The impact of the precision of accounting standards on the expanded auditor's report in the European Union

Abstract

One of the most important recent expansions of the auditor’s report within the EuropeanUnion, but also in the International Standards on Auditing, is the mandatory disclosure ofkey audit matters (KAMs). This paper investigates whether or not the likelihood of a KAMdepends upon the level of precision and detail of an accounting standard. We use the Rules-Based Characteristics (RBC) score of Mergenthaler (2009) validated in Donelson, McInnies,and Mergenthaler (2012) to determine whether an accounting standard is more precise,i.e., whether the accounting standard is more rules-based. We also analyze the impact ofaccounting standard precision on the readability of the auditor’s report. The sample consistsof FTSE 100 (UK), CAC 40 (France), and AEX 25 (Netherlands) companies that disclosedKAMs in 2016. The findings show that the probability of a KAM increases with more preciseaccounting standards. Our results also show that the disclosure of KAMs that are basedon accounting standards with higher rules-based characteristics decreases the readabilityof auditors’ reports. This paper contributes to the literature by showing how accountingstandard precision interacts with the auditor’s report from the point of view of the preparer(auditor) and of the user of the report