Received: 14 February 2018
| Accepted: 20 November 2018
DOI: 10.1111/jifm.12095
ORIGINAL ARTICLE
What matters in disclosures of key audit matters:
Evidence from Europe
Inês Pinto | Ana Isabel Morais
Advance/CSG, ISEG – Lisbon School of
Economics & Management, Universidade de
Lisboa, Lisboa, Portugal
Correspondence
Ana Isabel Morais, Advance/CSG, ISEG –
Lisbon School of Economics & Management,
Universidade de Lisboa, Lisboa, Portugal.
Email: anamorais@iseg.ulisboa.pt
Funding information
FCT—Fundação para a Ciencia e Tecnologia
(Portugal), Grant/Award Number: UID/
SOC/04521/2013
© 2018 John Wiley & Sons Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.
J Int Financ Manage Account. 2019;30:145–162.  wileyonlinelibrary.com/journal/jifm
Abstract
New regulation in the European Union has introduced the
mandatory disclosure of key audit matters (KAMs) to
audit reports. The EU has identified KAMs as significant
risks, significant transactions or events, or significant
judgments by auditors. This paper aims to determine the
factors that influence the number of KAMs that auditors
disclose in the main European countries under the new
regulation. We predict that the litigation risk, reputation
loss, auditor–client relationship, precision of accounting
standards, and the effect of regulators and supervisors’ ac-
tivities affect the number of KAMs that auditors disclose.
The sample consists of firms on the FTSE 100, CAC 40, or
AEX 25 that have disclosed KAMs at the 2016 fiscal year-­
end. In line with our hypotheses, the findings show that a
higher number of business segments (complexity) and
more precise accounting standards lead to the disclosure
of a higher number of KAMs. Contrary to our expecta-
tions, the results indicate that a positive association exists
between the audit fee and the number of KAMs disclosed.
As audit fees can be related to higher client risk, this find-
ing could indicate that litigation risk dominates any audi-
tor–client dependence. Further, although auditors often
view their audits of banks as complex, the findings show a
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negative association between banks and the number of dis-

closed KAMs. This evidence may be related to the fact
that financial institutions are in a highly regulated and su-
pervised industry that reduces the need to disclose the
KAMs.

KEYWORDS
auditor judgment, auditor report, determinants, key audit matters, risk

1 | IN T RO D U C T ION

In recent years, the pass/fail model for audit reports has been the subject of growing criticism by reg-
ulators and users as it provides little communicative value (Church, Davis, & McCracken, 2008). As a
result, several institutions and regulators began to work on a new reporting model for auditors in order
to enhance the report’s content and informational value.
The European Union adopted Regulation (EU) No 537/2014 of the European Parliament and the
Council in April 2014 that took effect for accounting periods starting on or after June 17, 2016. This
regulation sets out several measures to emphasize the importance of the auditor’s independence, new
requirements for audit committees, and greater transparency in the audit report. One of the most
important changes in the report is the expanded information on key audit matters (KAMs) that are
areas identified as significant risks, significant transactions or events, or significant judgments by
auditors (including the audit of accounting estimates). This new regulation began at the same time
as the revised International Standard on Auditing (ISA) 701: Communicating Key Audit Matters in
Independent Auditor’s Report that became effective for audits of financial statements for periods end-
ing on or after December 15, 2016.
Several interest groups have questioned the informativeness of the new regulation for investors
(Bédard, Gonthier-­Besacier, & Schatt, 2014; Lennox, Schmidt, & Thompson, 2017). They point to the
impact that the disclosure of KAMs may have on the auditor’s liability (Gimbar, Hansen, & Ozlanski,
2016b). They also argue that this type of information might lessen the focus on the remaining parts of
the financial statements (Sirois, Bédard, & Bera, 2017).
Following the financial scandals of the early twenty-­first century, regulating bodies, accounting
professionals, and academics have been working on the quality of audits. Their focus has been on the
idea of extended audit reporting as a way to increase the information content in the report to reduce
the information asymmetry between auditors and users (Bédard et al., 2014; Cordoş & Fülöpa, 2015).
Through experiments with professional and nonprofessional agents, different studies have investi-
gated the consequences of KAMs on investors’ decisions or auditors’ liability (Christensen, Glover, &
Wolfe, 2014; Gimbar et al., 2016b; Lennox et al., 2017; Sirois et al., 2017). Nevertheless, less research
focuses on what might influence the disclosure of KAMs by auditors. Köhler, Ratzinger-­Sakel, and
Theis (2016) suggest that future research on how auditors’ characteristics influence the communica-
tion of KAMs is needed as this communication is based on their judgment.
According to ISA 701, auditors must determine and disclose KAMs that are, in the auditor’s pro-
fessional judgment, the most significant issues in the audit of the financial statement. In this context,
auditors must choose which KAMs to disclose in their report each year. This decision-­making is
complex because it is dependent on different elements, subprocesses, and tasks (Einhorn & Hogarth,
1981).
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This paper uses Hogarth’s (1980) theory on information assimilation to identify the factors that
influence the number of KAMs that auditors disclose under the new regulation in the European coun-
tries of France, the UK, and the Netherlands. We expect that the auditors’ risk of litigation and the
auditor–client relationship combined with the precision of accounting standards and the regulators’
and supervisors’ activities are important drivers of the number of disclosed KAMs.
The sample consists of firms listed on the FTSE 100, CAC 40, or the AEX 25 that have disclosed
KAMs at the 2016 fiscal year-­end. We have chosen these indices because these three countries (the
UK, France, and the Netherlands) were already disclosing KAMs in their audit reports before 2016.
In line with our hypotheses, the findings show that a higher number of business segments (com-
plexity) and more precise accounting standards lead to the disclosure of a higher number of KAMs.
Contrary to our expectations, the results show a positive association between the audit fee and the
number of disclosed KAMs. As audit fees are related to higher client risk, this finding indicates that
litigation risk surpasses any auditor–client dependence and has the opposite effect on the number of
disclosed KAMs. Further, although auditors often view the audits of banks as complex, the findings
show a negative association between banks and the number of disclosed KAMs. This evidence may
be related to the fact that financial institutions are in a highly regulated and supervised industry that
reduces the need to disclose the KAMs. These findings are robust to different tests.
This paper contributes to the literature by examining the determinants of KAMs in this new type
of disclosure. The literature on KAMs mainly investigates the consequences of their disclosure on
the auditors′ liability and investors′ decision-­making by using experimental cases. This paper pro-
vides direct evidence on what motivates auditors to disclose KAMs. Although there are guidelines for
determining whether an issue constitutes a KAM, guidance about the number of KAMs that should
be reported is scarce. As the number of KAMs depends on professional judgment, it is important to
determine what factors influence the auditor′s behavior.
The identification of the determinants of the number of KAMs is relevant for three main reasons.
First, the greater the number of KAMs, the less useful the auditor’s report is. More KAMs increase
the complexity and can dilute their importance (Sirois et al., 2017). Second, KAMs attract the users’
attention and make the related disclosures in the financial statement more salient (Orquin & Loose,
2013), but increasing the number of such elements can also reduce the effectiveness of their signaling
(Li, Qi, Tian, & Zhang, 2017). Furthermore, because KAMs are more concise and credible than other
disclosures (Christensen et al., 2014), users may rely on these as substitutes.
This paper also contributes to the literature by showing the relation between the precision of ac-
counting standards and the disclosure of significant areas of risk in the audit report. Previous studies
investigate this relation by using experiment models. By contrast, this study provides direct evidence
of this relation.
Our results also show that auditors tend to disclose fewer KAMs for financial institutions than for
other firms. This paper contributes to the area of research that shows that auditors expend less effort
on firms that are more regulated and supervised.
Finally, our findings may be useful to standard setters, regulators, and financial managers as they
give a better understanding of the factors that may influence the decision process underlying an audi-
tor′s decision to disclose KAMs.

2 | L IT E R AT U R E R E V IE W A N D HYPOTHESES

One of the purposes of the new audit report is to reduce the expectation and information gaps between
users and auditors by improving the auditors’ communication by adding more information to the
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report (Church et al., 2008). The International Auditing and Assurance Standards Board (IAASB)
(2011) defines the expectation gap as the “difference between what users expect from the auditor and
the financial statement audit and the reality of what an audit is.” It goes on to define the information
gap as the “gap between the information users believe is needed to make informed investment and
fiduciary decisions, and what is available to them through the entity’s audited financial statements or
other publicly available information.” Previous studies show mixed results for the changes to the audit
report and the reduction in the expectation gap (Church et al., 2008; Coram, Mock, Turner, & Gray,
2011; Geiger, 1994; Gray, Turner, Coram, & Mock, 2011; Miller, Reed, & Strawser, 1990; Mock
et al., 2013; Turner, Mock, Gray, & Coram, 2010) but provide evidence that the information gap may
be reduced when information in the audit report increases (CFA Institute 2010; IAASB 2011; IOSCO
2009).
This study is based on the sociopsychological tradition. We focus on the process underlying the
production of the KAMs in the audit report. We use Hogarth’s (1980) theory on information as-
similation for judgment and choice decisions. The theory has four stages: information acquisition,
processing, output, and feedback. This theory is used to evaluate the processes behind an auditor’s
decision to disclose KAMs. We focus on the third stage, the output, and we consider that the decision
to disclose a KAM is affected by both the auditor and the environment. Also, based on Einhorn and
Hogarth (1981), we assume that the conflict inherent in disclosing a KAM in the audit report (the ac-
tion to disclose or not to disclose a KAM) is distinct from a conflict in judgment (judgment if an area
or transaction is significant or not). The disclosure of a KAM can lead to a greater commitment and
may be tied to feelings of regret and responsibility.
To solve the conflict in action, auditors can use avoidance or confrontation (Einhorn & Hogarth,
1981). The use of avoidance means that the auditor will not disclose a KAM or will delay the disclo-
sure. We expect that avoidance happens when the auditors consider that there is less responsibility
associated with the effects of not disclosing a KAM than with disclosing one. The use of confrontation
means that the auditor uses compensatory strategies that are expressed in the expected utility model
where the auditor is risk averse.
The disclosure of KAMs in the audit report is influenced by the auditor’s perceived consequences
of the economic trade-­off between the probability of being exposed to litigation and the loss of reputa-
tion on the one hand and the expected cost of losing a client on the other hand. We also predict that the
precision of an accounting standard and the fact that certain entities are more regulated and supervised
than others can affect the number of disclosed KAMs.

2.1 | Litigation risk and auditors’ loss of reputation

Previous studies show that the disclosure of KAMs can affect the auditor’s litigation risk. Kachelmeier,
Schmidt, and Kristen (2017) conclude that the information in KAMs causes attorneys to find auditors
less responsible for a misstatement, and this result holds regardless of the inclusion of a resolution
paragraph that describes the audit procedures to be performed. They conclude that the results support
a “disclaimer effect” from KAM disclosures. Brasel, Marcus, Jonathan, Grenier, and Reffett (2016)
also find that users react less negatively when an auditor fails to detect misstatements if a related
KAM has been previously disclosed. Gimbar, Hansen, and Ozlanski (2016a) conclude that disclosed
KAMs do not affect the auditor’s liability in an environment with an imprecise accounting standard.
Köhler et al. (2016) extend these studies by including not only nonprofessional investors but also
investment professionals. Like Backof (2015), they find that KAMs have no communicative value
for nonprofessional investors, but for professional investors, a negative KAM (small changes in key
assumptions could eventually lead to goodwill impairment) leads to a better assessment of a firm’s
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economic situation than a positive KAM (large changes in key assumptions could eventually lead to
goodwill impairment).
So, we predict that auditors disclose more KAMs to reduce their liability and maintain their rep-
utation, and these disclosures are particularly relevant for riskier firms. In general, higher leverage
involves higher financial risk and, consequently, a higher risk of litigation. As the financial risk of
a firm increases, auditors tend to review this firm more thoroughly, which results in increased effort
and fees (Nelson, Ronen, & White, 1988). An increase in the auditor’s effort to reduce liability tends
to improve the procedures in the audit and therefore the identification of KAMs. On the other hand,
as the leverage increases, managers have more incentives to adopt accounting policies that avoid that
cost but increase the risk of certain areas. Laitinen and Laitinen (1998) and Reynolds and Francis
(2000) find that a higher proportion of external funds significantly decreases the likelihood of receiv-
ing an unqualified audit opinion. Further, firms with higher leverage tend to have more difficulty in
maintaining funding support from lenders. This difficulty increases their risk, and auditors need to be
aware of the firms’ potential failure and shareholder’s litigation that may arise from the discontinua-
tion of operations.
We also predict that auditors tend to disclose more KAMs for more complex firms. In more com-
plex firms, there are more areas of risk that lead to an increase in the number of disclosed KAMs.
Following previous studies (Bédard, Hoitash, & Hoitash, 2008; Markanian & Parbonetti, 2007), we
use the number of segments as a proxy for complexity. We predict that managers from more diversi-
fied firms have more incentives to manage earnings due to agency problems (Berger & Ofek, 1995;
Ozbas & Scharfstein, 2010; Rajan, Servaes, & Zingales, 2000). These managers tend to manipulate
more earnings at the segment level to hide an inefficient allocation of capital.
These arguments lead to the following hypotheses:
H1: There is a positive association between the firms′ risk and the number of disclosed KAMs.
H1a: There is a positive association between the firms′ leverage and the number of disclosed
KAMs.
H1b: There is a positive association between the firms′ number of segments and the number of
disclosed KAMs.

2.2 | Auditor–client relationship

The number of KAMs can also be influenced by the level of the relationship between the auditor and
his or her client in terms of tenure and the level of audit fees.
We predict a negative association between the auditors’ tenure and the number of disclosed KAMs.
Some studies argue that a longer auditor–client relationship reduces the quality of the audit as man-
agers become more likely to act in favor of management (Tepalagul & Lin, 2015). But, the literature
on auditors’ tenure has generally supported a positive association between tenure and the quality of
financial reporting (Carcello & Nagy, 2004; Johnson, Khurana, & Reynold, 2002; Myers, Myers, &
Omer, 2003). It finds that when the tenure is longer, the financial reporting quality is higher (lower ab-
solute value of unexpected accruals and more persistent accruals) (Johnson et al., 2002; Myers et al.,
2003) and that there is a lower likelihood of fraud (Carcello & Nagy, 2004). These two factors can
decrease the number of disclosed KAMs. Additionally, the studies of Levinthal and Fichman (1988)
and Vanstraelen (2000) show that long-­term auditor–client relationships significantly increase the
likelihood of unqualified audit reports. Singer and Zhang (2018) find that a longer tenure for auditors
leads to fewer corrected misstatements.
Based on the positive association between tenure and financial quality, we state the following
hypothesis:
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H2a: There is a negative association between the auditor’s tenure and the number of disclosed
KAMs.
Regarding the effect of audit fees, the results can conflict. As audit fees are the main source of
income for auditors, the level of relevance of a client can determine the incentive that auditors have
to compromise their independence. In fact, the auditor’s decision to disclose a KAM can be a choice
between maintaining his or her reputation and maintaining a certain level of income. DeAngelo
(1981) points out that auditors are more likely to question their independence from important clients.
McKeown, Mutchler, and Hopwood (1991) conclude that larger clients benefit from their bargaining
power and consequently are less likely to receive a qualified opinion. Reynolds and Francis (2000)
investigate the influence of large clients on auditors’ reporting decisions and conclude that economic
factors can incentivize auditors to agree with the clients’ decisions in terms of financial reporting so
as to retain them as clients. Chung and Kallapur (2003) study the relationships among the importance
of customers, nonaudit services, and abnormal accruals and find that the auditors’ independence is
compromised by the importance of clients as the amount of corporate governance and the number of
industry specialists increase. Cenker and Nagy (2008) also find that auditors are less likely to give up
customers who pay high audit fees than they are to give up other customers.
Nevertheless, the literature gives evidence that audit fees may be positively associated with higher
perceived risk (Lyon & Maher, 2005). Yang, Yu, Liu, and Wu (2018) finds that audit fees are posi-
tively related to firm-­specific financial, strategic, and operational risks. In this context, the association
between the disclosure of a KAM and the audit fee may be positive.
Based on the arguments for auditors’ independence, we state the following hypothesis:
H2b: There is a negative association between audit fees and the number of disclosed KAMs.

2.3 | Precision of accounting standards

We also predict that auditors tend to disclose more KAMs because of more precise (or more rule-
based) accounting standards. In fact, we expect that if an accounting standard is less precise (more
principle-based), the auditor’s willingness to disclose a KAM decreases. The auditor tends to avoid
raising a potential KAM because it could lead to unknown outcomes. So, the auditor may prefer to
not disclose a KAM related to a principle-based accounting standard because he or she can argue that
KAM may not be worth disclosing. Dugan (2009) concludes that auditors delay loss recognition until
concrete information is available due to a strict interpretation of the incurred loss model and earnings
management concerns.
Hackenbrack and Nelson (1996) find that auditors use the imprecision in accounting standards to
justify an accounting treatment consistent with their incentives. The results show that flexibility in
accounting standards can allow auditors to adopt the client’s preferred positions, given the presence of
incentives to please the client (Hackenbrack & Nelson, 1996; Mayhew, Schatzberg, & Sevcik, 2001)
that therefore reduces the number of disclosed KAM.
Previous studies also show that auditors are more likely to allow aggressive reporting by manage-
ments under less precise accounting standards (Cohen, Krishnamoorthy, Peytcheva, & Wright, 2013;
Jamal & Tan, 2010; Nelson, Elliot, & Tarpley, 2002; Salterio & Koonce, 1997; Segovia, Arnold, &
Sutton, 2009; Trompeter, 1994). Trompeter (1994) uses audit partners and varies the precision of
accounting standards in a marketable security valuation case. He shows that audit partners allow for
more income-­increasing interpretations in cases with less precise standards. Lin and Fraser (2008)
also argue that the specificity of an accounting standard affects the auditor’s ability to resist pressure
from the client. They find that UK auditors perceive that clients tend to obtain preferred treatment
when the accounting standard in dispute is less specific. Further, Gimbar et al. (2016a) show that the
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auditor’s liability increases with KAMs when the accounting issue is governed by a precise accounting
standard.
Thus, we conclude that under more principle-based accounting standards, auditors tend to disclose
fewer KAMs. In fact, facing the subjectivity of the accounting standard, auditors are more willing to
accept the client’s preferred accounting treatment.
These arguments lead to the following hypothesis:
H3: There is a positive association between the precision of an accounting standard (more rule-­
based accounting standard) and the number of disclosed KAMs.

2.4 | Sector regulation and supervision

The literature identifies some industries as more difficult to audit than others (Hay, Knechel, & Wong,
2006; Simunic, 1980).
Auditors can issue more KAMs for banks than for other firms because of the banks’ greater com-
plexity, opacity, and agency conflicts. They often view banks as opaque due to their complex and
interrelated on-­balance sheet and off-­balance sheet exposures and due to the individual and collective
values and risks that are difficult to evaluate by users. This difficulty may enhance the banks’ ability
to manage or obscure their financial reporting. The empirical research provides evidence that sup-
ports this view. Morgan (2002) shows that banks receive more different bond ratings from different
rating agencies than do nonbanks. The increasing length and complexity of their financial reports
due to more complex accounting standards leads to the increasing economic complexity of banks.
Accounting standard setters have written many complex and lengthy standards for financial instru-
ments and transactions to try to adequately capture their economics (Guay, Samuels, & Taylor, 2016).
However, auditors may find less areas of risk in audits of firms that are more regulated and super-
vised. Because of the role of regulators and supervisors, auditors need to perform less extensive audit
work than do auditors of other firms and, therefore, tend to disclose fewer KAMs. Ghosh, Jarva, and
Ryan (2017) show that the regulation and supervision of banks provide auditors with incentives to
reduce their effort on the audits of banks.
These arguments lead to the following hypothesis:
H4: There is a negative association between the level of regulation and supervision of the entity’s
sector and the number of disclosed KAMs.
We use several control variables: size, profitability, proportion of inventories and receivables (in-
herent risk), and the auditor’s busy season. Studies show that larger firms also have more power to
negotiate with auditors in terms of audit fees (Casterella, Francis, Lewis, & Walker, 2004; Huang,
Liu, Raghunandan, & Dasaratha, 2007) and that large clients are able to bring more pressure to bear
on auditors to disclose fewer KAMs. Therefore, we expect a positive relation between larger firms
and KAMs due to the firms’ complexity. We predict a negative association between the firms’ prof-
itability and the number of disclosed KAMs. Profitability is, in general, associated with future via-
bility. Therefore, the firms with higher profitability tend to have less probability of default and tend
to receive an unqualified audit opinion (Beasley, Carcello, & Hermanson, 1999; Laitinen & Laitinen,
1998; Loebbecke, Eining, & Willingham, 1989) that decreases the litigation between the auditor and
managers. Also, firms with lower profitability tend to use more creative accounting in the preparation
of financial statements that increases the probability of a qualified opinion and/or the disclosure of
more KAMs. The literature refers to inventory and receivables as two areas that are more difficult to
audit and therefore have a higher probability of error. Thus, they require specialized audit procedures
(Hay et al., 2006; Simunic, 1980). Because these two parts of the audit process can increase the risk
associated with the process, we expect a positive association between the proportion of total assets in
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accounts receivable and inventories and the number of KAMs. Further, we also control for the audi-
tor’s busy season. As December 31 is the most common fiscal year-­end in Europe (Hay et al., 2006),
this busy season may make conducting all the audit procedures difficult that could cause auditors to
disclose more KAMs in order to reduce their liability.

3 | R E S EA RCH D E SIGN

Based on the previous literature review, we use the following cross-­sectional regression model to
examine the association between the entity or the auditors’ characteristics and the number of KAMs
in their reports:
KAM = 𝛽0 + 𝛽1 LEV+𝛽2 SEGMENT + 𝛽3 TENURE + 𝛽4 AUDITFEE
(1)
+𝛽5 IRBC + 𝛽6 INDFI + 𝛽7 LNTA + 𝛽8 PROF + 𝛽9 RECINV + 𝛽10 FYI + 𝜀

where, KAM is the number of disclosed KAMs at fiscal year-­end 2016 divided by the average num-
ber of sample KAMs. LEV is computed as the ratio of total debt to total assets. SEGMENT is the
natural log of the number of business segments of the firm. TENURE is the natural log of the number
of years of the actual duration of the current auditor’s tenure. AUDITFEE is the ratio of audit fees to
total assets. The precision of accounting standards is based on the rule-­based characteristics (RBC2)
score of Mergenthaler (2011), which Donelson, McInnies, and Mergenthaler (2012) have validated,
to determine whether an accounting standard is more rule-­based or more principle-­based.1 The higher
the RBC2 score, the more rule-­based characteristics the accounting standard contains.
From the auditor’s report, we identify the accounting standard that is related to each KAM. Based
on Mergenthaler (2011), Donelson et al. (2012), and Morais (2016), we attribute RBC2 to each ac-
counting standard applied to the KAM. Then, we compute the IRBC as the ratio between the total
RBC2 score obtained for each firm divided by the number of KAMs disclosed. The INDFI is a dummy
variable with the value of one for financial institutions and zero otherwise. LNTA is the natural log
of the firm′s total assets; RECINV represents the proportion of total assets in accounts receivable and
inventory. PROF is computed as the ratio EBIT to total assets. FYE is a dummy variable that takes the
value of one for firms with a fiscal year-­end on December 31 and zero otherwise.
We first estimate an OLS. But, as the number of KAMs is a count variable, we also run a Poisson
regression to estimate the above model using the number of KAMs (NKAM) as the dependent vari-
able. We also investigate whether the determinants remain the same for firms that have a number of
KAMs above the sample average (DAKAM).

4 | SA M P L E A N D DATA

We use a sample of firms on the UK’s FTSE 100, France’s CAC 40, or the Netherlands’s AEX 25
that have disclosed KAMs at the 2016 fiscal year-­end. We have chosen these three indices because,
although the Regulation (EU) No 537/2014 is only effective for financial statements starting on or
after June 17, 2016, these three countries were already disclosing KAMs in their audit reports. We
hand collect the information about the number of KAMs and the accounting standards associated with
these KAMs. Firm-­level characteristics such as leverage, total assets, EBIT, audit fees, segments, and
tenure are obtained from Datastream for 2015 and 2016.
We collect KAMs for 142 firms. The mean number of KAMs for the firms in our sample is 3.8
with a minimum of 0 and a maximum of 9. There are 81 (57%) firms that disclose a number of KAMs
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above the sample average. After deleting firms with missing independent variables, 93 firms remain
in our sample. Table 1 provides the data on the sample. Our sample includes large firms as it includes
only listed firms in the three countries. Firms in the sample are not highly leveraged with debt repre-
senting on average 23% of their total assets. Financial institutions represent 20% of our sample.
We collected 577 KAMs for our sample firms. KAMs associated with accounting standards rep-
resent 92.7% of the total number of KAMs disclosed. The remainder are related to other risk areas
such as IT (38%), judgments (17%), and internal control (12%). With regard to KAMs associated
with accounting standard IAS 36, the impairment of assets is the main risk area with 102 KAMs that
are disclosed (19%). The major concern of auditors is related to the impairment of goodwill (14%
of accounting standard KAMs). For other accounting, the relevant weights are IAS 18, revenue rec-
ognition (14%); IAS 37, provisions, contingent liabilities, and contingent assets (12%); and IAS 12,
income taxes. The RBC2 for these accounting standards is 3.87, 3.01, 3.25, and −2.37, respectively. It
varies between −3.49 (IAS 7—Statement of Cash Flows) and 11.98 (IAS 39—Financial Instruments:
Recognition and Measurement) with a median of −0.31.

5 | E M P IR ICA L R E SU LTS

Table 2 provides the results of our model to determine the factors that influence the number of KAMs
that auditors disclose.
With regard to our first hypothesis that relates the firm′s risk to the number of KAMs, we
only find that this association is marginally positive when using the number of segments as a
proxy for complexity and risk. In fact, the coefficient for the firms’ leverage is not statistically
significant, and the coefficient for the number of segments (β 2) is positive and statistically
significant at the 10% level.
The number of business segments is a proxy for the firms′ complexity (Hay et al., 2006). The
more complex a client, the riskier auditing the firm is. With the aim to reduce his or her liability and
maintain their reputation, the auditor tends to disclose more KAMs in firms with a higher number of
business segments. Contrary to our expectation, the firms’ leverage does not influence the number of
KAMs. This result can be related to the fact that our sample only includes large listed firms that are
not highly leveraged.
Considering the auditor–client relationship, we find that the auditor’s tenure does not influence his
or her behavior regarding the number of disclosed KAMs as the coefficient for the variable TENURE
(β3) is not statistically significant.
However, and contrary to our hypothesis H2b, we conclude that the higher the audit fees the greater
the number of KAMs received by the firms. The coefficient for AUDITFEE is positive and statisti-
cally significant at the 1% level. As some authors argue, this result may be because higher audit fees
are associated with the client’s higher risk and complexity (Lyon & Maher, 2005; Simunic & Stein,
1996). Therefore, we conclude that the litigation risk overlaps the effect of the auditor–client depen-
dence that indicates a negative association between audit fees and the number of KAMs.
In line with our third hypothesis, we find that auditors tend to disclose more KAMs under rule-­
based accounting standards. The coefficient for IRBC is positive (β5 = 0.043) and statistically sig-
nificant at the 10% level. In line with Dugan (2009), this result indicates that under a less precise
accounting standard, auditors might find it easier to justify not disclosing a KAM. On the other hand,
the literature shows that the auditor’s liability increases with the level of precision in the accounting
standards (Gimbar et al., 2016a) that might incentivize auditors to disclose more KAMs because of
more rule-­based accounting standards.
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TABLE 1 Descriptive statistics

Panel A: Descriptive statistics for continuous variable

Mean Median Standard Deviation Min Max

KAM 0.94 1.04 0.56 0.00 2.34
NKAM 3.84 4.00 2.03 0.00 9.00
LEV 0.23 0.22 0.15 0.00 0.69
SEG 4.53 5.00 2.72 0.00 10.00
TENURE 5.01 3.00 4.03 0.00 15.00
AUDITFEE (%) 0.03 0.02 0.03 0.00 0.20
IRBC 2.81 2.56 1.66 −2.26 7.46
LNTA 16.91 16.73 1.91 4.24 21.46
RECINV 0.21 0.17 0.17 0.00 0.92
LNTA 16.91 16.73 1.91 4.24 21.46
PROF 0.063 0.061 0.07 −0.26 0.37

Panel B: Mean, median, and frequencies for dichotomous variables

Mean Median No. Firms coded = 1 No. Firms coded = 0

DAKAM 0.57 1 81 61
FYE 0.82 1 117 25
INDFI 0.20 0 28 114

Panel C: KAMs by Accounting Standards

Mean (%) Freq

IAS 1—Presentation of Financial 3.0 16
Statements
IAS 2—Inventories 3.2 17
IAS 12—Income Taxes 11.0 59
IAS 16—Property, Plant and Equipment 4.1 22
IAS 17—Leases 0.4 2
IAS 18—Revenue 14.2 76
IAS 19—Employee Benefits 7.5 40
IAS 23—Borrowing Costs 0.6 3
IAS 36—Impairment of Assets 19.1 102
IAS 37—Provisions, Contingent 12.1 65
Liabilities and Contingent Assets
IAS 38—Intangible Assets 3.9 21
IAS 39—Financial Instruments: 9.2 49
Recognition and Measurement
IAS 40—Investment Property 0.7 4
IFRS 3—Business Combinations 6.4 34
IFRS 4—Insurance Contracts 2.8 15

(continues)
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TABLE 1 (continues)
Panel C: KAMs by Accounting Standards

Mean (%) Freq

IFRS 5—Non-­current Assets Held for 1.5 8
Sale and Discontinued Operations
IFRS 13—Fair Value Measurement 0.4 2
KAMs Accounting Standard 92.7 535
KAMs Others 7.3 42
Total KAMs 577
KAM = number of KAMs disclosed at fiscal year-­end 2016/average of sample KAMs; NKAM = number of KAMs disclosed at fiscal
year-­end 2016; DAKAM = one for firms with a number of KAMs above the sample average; LEV = ratio of total debt to total assets;
SEGMENT = natural log of the number of business segments; TENURE = natural log of the number of years of the actual duration of
the current auditor tenure; AUDITFEE = ratio of audit fee to total assets; IRBC = ratio between the total RBC2 score obtained for each
firm divided by the number of KAMs disclosed. We define precision of accounting standards based on the rule-­based characteristics
(RBC2) score of Mergenthaler (2011) and Donelson et al. (2012); LNTA = natural log of firm′s total assets; RECINV = proportion of
total assets in accounts receivable and inventory; PROF = EBIT divided by total assets; FYE = one for firms with fiscal year-­end on
December 31 and zero otherwise; INDFI = one for financial institutions and zero otherwise.

Finally, in line with our last hypothesis, the results show that auditors disclose less KAMs for fi-
nancial institutions. Although auditors may disclose more KAMs in banks due to the complexity and
opacity of this industry, the fact that the industry is very well regulated and supervised may lead them
to find less areas of risk. In regulated industries, the high level of required disclosure and monitoring
can lead auditors to have lower incentives to disclose KAMs (Dunn & Mayhew, 2004).
Regarding the control variables, auditors of large firms disclose more KAMs as the coefficient
for LNTA is positive (β7 = 0.136) and statistically significant at the 1% level. This finding relates to
large firms being more complex, requiring more work from the auditors, and posing a greater risk to
the auditors′ liability. This finding is robust using the natural log of sales as an explanatory variable
to measure firm size.
The results also provide evidence of a negative relation between profitability and the number of
disclosed KAMs. Firms with lower profitability present a higher risk of failure and therefore auditors
may need to extend the scope of their work and disclose more KAMs.
In contrast, the fiscal year-­end (“busy season”) does not have an effect on the number of disclosed
KAMs (Hay et al., 2006). The fact that December 31 is the most common fiscal year-­end and therefore
is considered the auditors′ busy season does not seem to influence auditors regarding the disclosure
of KAMs.
Firms with extensive inventory and receivables, which are areas viewed as being difficult to audit,
increase the client’s inherent risk (Simunic, 1980; Stice, 1991) but do not seem to influence the dis-
closure of KAMs.
We also observe that the UK and the Netherlands disclose more KAMs than France, which sug-
gests that auditors’ judgments and decisions on disclosing KAMs might be a function of culture and
institutional factors (Nolder & Riley, 2014).
As some firms have the fiscal year-­ends before December 31, 2016, we estimate the above re-
gression using the simple average of 2015 and 2016 for all independent variables. All results remain
similar.
As sensitive analyses, we also perform additional tests in order to investigate the influence of the
different determinants presented above on the number of KAMs disclosed in the audit report.
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TABLE 2 Determinants of the number of KAMs—regression results

Independent Variables: Coefficient Predicted Sign Coefficient p-­value

Intercept β0 ? −1.935** 0.021
LEV β1 + −0.257 0.254
SEG β2 + 0.086* 0.087
TENURE β3 − −0.016 0.718
AUDITFEE β4 − 4.768*** 0.000
IRBC β5 + 0.043* 0.075
INDFI β6 − −0.382*** 0.003
LNTA β7 + 0.136*** 0.003
RECINV β8 + 0.534** 0.036
PROF β9 − −2.052*** 0.000
FYE β10 ? −0.074 0.445
DUK β11 ? 0.619*** 0.000
DNTHL β12 ? 0.502*** 0.001
No. of Observations 93
Adj-­R2 57.67%
This table presents estimates of the coefficients for the following OLS: KAM = β0 + β1LEV + β2SEGMENT + β3TENURE +
β4AUDITFEE + β5IRBC + β6LNTA + β7PROF + β8RECINV + β9FYE + β10INDFI + ε
KAM = number of KAMs disclosed at fiscal year-­end 2016/average of sample KAMs; LEV = ratio of total debt to total assets;
SEGMENT = natural log of the number of business segments; TENURE = natural log of the number of years of the actual duration of
the current auditor tenure; AUDITFEE = ratio of audit fee to total assets; IRBC = ratio between the total RBC2 score obtained for each
firm divided by the number of KAMs disclosed. We define precision of accounting standards based on the rule-­based characteristics
(RBC2) score of Mergenthaler (2011) and Donelson et al. (2012); LNTA = natural log of firm′s total assets; RECINV = proportion of
total assets in accounts receivable and inventory; PROF = EBIT divided by total assets; FYE = one for firms with fiscal year-­end on
December 31 and zero otherwise; INDFI = one for financial institutions and zero otherwise; DUK = one if the firm is from the UK and
zero otherwise; DNTHL = one if the firm is from the Netherland and zero otherwise.
Significance at ***1%, **5%, and *10% level.

First, as the number of KAMs is a count variable, we estimate the model using a Poisson regres-
sion. Table 3 provides the results from this regression.
All the conclusions remain unchanged. The coefficient for LNTA is 0.133, which means that an
increase of 1% in the firm size is associated with 13% in the number of KAMs disclosed in the audit
report. We assess the fit of the model through the goodness-­of-­fit chi-­squared test and find the test is
not statistically significant, which indicates the model has good fit.
We also use a dummy (DAKAM) as the dependent variable in a logit regression that equals one
for firms with a number of KAMs above the sample average and zero otherwise. The findings are
presented in Table 4.
We also conclude that the number of business segments, size, audit fees, and the industry are all
factors that influence the probability of the number of KAMs being higher than the sample average.

6 | CO NC LUSION S

A change in the way auditors report their opinions about financial statements creates an opportunity
to investigate what factors move auditors to disclose more or less KAMs. KAMs are areas that the
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TABLE 3 Determinants of the number of KAMs—Poisson regression results

Independent variables Coefficient Predicted Sign Coefficient p-­value

Intercept β0 ? −1.606** 0.015
LEV β1 + −0.322 0.155
SEG β2 + 0.091** 0.032
TENURE β3 − −0.210 0.586
AUDITFEE β4 − 4.761*** 0.000
IRBC β5 + 0.041* 0.093
INDFI β6 − −0.471*** 0.000
LNTA β7 + 0.133*** 0.000
RECINV β8 + 0.478* 0.063
PROF β9 − −1.683*** 0.000
FYE β10 ? −0.077 0.353
DUK β11 ? 0.643*** 0.000
DNTHL β12 ? 0.572*** 0.000
No. of Observations 93
Pseudo-­R2 11.38%
This table presents estimates of coefficients for the following OLS: NKAM = β0 + β1LEV + β2SEGMENT + β3TENURE +
β4AUDITFEE + β5IRBC + β6LNTA + β7PROF + β8RECINV + β9FYE + β10INDFI + ε
NKAM= number of KAMs disclosed at fiscal year-­end 2016; LEV = ratio of total debt to total assets; SEGMENT = natural log of the
number of business segments; TENURE = natural log of the number of years of the actual duration of the current auditor tenure;
AUDITFEE = ratio of audit fee to total assets; IRBC = ratio between the total RBC2 score obtained for each firm divided by the number
of KAMs disclosed. We define precision of accounting standards based on the rule-­based characteristics (RBC2) score of Mergenthaler
(2011) and Donelson et al. (2012); LNTA = natural log of firm′s total assets; RECINV = proportion of total assets in accounts receiv-
able and inventory; PROF = EBIT divided by total assets; FYE = one for firms with fiscal year-­end on December 31 and zero otherwise;
INDFI = one for financial institutions and zero otherwise; DUK = one if the firm is from the UK and zero otherwise; DNTHL = one if
the firm is from the Netherland and zero otherwise.
Significance at ***1%, **5%, and *10% level.

auditor considers are significant risks or require significant judgment and must be identified in the
new model of the audit report. We expect that auditors of firms with higher risk disclose more KAMs.
We also anticipate that the auditor–client relationship and the precision of the accounting standards
can influence the number of disclosed KAMs. To test our hypotheses, we use a sample of firms on the
FTSE 100, CAC 40, or AEX 25 that disclosed KAMs at the 2016 fiscal year-­end. Our results show
that there is a positive association between the number of business segments, audit fees, precision of
accounting standards, and size; while the association is negative for financial institutions and profit-
ability. There is also evidence that culture and institutional factors may influence auditors’ judgments
and decisions on disclosing KAMs.
This study contributes to the audit literature in several ways. First, it is the first, as far as we know,
to provide an analysis of the determinants of the KAMs’ disclosure. Previous studies about KAMs
identify the potential consequences of their disclosure. Second, the findings are useful to standard set-
ters and regulators by highlighting the factors that influence the identification of a KAM. Further, for
financial managers, it gives a better understanding of the factors that influence the processes behind
the auditors′ decisions to disclose KAMs.
Our study is subject to limitations. In our sample, we include firms that in prior years adopted
an audit report that included a description of the KAMs. So, our sample does not include first-­time
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TABLE 4 Determinants of the number of KAMs—logit regression results

Independent Variables: Coefficient Predicted Sign Coefficient p-­value

Intercept β0 ? −25.843*** 0.002
LEV β1 + −5.544 0.114
SEG β2 + 1.109* 0.055
TENURE β3 − −0.313 0.281
AUDITFEE β4 − 39.854*** 0.001
IRBC β5 + 0.374 0.113
INDFI β6 − −5.853*** 0.001
LNTA β7 + 1.314*** 0.002
RECINV β8 + 0.850 0.726
PROF β9 − −5.206 0.480
FYE β10 ? −0.516 0.497
DUK β11 ? 4.191*** 0.001
DNTHL β12 ? 4.027** 0.012
No. of Observations 93
Pseudo-­R2 41.26%
This table presents estimates of coefficients for the following OLS: DAKM= β0 + β1LEV + β2SEGMENT + β3TENURE +
β4AUDITFEE + β5IRBC + β6LNTA + β7PROF + β8RECINV + β9FYE + β10INDFI + ε
DAKAM = one for firms with a number of KAMs above the sample average; LEV = ratio of total debt to total assets; SEGMENT =
natural log of the number of business segments; TENURE = natural log of the number of years of the actual duration of the current
auditor tenure; AUDITFEE = ratio of audit fee to total assets; IRBC = ratio between the total RBC2 score obtained for each firm divided
by the number of KAMs disclosed. We define precision of accounting standards based on the rule-­based characteristics (RBC2) score
of Mergenthaler (2011) and Donelson et al. (2012); LNTA = natural log of firm′s total assets; RECINV = proportion of total assets in
accounts receivable and inventory; PROF = EBIT divided by total assets; FYE = one for firms with fiscal year-­end on December 31
and zero otherwise; INDFI = one for financial institutions and zero otherwise; DUK = one if the firm is from the UK and zero other-
wise; DNTHL = one if the firm is from the Netherland and zero otherwise.
Significance at ***1%, **5%, and *10% level.

adopters. The effect of culture and institutional factors on auditors’ behavior regarding the disclosure
of KAMs is a topic of interest for future research.

ACKNOWLEDGEMENTS
The authors gratefully acknowledge the helpful comments and suggestions provided by the editors,
two anonymous reviewers, and the participants of EARNet Symposium (Louvain) and 21st Annual
Financial Reporting and Business Communication Conference, British Accounting & Finance
Association (BAFA), and University of Durham. Financial support from FCT—Fundação para a
Ciencia e Tecnologia (Portugal), national funding through research grant UID/SOC/04521/2013, is
gratefully acknowledged.

ENDNOTE
1
RBC2 is a continuous metric that considers the following factors in order to determine the precision of each ac-
counting standard: high level of detail as the total number of words in each accounting standard; large volumes of
implementation guidance as the total number of SIC/IFRIC and application guidance for each accounting standard;
PINTO and MORAIS   
| 159

bright-­line thresholds as the total number of bright-­line thresholds in each accounting standard; and exceptions as the
total number of exceptions in each accounting standard (Donelson et al., 2012; Mergenthaler, 2011; Morais, 2016).

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How to cite this article: Pinto I, Morais AI. What matters in disclosures of key audit matters:
Evidence from Europe. J Int Financ Manage Account. 2019;30:145–162. https://doi.org/10.1111/
jifm.12095
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