estimates with KAMs reporting measurement
uncertainty and/or management bias in Column (4), KAM-MU-MB. Estimations in Column (4) are based on Table 6.
firm-year observations involving accounting estimates only (N 5 1,067), while estimations in all other columns Value and predictive
are based on all firm-year observations (N 5 1,306 for price model and N 5 1,302 for earnings persistence relevance of
model). ***, ** and * denote statistically significant at 1%, 5% and 10%, respectively accounting estimates

management bias on accounting estimates and accounting information. In China, auditors are
required to report KAMs with effect from 2017, which creates a natural experiment (see Perez-
Gonzalez and Yun, 2013) to assess the investors’ use of KAM disclosures. If investors could
identify measurement uncertainty and management bias associated with accounting
estimates using KAM disclosures, there should be market reactions to reflect this effect. As
presented in panel A column 4, the coefficient for KAMs Djt, reporting measurement
uncertainty and/or management bias, is negative and significant at 0.01. This indicates that
market does price the measurement uncertainty and management bias associated with
accounting estimates as reported in KAMs.
The coefficient for reported earnings D*Ejt, α5 is negative, significant at 0.10, indicates
that reported earnings of estimate firms with KAMs, reporting measurement uncertainty and
management bias, are less value relevant than those of the estimate firms without the same
KAMs, consistent with H3. The coefficient for net assets D*BVjt, α4 is positive, significant at
0.01, not supporting H3. This is consistent with past studies (i.e. Barth et al., 2008) that the
value relevance of net assets normally increases when that of reported earnings is
diminishing. On the other hand, the coefficient for current reported earnings D*Ejt, γ 3,
is positive, significant at 0.10, indicates that the predictive relevance of reported earnings is
better with KAMs, reporting measurement uncertainty and management bias as compared to
that without such KAMs. These mixed observations suggest that the reporting of
measurement uncertainty and management bias in KAMs signals auditor’s concern over
the use of accounting estimates, and hence reported earnings are less value relevant.
However, the assurance work of the auditors in addressing the issues of measurement
ARA uncertainty and management bias as reported in KAMs enhances the predictive relevance of
reported earnings.

5. Conclusions
This study finds that, despite pervasive recent debate, fair value estimation represents only a
small proportion, while impairment review and loss estimation makes up the major portion of
the total KAMs related to accounting estimates. This study concludes that measurement
uncertainty is the major determinant of auditors reporting KAMs related to accounting
estimates and impairment of assets. It, however, finds that the use of accounting estimates
enhances the value relevance of net assets, but not the value and predictive relevance of
reported earnings. While the assurance work and reporting of KAMs send adverse signals
(like a “red flag”) with respect to the accounting estimates and impairment of assets on
reported earnings.
The IASB’s stand in CFW 2018 establishes a new ground that financial reporting
stakeholders would have to bear with the costs, challenges and risks associated with
measurement uncertainty of using accounting estimates, which believed would provide
decision useful information. In this respect, auditors play a crucial role in ensuring that the
associated issues of measurement uncertainty (and management bias, if any) are
appropriately identified, addressed and verified. After all, the role of auditors is by its
nature to provide stewardship and to serve as an effective check-and-balance to the discretion
managers have in providing decision-useful information from opportunistic reporting.
Finally, the reporting of KAMs in auditor’s reports is a recent outcome of international
audit reform. China has been quick and reasonably dynamic in bringing its auditing
standards in line with the ISA. The empirical evidence provided in this study, though based
on sample firms in China, is also highly relevant to other markets and regulators where the
ISA have been adopted. The KAMs (and other new requirements in auditor’s reports) are a
rich source of direct evidence available for future research to address financial reporting and
auditing issues in practice.

References
Barth, M., Landsman, W. and Lang, M. (2008), “International accounting standards and accounting
quality”, Journal of Accounting Research, Vol. 46 No. 3, pp. 467-498.
Beaver, W.H. (2002), “Perspectives on recent capital market research”, The Accounting Review, Vol. 77
No. 2, pp. 453-474.
Beaver, W., Landsman, W. and Owens, E. (2012), “Asymmetry in earnings timeliness and persistence:
a simultaneous equations approach”, Review of Accounting Studies, Vol. 17 No. 4, pp. 781-806.
Bell, T.B. and Griffin, J.B. (2012), “Commentary on auditing high-uncertainty fair value estimates”,
Auditing: A Journal of Practice and Theory, Vol. 31 No. 1, pp. 147-155.
Bratten, B., Gaynor, L.M., McDaniel, L., Montague, N.R. and Sierra, G.E. (2013), “The audit of fair
values and other estimates: the effects of underlying environmental, task, and auditor-specific
factors”, Auditing: A Journal of Practice and Theory, Vol. 32, Suppl. 1, pp. 7-44.
Capkun, V., Collins, D. and Jeanjean, T. (2016), “The effect of IAS/IFRS adoption on earnings
management (smoothing): a closer look at competing explanations”, Journal of Accounting and
Public Policy, Vol. 35 No. 4, pp. 352-394.
Chen, C.J., Chen, S., Su, X. and Wang, Y. (2004), “Incentives for and consequences of initial voluntary
asset write-downs in the emerging Chinese market”, Journal of International Accounting
Research, Vol. 3 No. 1, pp. 43-61.
Chen, H., Chen, J.Z., Lobo, G. and Wang, Y. (2011), “Effects of audit quality on earnings management
and cost of equity capital: evidence from China”, Contemporary Accounting Research, Vol. 28
No. 3, pp. 892-925.
Christensen, B.E., Glover, S.M. and Wood, D.A. (2012), “Extreme estimation uncertainty in fair value Measurement
estimates: implications for audit assurance”, Auditing: A Journal of Practice and Theory, Vol. 31
No. 1, pp. 127-146. uncertainty and
Christensen, T., Paik, G. and Stice, E. (2008), “Creating a bugger bath using the differed tax valuation
management
allowance”, Journal of Business Finance and Accounting, Vol. 35 Nos 5-6, pp. 601-625. bias
CICPA (2018), Overview of the Accountancy Profession of China, CICPA, Beijing.
Comprix, J. and Muller, K.A. (2011), “Pension plan accounting estimates and the freezing of defined
benefit pension plans”, Journal of Accounting and Economics, Vol. 51 Nos 1-2, pp. 11-133.
Dechow, P., Ge, W. and Schrand, C. (2010), “Understanding earnings quality: a review of the proxies,
their determinants and their consequences”, Journal of Accounting and Economics, Vol. 50
Nos 2-3, pp. 344-401.
Ewert, R. and Wagenhofer, A. (2018), “Effects of increasing enforcement on financial reporting quality
and audit quality”, Journal of Accounting Research, Vol. 57 No. 1, pp. 121-168.
Fiechter, P. and Farkas, Z. (2017), “The impact of the institutional environment on the value relevance
of fair values”, Review of Accounting Studies, Vol. 22, pp. 392-429.
Gaynor, L.M., Kelton, A.S., Mercer, M. and Yohn, T.L. (2016), “Understanding the relation between
financial reporting quality and audit quality”, Auditing: A Journal of Practice and Theory,
Vol. 35 No. 4, pp. 1-22.
Griffin, E.E., Hammersley, J.S., Kadous, K. and Young, D. (2015), “Auditor mindsets and audits of
complex estimates”, Journal of Accounting Research, Vol. 53 No. 1, pp. 49-77.
Griffin, J.B. (2014), “The effects of uncertainty and disclosure on auditors’ fair value materiality
decisions”, Journal of Accounting Research, Vol. 52 No. 5, pp. 1165-1193.
Hann, R.N., Heflin, F. and Subramanayam, K.R. (2007), “Fair value pension accounting”, Journal of
Accounting and Economics, Vol. 44 No. 3, pp. 328-358.
Hao, J., Sun, M. and Yin, J. (2019), “Convergence to IFRS, accounting quality, and the role of regional
institutions: evidence from China”, Asian Review of Accounting, Vol. 27 No. 1, pp. 29-48.
Huang, T.C., Lin, Y.H. and Hairston, S. (2019), “Is there an association between accounting firm ranks
and audit quality? An examination of the top 100 accounting firms in China”, International
Journal of Auditing, Vol. 23 No. 2, pp. 204-230.
Hwang, S. and Sarath, B. (2018), “Disclosure of pension asset allocation and expected rate of return
management”, Asian Review of Accounting, Vol. 26 No. 2, pp. 182-207.
IASB (2018), Conceptual Framework of Financial Reporting, IASB, London.
Jackson, S.B. and Liu, X. (2010), “The allowance for uncollectible accounts, conservatism, and earnings
management”, Journal of Accounting Research, Vol. 48 No. 3, pp. 565-601.
Joe, J.R., Vandervelda, S.D. and Wu, Y. (2017), “Use of high quantification evidence in fair value audits:
do auditors stay in their comfort zone?”, The Accounting Review, Vol. 92 No. 5, pp. 89-116.
Knechel, W.R. and Leiby, J. (2016), “If you want my advice: status motives and audit consultations
about accounting estimates”, Journal of Accounting Research, Vol. 54 No. 5, pp. 1331-1363.
Li, K.K. and Sloan, R.G. (2011), “Has goodwill accounting gone bad?”, Review of Accounting Studies,
Vol. 22, pp. 964-1003.
Lilien, S., Sarath, B. and Yan, Y. (2020), “Fair value accounting, earnings management, and the case of
bargain purchase gain”, Asian Review of Accounting, Vol. 28 No. 2, pp. 229-253.
Moroney, R., Phang, S. and Xiao, X. (2020), “When do investors value key audit matters?”, European
Accounting Review, latest article, doi: 10.1080/09638180.2020.1733040.
Perez-Gonzalez, F. and Yun, H. (2013), “Risk management and firm value: evidence from weather
derivatives”, The Journal of Finance, Vol. 68, pp. 2143-2176.
Shadish, W.R., Cook, T.D. and Campbell, D.T. (2002), Experimental and Quasi-Experimental Designs
for Generalized Causal Inference, Houghton-Mifflin, Boston, MA.
ARA Sierra-Garcia, L., Gambetta, N. and Garcia-Benau, A. (2019), “Understanding the determinants of the
magnitude of entity-level risk and account-level risk key audit matters: the case of the United
Kingdom”, The British Accounting Review, Vol. 51, pp. 227-240.
Tucker, J. and Zarowin, P. (2006), “Does income smoothing improve earnings informativeness?”, The
Accounting Review, Vol. 81 No. 1, pp. 251-270.
Walker, M. (2013), “How far can we trust earnings numbers? What research tells us about earnings
management?”, Accounting and Business Research, Vol. 43 No. 4, pp. 445-481.
Watkins, A.L., Hillison, W. and Morecroft, S.E. (2004), “Audit quality: a synthesis of theory and
empirical evidence”, Journal of Accounting Literature, Vol. 23, pp. 153-192.
Whittington, G. (2008), “Fair value and the IASB/FASB Conceptual Framework project: an alternative
view”, Abacus, Vol. 44 No. 2, pp. 139-168.
Xu, W., Anandarajan, A. and Curatola, A. (2011), “The value relevance of goodwill impairment”,
Research in Accounting Regulation, Vol. 23, pp. 145-148.
Yeung, W.H. and Lento, C. (2020), “Earnings opacity and corporate governance for Chinese listed
firms: the role of the board and external auditors”, Asian Review of Accounting, Vol. 28 No. 4,
pp. 487-515.
Zhang, R., Lu, Z. and Ye, K. (2010), “How do firms react to the prohibition of long-lived asset
impairment reversals? Evidence from China”, Journal of Accounting and Public Policy, Vol. 29
No. 5, pp. 424-438.
Zhang, Y., Andrew, J. and Rudkin, K. (2012), “Accounting as an instrument of Neoliberalisation?
Exploring the adoption of fair value accounting in China”, Accounting, Auditing and
Accountability Journal, Vol. 25 No. 8, pp. 1266-1289.
Appendix Measurement
uncertainty and
KAM Construction of variable management
Description The description of a KAM is used to identify whether or not it is related to accounting
bias
estimates – fair value, asset impairment or other estimates
Reasons The reasons for reporting a KAM indicate whether the auditor is concerned about
measurement uncertainty, management bias or other reasons related to the KAM
Reasons quoted are as follows

Measurement uncertainty
The KAM requires management judgment, assumptions and estimations
Macroeconomic risks
The KAM requires management judgments and assumptions about macroeconomic
risks such as market fluctuations – exchange rates, commodity prices and interest
rates – and the market outlook for future cash flow forecasts
Task structure
The KAM involves task difficulty, complexity, ambiguity, discretion, accounting
choices, etc
Management bias
The KAM may be subject to management manipulation, the amount involved is
significant to the reported profit, possible incentives for manipulation, etc
Audit work The audit work performed to address a KAM provides supplementary input to
performed management uncertainty, macroeconomic risks, task structure and management bias,
if these are less clear in the description for reasons as KAM. It also provides input to the
following variable

Auditor’s specialization
Audit work performed describes the auditor’s specialization in the audit such as the use
of in-house specialists in estimation
Table A1.
Note(s): According to CSA1504/ISA701, an auditor shall provide descriptions of each individual key audit Construction of key
matter covering why (reasons) the matter was considered to be significant and therefore a key audit matter, and variables from key
how the matter was addressed in the audit (audit work performed). Other variables are defined and measured as audit matters (KAM)
presented in Table 3 disclosure

Corresponding author
Chee Kwong Lau can be contacted at: laucheekwong@gmail.com

For instructions on how to order reprints of this article, please visit our website:
www.emeraldgrouppublishing.com/licensing/reprints.htm
Or contact us for further details: permissions@emeraldinsight.com