Received: 7 May 2020 Revised: 30 July 2020 Accepted: 17 August 2020

DOI: 10.1111/ijau.12203

SPECIAL ISSUE ARTICLE

The effect of disclosing key audit matters and accounting

standard precision on the audit expectation gap

Paul J. Coram | Leiyu Wang

The University of Adelaide, Australia

Correspondence
Paul J. Coram, The University of Adelaide.
Email: paul.coram@adelaide.edu.au
This study reports an experiment using nonprofessional financial report users to
investigate the effect of disclosing key audit matters (KAMs) on the audit expectation
gap. This study also explores how differences in precision of accounting standards
interacts with the auditor's reporting of KAMs to affect users' perceptions. We find
that disclosing KAMs per se in the audit report does not effect the audit expectation
gap, which is consistent with prior research on the effect of additional disclosures in
audit reports. However, the expectation gap actually increases on measures associ-
ated with perceptions on the reliability of the audited financial reports when the
audit report includes a KAM that follows a precise accounting standard, suggesting
some potential unintended consequences of this reporting change.

KEYWORDS

Accounting Standard Precision, Audit Expectation Gap, Critical Audit Matters, Key Audit
Matters

1 | I N T RO DU CT I O N
Key audit matters (KAMs) have now been introduced in many jurisdic-
tions around the world. An important research question from these
reporting changes is how KAMs have affected financial report users'
perceptions of the responsibility of auditors and the reliability of what
they provide. These issues form part of the audit expectation gap,
which is the difference between what users expect from the auditor
and the financial statement audit, and the reality of what an audit is
(IAASB, 2011). Reduction of this gap was presented as a motivation
for the changes that ultimately resulted in the introduction of KAMs.
Although studies have looked at whether KAMs have affected auditor
liability, that is a related but different question and results on this
have been mixed (e.g., Backof, Bowlin, & Goodson, 2018; Brasel,
Doxey, Grenier, & Reffett, 2016; Brown, Majors, & Peecher, 2018;
Gimbar, Hansen, & Ozlanski, 2016; Kachelmeier, Rimkus, Schmidt, &
Valentine, 2019).
KAMs can also relate to a range of topics that vary by their nature
and effect on the financial statements. The question of the precision
of accounting standards is a major difference in financial reporting
that may be reflected in KAMs. This was examined in the context of
jurors assessments (Gimbar et al., 2016) but how these differences
may affect users' perceptions has not been the subject of research. In
this article we develop research questions to explore first how KAMs
per se affect users' perceptions on responsibility and reliability and
second how the nature of the KAMs affect these perceptions. Insights
from examining these perceptions we believe are important contribu-
tions from this article.
The introduction of KAMs is one of the most signifcant changes
to the audit reporting model in the past 90 years. It has been charac-
terized by one of the Big Four accounting firms as “the most signifi-
cant expansion of tailored information provided about a financial
statement audit by auditors to the user community in the profession's
history” (Zietsman, Burns, Pruitt, & Simer, 2013, p. 1). Therefore,
understanding how users perceive these changes is a very important
issue that warrants research. Results from this research can provide
feedback to the International Auditing and Assurance Standards
Board (IAASB) and Public Company Accounting Oversight Board
(PCAOB) on the ability of disclosing key audit matters per se to
improve communication between users and auditors. The second
objective of this study is to consider how the impact of a KAM on the
audit expectation gap may differ when the underlying issue is
governed by either a precise or an imprecise accounting standard. This
is an important issue to explore because accounting standards vary

270 © 2020 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/ijau Int J Audit. 2021;25:270–282.
CORAM AND WANG
based on their level of precision. International Financial Reporting
Standard (IFRS) are more principles based and therefore are less pre-
cise than some national accounting standards, such as those that exist
in the United States. Studying the interaction between KAMs and
standard precision will also provide useful insights into the mecha-
nisms underlying the relationship between KAM disclosures and the
audit expectation gap.
In this study, we performed a 3 × 1 between-subjects design
experiment to examine the impact of a KAM disclosure on non-
professional financial statement users' perceptions of auditors'
responsibility and reliability of the audited financial statements. These
perceptions are two main components that relate to the audit expec-
tation gap. The experiment compares the perceptions formed on the
basis of the traditional audit report, which does not include any KAMs
with the two other versions. One includes a KAM that is governed by
a precise accounting standard (objective KAM), and another one
includes a KAM governed by an imprecise accounting standard
(subjective KAM).
This study shows that generally the disclosure of KAMs per se
did not reduce the audit expectation gap. However, users tend to
assign a relatively higher level of reliability to the audited financial
statements when the KAM area conforms to an objective (precise)
standard than under a subjective (imprecise) standard, suggesting
the expectation gap is actually increasing with disclosure of the
objective KAM. These findings suggest that the nature of the KAM
disclosure makes a difference to users, which is consistent with
the findings by Gimbar et al. (2016). We also conclude that if stan-
dard setters are to accomplish the objective of reducing the expec-
tation gap, it is important to educate users about the contents of
the audit report in conjunction with changing its format and
content.
Our article makes a couple of important contributions to the liter-
ature. The majority of the behavioral research on this topic so far has
been focused on the impact of KAMs disclosure on auditor liability
(e.g., Backof et al., 2018; Brasel et al., 2016; Brown et al., 2018;
Gimbar et al., 2016; Kachelmeier et al., 2019). However, in response
to the calls for more research on this topic (Bédard, Coram, Espahbodi,
& Mock, 2016), we contribute to the literature by addressing a couple
of different issues not specifically addressed by prior research.
First, we contribute to the literature by showing how these
changes affect the audit expectation gap, which was highlighted as an
important motivation for the changes in the first place. To the best of
our knowledge, there has been limited research so far that has
explored the effect of KAMs on the audit expectation gap. One
exception is a study by Köhler, Ratzinger-Sakel, and Theis (2020) who
explore the communicative value of KAMs by assessing how users'
perceive the company's economic situation. They find that KAMs'
relating to negative information have a positive effect on investment
professionals' perceptions of the information provided. However, they
found that KAMs had no effect on nonprofessionals perceptions of
the information provided by the auditor. Second, prior studies have
mainly examined KAMs in general. However, the nature of the issue
that is the subject of the KAM we believe is something that is also
271
potentially important, in particular whether it relates to a subjective or
objective accounting issue.1
In summary our contribution from this study is firstly that KAMs
per se do not reduce users' perceptions of auditors' responsibility or
reliability, therefore we find they are not reducing the audit expecta-
tion gap. However, we do find that a KAM relating to a precise
accounting issue results in users expecting a higher level of reliability
from the audit, which actually increases the audit expectation gap.
2 | BAC KGROU ND
Historically, the audit report has been criticized as a standardized boil-
erplate as it follows specific wording and format requirements set in
the auditing standards (e.g., ISA 700) and research has found it has
not met the needs of users of financial statements (Mock et al., 2013).
The IAASB and the PCAOB have implemented significant changes to
the auditor's report in an attempt to provide more company-specific
information and reduce the expectation gap between auditors and
users.
This change process started with a report issued by the IAASB
exploring different options for the audit report and they were explicit
about the fact that the changes would hopefully reduce the audit
expectation gap as they stated: “Because the standard auditor's report
uses generic language to describe the auditor's work effort, users do
not get a complete picture about the extent of the auditor's proce-
dures on a particular audit and therefore feel left with a ―gap
between what is actually done and what they perceive is done in con-
nection with the audit” (IAASB, 2011, p. 7).
From these new standards, the main change is for auditors to
identify and disclose KAMs in a separate section of the auditor's
report. KAMs discuss areas of the audit that are of most significance
or require significant auditor attention in performing the audit (ISA
701, IAASB, 2015). Both the IAASB and PCAOB proposals highlight
fair value estimates as an example of a KAM due to the difficulty of
auditing these matters (IAASB, 2012; PCAOB, 2013). The new
auditing standards also require the auditor to describe the identified
matters and to explain why the matters were considered to be of
most significance in the audit, or in simple terms, appropriate for
disclosure.
In the next section of the article we discuss the literature in rela-
tion to these topics and present our research questions.
3 | LI T E RA T U R E RE V I E W A N D R ES EA R C H
QUESTION DEVELOPMENT
3.1 | The audit expectation gap
The audit expectation gap relates to the difference between what
users expect from the auditor and the financial statement audit and
the statutory requirement for an audit. The issuance of an unqualified
audit opinion in the auditor's report demonstrates that the auditor
272
concludes the audited financial statements provide a true and fair
view of the financial position and performance of the company and
comply with the relevant financial reporting framework. Prior research
has found the users of financial statements (such as investors,
bankers, and financial analysts) often perceive that auditors provide
an absolute level of assurance when they read such information. In
other words, they perceive auditors guarantee the accuracy of the
audited financial statements, leading to naïve and unreasonable
expectations (e.g., Epstein & Geiger, 1994).
However, the IAASB merely requires the auditor to obtain a rea-
sonable level of assurance since inherent audit limitations exist to pre-
vent auditors from achieving absolute assurance (IAASB, 2009a).
McEnroe and Martens (2001) performed a survey of audit partners
and investors on a number of different attributes of auditor's respon-
sibilities. They found many significant differences on what an auditor
should do or judge before issuing a qualified opinion, for example,
fraud detection. Investors' assigned much greater responsibility on
auditors than would be reasonable according to what is required by
the auditing standards. Anderson, Maletta, and Wright (2003) also
observed that users assign greater responsibilities to auditors. For
instance, they perceive that it is the auditor's responsibility to prepare
and present the financial report. However, that is clearly the manage-
ment's responsibility. Users may erroneously associate audits with a
guarantee of the absence of fraud and a recommendation for them to
make investment in the respective firm. These types of differences in
perceptions make up the audit expectation gap.
A recent survey by the Association of Chartered Certified
Accountants (ACCA) of 11,000 members of the public from around
the world support these findings. They show that users continue
to expect more from auditors compared to what they actually do
(ACCA, 2019). They describe this component of the expectation
gap as the knowledge gap and note that the introduction of KAMs
by the IAASB is an important step in reducing this gap. Overall,
prior research shows that users generally expect far more than the
audit currently delivers. Therefore, if KAMs are to reduce the audit
expectation gap, they need to reduce users' perceptions on what
the audit provides.
3.2 | Audit report formats
Chong and Pflugrath (2008, p. 223) note that the primary strategy of
regulators to reduce the expectations gap is to “provide additional
explanations, clarifications and condensed summaries of the auditors'
role and the audit process in the audit report” (e.g., SAS 58, SAS
600, and AUP 3). There are distinct but related possibilities in which
changes to the format of the audit report may be useful to minimize
the expectation gap as outlined in Mock et al. (2013). As audit reports
are often criticized for adopting standardized wording, the first possi-
bility is to depart from that, allowing auditors to decide what shall be
said to satisfy the need of users in the audit report. The second possi-
bility is to maintain the standardized wording and expand the audit
report. This is to enable reporting of significant management and
CORAM AND WANG
auditor's judgments involved in the audit, the inherent limitations of
the financial report, and the scope, nature, and extent of the
audit work.
It can be seen from standards implemented over the last two
decades that standard setters have paid more attention to the second
possibility (i.e., ISA 700, IAASB, 2009b). However, users may lose
interest in the auditor's report as it becomes more standardized
(Mock et al., 2013). Users' interest is important since this strategy
depends on users reading the lengthy description of the responsibili-
ties of auditors and the audit process.
In the 1980s in response to the findings of the Cohen Commis-
sion, a new audit report standard SAS 58 was released in the United
States. Research that investigated the effect of these changes to the
format, wording, and content of the audit report in SAS 58 concluded
that it did not significantly reduce the expectation gap. It was found
that this expanded audit report made no difference in users' percep-
tions (Bailey, Bylinski, & Shields, 1983). Monroe and Woodliff (1994)
examined the impact of a then-new Australian reporting standard—
AUP 3. This standard provided greater details of management's
responsibilities and a better explanation of the audit objectives and
procedures in the scope section of the auditor's report. They reported
that users' perceived responsibilities of auditors and management
altered significantly. However, new and widening differences
occurred in other areas, thus the authors concluded that an expanded
audit report has a limited impact on the expectation gap overall.
Chong and Pflugrath (2008) in a between-subjects design com-
pared the SAS 58 report; the ISA 700 plain language report
(by removing jargon and presenting the audit report using a language
that is easily understood by users) at the beginning of the financial
statements; and the ISA 700 plain language report at the end of the
financial statements. The differences between shareholders' and audi-
tors' perceptions were still evident for the expanded format compare
to short format (audit-opinion only), although the plain language
expanded report with the audit opinion at the start, the differences
decreased but not significantly. In another experiment on the revised
ISA 700, Gold, Groneworld, and Pott (2012) manipulated an auditor's
report with explanations as mandated by ISA 700 compared to an
opinion only audit report. They found that more explanations do not
result in a narrower expectation gap, and the audit opinion alone
would be enough to signal sufficient relevant information.
It is clear that the auditing research literature shows the various
changes in formats of the audit report over the years have made little
impact on users' perceptions and failed to reduce the audit expecta-
tions gap as the gap exists and continues to persist.
3.3 | Key audit matters
The IAASB and the PCAOB have implemented several significant
changes to the auditor's report. The IAASB were quite explicit that an
important motivation for the changes is an attempt to reduce the
expectation gap between auditors and users (IAASB, 2011). Among
those changes, there is the requirement for auditors to identify and
CORAM AND WANG
disclose KAMs in a separate section of the auditor's report. KAMs dis-
cuss areas of the audit that were of most significance or required sig-
nificant auditor attention in performing the audit (ISA 701, 2015). The
proposed auditing standards also require the auditor to describe the
identified matters and to explain why the matters were considered to
be of most significance in the audit, or in simple terms, appropriate for
disclosure.
The audit report has often been criticized as a standardized boil-
erplate because it follows specific wording and format requirements
set in the auditing standards (e.g., ISA 700), which can reduce its
communicative value (Gray, Turner, Coram, & Mock, 2011; Mock
et al., 2013). A KAM paragraph responds to investor demands for
more company-specific information that can be relevant and useful
for their decision-making. Sirois, Bédard, and Bera (2018) in evaluating
users' information acquisition using eye-tracking technology find that
KAMs do direct the attention of users to disclosures related to KAMs
communicated in the auditor's report. However, communication of
several matters in the auditor's report reduce attention to other parts
of the financial statements, that is, a substitution effect.
Much of the behavioral research on KAMs so far performed has
focused on evaluating auditor liability. In an experiment conducted by
Brasel et al. (2016) using lay jurors as participants, they find auditors
who disclosed a KAM related to the undetected misstatement were
judged to be less liable than auditors who did not. Brown et al. (2018)
report that KAMs have the effect of reducing negligence assessment
and did not have an adverse effect on increasing damages.
Kachelmeier et al. (2019), who use MBA students as participants,
observe that users' perceive less auditor liability for a misstatement in
a financial statement area disclosed in the auditor's report as a KAM
compared to a financial statement area not disclosed as a KAM. Over-
all, these studies suggest that KAMs do not increase auditors' liability
and the likely explanation for these findings is that KAM disclosures
are regarded as a partial disclaimer of auditor responsibility.
In contrast to these findings, Gimbar et al. (2016) find that that
jurors perceive that KAMs constrain auditors' control over financial
reporting outcomes so they perceive lower liability for auditors, how-
ever, this is only in a scenario where there are precise accounting
standards. Backof et al. (2018) report that jurors perceived auditors to
be more negligent when KAM disclosures relate to an undetected
misstatement. However, they find that clarifying the limitations of
reasonable assurance provided some protection from increased
liability.
The focus of previous research on perceived auditor liability
(while important) is more at the extreme end of reactions to the provi-
sion of KAM disclosures. KAMs are providing information to users of
financial statements and so it is reasonable that they may affect users'
perceptions on responsibility and reliability of the audit information
provided without necessarily thinking about legal liability.
Prior research has repeatedly indicated the existence of an expec-
tation gap between auditors and users in relation to the auditor's
responsibilities and the reliability of the audited financial statements.
Various institutional changes have been made to narrow the gap, the
proposal of disclosing KAMs in the audit report is one such attempt.
273
One of the reasons for the implementation of KAMs was to
reduce the expectation gap by improving the communicative value of
the audit report. However, the prior research on previous unsuccess-
ful efforts to reduce the expectation gap by changing the audit report
(see Mock et al., 2013) and recent mixed findings on the effect on
auditor liability from disclosing KAMs (Backof et al., 2018; Brasel
et al., 2016; Brown et al., 2018; Gimbar et al., 2016; Kachelmeier
et al., 2019) suggest that the effect of this type of disclosure may
not affect the perceived responsibility of auditors and perceived reli-
ability of the financial statements—and thereby affect the audit
expectation gap.
In this study we first explore whether the inclusion of KAMs
changes users’ perceptions on a couple of important aspects of the
audit expectation gap as outlined in the following research questions:
RQ1. Does the inclusion of a KAM in an unqualified audit report change
users' perceptions of auditor responsibility?
RQ2. Does the inclusion of a KAM in an unqualified audit report change
users’ perceptions of auditor reliability?
3.4 | Precision of accounting standards
An important issue that may affect the value of KAMs in the audit
report relates to the nature of the disclosure made by the auditor. A
significant issue that affects accounting disclosures is the precision of
the accounting standards and this may be a relevant issue in determin-
ing user perceptions of auditors' responsibility (Gimbar et al., 2016).
The precision of accounting standards concerns whether they relate
to subjective or objective matters and the effect of this on the percep-
tion of users about auditors' responsibility.
A subjective KAM is governed by imprecise accounting standards,
which are more associated with principles-based standards, while an
objective KAM is governed by precise accounting standards, which
are more associated with rule-based standards. Significant profes-
sional judgment and estimates are required in the application of
imprecise standards as they provide less-detailed guidance to practi-
tioners and auditors. Almost all companies are required to prepare
their financial report as set out by the IASB, whose standards are
often regarded as imprecise (generally principles-based). In contrast,
the precise standard is basically a list of detailed rules that must be
complied with when preparing financial statements. The most promi-
nent example of this is in the United States where generally accepted
accounting principles (GAAP) are frequently referred to as rules-based
standards. Gimbar et al. (2016) showed that critical audit matters
relating to different types of accounting standards had an impact on
users' perceptions of auditor liability.
Disclosure of KAMs implies that the auditor has identified and
considered the matters as requiring a significant amount of profes-
sional judgment or posing difficulty in obtaining and evaluating evi-
dence (PCAOB, 2017). Users are likely to view the client's compliance
with the precise standards as evidence that the auditor intended and
274
did fulfill their responsibility to perform a high-quality audit (Kadous &
Mercer, 2016). It is expected users will assess auditors as having less
responsibility when a KAM disclosure relates to a precise standard
(objective KAM) because they are perceived to have limited control
over the underlying accounting treatment. The perception is consis-
tent with Jamal and Tan's (2010) argument that the ability of auditors
to negotiate with clients to implement an alternative accounting pol-
icy is constrained when they disagree with a proposed accounting pol-
icy that complies with a precise standard. By contrast, imprecise
standards emphasize the importance of professional judgment and
auditor skill (Carmona & Trombetta, 2008).
Practitioners may have different interpretations toward the same
standard after considering a variety of contingent factors. Imprecise
standards remove the auditor's constraint on negotiation with clients
under precise standards and auditors are likely to have more control.
This can enable them to require clients to make adjustments in the
financial report. By disclosing a KAM on an imprecise standard (sub-
jective KAM), it indicates that the auditor was aware of “the height-
ened risk associated with the accounting treatment” (Gimbar
et al., 2016, p. 1633). Under these circumstances, users can perceive
the auditor should have performed necessary audit procedures to
assure relevant accounts are fairly presented. We present this as a
research question as follows:
RQ3. Do users of financial statements with an unqualified audit report
including an objective KAM perceive auditors having relatively less
responsibility compared to when the audit report includes a sub-
jective KAM?
Jamal and Tan (2010) argue that precise standards constrain the
ability of auditors to negotiate with clients when there is a dispute
about a proposed accounting treatment that conforms to a precise
standard. This is reasonable to the extent that the client may argue its
accounting treatment is consistent with the relevant standards and
there is no need to make an adjustment. Auditors are not able to give
a modified opinion merely because of this disagreement. Instead, they
could disclose the issue as a KAM in the audit report. The disputed
issue may be determined to be a KAM because it is of a higher
assessed risk of material misstatement (ISA 701, para 9(a)).
However, imprecise standards remove this constraint, enhancing
the negotiating power of auditors (Gimbar et al., 2016). The auditor is
more able to require the client to alter the accounting treatment. Cli-
ents are more likely to amend their accounting treatments if auditors
provide alternative interpretations toward relevant standards because
auditors can express a modified opinion if a disagreement occurs. The
main objective of disclosing the disputed issue as a KAM in this situa-
tion instead is to simply indicate significant difficulty encountered in
the audit process as per para 9 (b) in ISA 701 (e.g., time spent for the
auditor to negotiate with the client).
However, earlier research on this topic generally came to a differ-
ent conclusion that less-precise standards gave auditors a chance to
acquiesce to their clients' demands because there is no bright line to
constrain aggressive reporting (Hackenbrack & Nelson, 1996; Ng &
CORAM AND WANG
Tan, 2003; Trompeter, 1994). If this is the way users' perceive audi-
tors behave where there are less-precise standards, we expect that
this manifests in their perceptions more in terms of the reliability of
the audit rather than the auditor's responsibility. Given the mixed
findings on this we pose our final research question as follows:
RQ4. Do users of financial statements with an unqualified audit report
including an objective KAM assign the same level of reliability to
the underlying financial statements compared to when the audit
report includes a subjective KAM.
4 | METHOD
4.1 | Participants
Recall that, the objective of this study is to evaluate whether the
changes implemented by KAMs have reduced the audit expectation
gap. The expectation gap is made up of an information gap and a com-
munication gap (Mock et al., 2013).2 Central to both of these gaps are
the financial statement users as presented in the model developed
by Mock et al. (2013). Some prior expectation gap studies have sou-
ght the views of auditors (e.g., Chong & Pflugrath, 2008; Gold
et al., 2012). However, we have focused on users because the expec-
tation gap is the difference between what users expect from the audi-
tor and the financial statement audit, and the statutory requirement
for an audit (IAASB, 2011). The statutory requirements clearly outline
what an audit is meant to provide. Therefore we think that by focus-
ing on how users' perceptions change and whether their perceptions
move closer to what is defined in the auditing standards helps
answer the question on whether KAMs have reduced the audit
expectation gap.
We obtained financial statement users with a range of levels of
financial sophistication to represent a variety of user groups to partici-
pate in this experiment. The participants were obtained from Amazon
Mechanical Turk (AMT), which is an online web-based platform for
recruiting and paying workers to perform tasks (Berinsky, Huber, &
Lenz, 2012).3 The first group selected were users who were working
in the areas of accounting and finance (excluding auditors) to enable
an assessment of more sophisticated investors. The second group
selected were graduates that in AMT are defined as those holding a
bachelor's degree to represent nonsophisticated investors. Compared
to the average person in society, graduates should have some knowl-
edge of financial reporting practices and a number of them have been
involved in some levels of investing activities. They have the ability to
make reasonably informed assessments, but are not experts so they
are an appropriate representation of nonsophisticated investors.
In running the second experiment we excluded workers whose
job function was accounting or finance.4 Both of these two groups
were located in the United States. The recruitment of participants
was in two stages to ensure there was no overlap. A possible concern
was that the two participant groups may overlap because those work-
ing in the accounting and finance industry probably also have a
CORAM AND WANG
bachelor's degree. The two groups were analyzed together because as
a total group they all fit within the definition of users of financial state-
ments. However, an advantage of obtaining these two different
groups is that obtaining a range of differing levels of task expertise
and diverse backgrounds allows us to make conclusions more gener-
ally on users' perceptions of KAMs.
The total sample contains responses from 240 participants, which
includes 120 from each group. Each participant within each group was
randomly assigned to an experimental condition. In terms of the over-
all group, the average participant was 40 years old and had 7 years of
work experience. Further, 52% of the sample were females and 8%
were full-time students. Participants with CPA or ACCA qualifications
comprised 12% of the total sample, a percentage that is consistent
with previous studies that have used users of financial reports (refer
to Hasan, Roebuck, & Simnett, 2003).
Participants were also asked questions relating to audit reports.
They were asked: first, how often they read the audit report when
considering whether to invest in a company (11-point scale with
0 never and 10 always) and the mean response was 7.37; second, they
were asked their familiarity with the audit report (11-point scale with
0 not at all familiar and 10 very familiar) and the mean response was
6.58; and finally, they were asked their understanding of the report
(11-point scale with 0 not at all easy to understand and 10 very easy to
understand) and the mean response was 7.46. Overall, the participant
group had a reasonable knowledge of audit reports based on their
self-reported evaluations.
The significant differences between the two groups were as
expected relating to work experience, professional accounting qualifi-
cations, and use, familiarity, and understandability of the audit report.
4.2 | Experiment task design
A 3 × 1 between-subjects experiment was conducted that involved
manipulation of audit reports with three variables: no KAMs, subjec-
tive KAM, and objective KAM. The experimental instrument started
with instructions for participants and some background information
about a hypothetical stock-listed airline company (see Appendix). Pro-
viding too much financial information on the company could have
diluted participants' attentiveness to the audit report (consistent with
Kachelmeier et al. (2019)), and it was not necessary for the objectives
of this study. All participants then received a copy of the auditor's
report on the financial statements that began with the standard word-
ing for an unqualified audit report adopted in current practice.
The between-subjects manipulations was as follows. The first was
no provision of a KAM so no extra information was provided beyond
the standard audit report. The second was the provision of a subjec-
tive KAM and some details of the relevant accounting standard with a
principles-based focus. Finally, the third manipulation was the provi-
sion of an objective KAM, which was also provided with some details
of the relevant accounting standard with a rules-based focus. These
KAMs were adopted from actual KAMs from a couple of audit
reports.
275
The relevant accounting standard used in the experimental mate-
rials related to revenue and this is a very common KAM issue.
According to KPMG's Auditor's Report Snapshot (KPMG, 2017), it is
reported that 20% of the entities they observed reported a KAM on
revenue in their audit report. The company in the case study was an
airline company and from perusal of audit reports from a number of
airlines it became apparent that the accounting treatment for revenue
recognition for customer loyalty programs (CLP) is particularly
highlighted in most of the top airlines' audit reports. The likely expla-
nation is that although International Financial Reporting Interpreta-
tions Committee (IFRIC) 13 has been released in an attempt to
standardize alleged widespread and divergent accounting practice in
accounting for customer loyalty programs since July 1, 2008 (Chapple,
Moerman, & Rudkin, 2010), some problems still remain unresolved.
For example, IFRIC 13 requires using fair value accounting for revenue
recognition, which is the amount for which the award credits could be
sold separately (IFRIC 13, IASB, 2008). However, no clarification has
been given regarding how to measure this amount, and thus the mea-
surement is ultimately determined by the reporting entity itself. This
means that this topic is an ideal one to manipulate the accounting
standard type (imprecise vs precise) in an experiment without violat-
ing requirements set out in IFRIC 13.
Within the audit report, we manipulated KAM disclosure at three
levels: without KAM, subjective KAM, and objective KAM. In the
without KAM condition, participants received the standard audit
report as is currently mandated by the U.S. auditing standards.5
Although the study was undertaken in the United States, we decided
to call the additional disclosures KAMs even though they will be called
critical audit matters (CAMs) when they are required to be disclosed
in that jurisdiction. The reasoning for this is that CAMs had not been
implemented at the time of undertaking this experiment. CAMs were
implemented in the United States first for large accelerated filers for
fiscal years ending on or after June 30, 2019. It is therefore unlikely
that the participants have seen either a KAM or CAM and the proba-
bility that they have been following the development of these new
auditing standards is low. Therefore, for the purposes of developing
this experiment and evaluating users' perceptions we decided to use
the current international terminology, which is KAMs.
In both KAM conditions, the audit report included a separate par-
agraph titled Key Audit Matters, described as “those matters that, in
our professional judgement, were of most significance in our audit of
the Financial Report of the current period” (para. 8).6 The KAM in the
subjective condition stated that the company's unredeemed frequent
flyer revenue was measured by applying a forward-looking model and
this measurement involved significant management's judgment and
estimates. The KAM in the objective condition stated that the
unredeemed frequent flyer revenue's measurement was calculated by
actuarial specialists based on historical redemption trends, and this
measure may not reflect changes in the environment in the future.
The given accounting standard excerpt precision was also manip-
ulated across different experimental treatments. In the subjective con-
dition, the accounting standard excerpt merely stated that the
unredeemed revenue was measured by reference to their fair value
276
and it especially emphasizes that judgment was required to select and
apply an estimation technique that should be most appropriate in the
circumstances. Alternatively, in the objective condition, the excerpt of
accounting standard explicitly required that actuarial specialists should
be employed to make the estimate and their estimate shall be based
on historical redemption trends. The wording of these manipulations
is presented in the Appendix.
4.3 | Dependent variables
Following the case study information, participants were asked to
respond to a series of questions relating to the two expectation-gap
constructs (discussed below) on 11-point Likert-type scales. The order
of questions was randomized, and the questions were followed by
demographic questions and manipulation checks. The demographic
questions relate to the readership of, familiarity with, and understand-
ability of the audit reports that are used as proxies for the financial
statement users' auditing/accounting background.
The audit expectation gap is normally measured based on
multiple-item constructs in prior research (i.e., auditor responsibility
factor, financial statement reliability factor, and management respon-
sibility factor). For the purpose of this study, we focus on the first two
of these constructs because they are where KAMs would most likely
have affected perceptions relating to the audit expectation gap.
The questions in this study to measure the audit expectation gap
were drawn from the types of questions used in recent expectation-
gap studies (e.g., Chong & Pflugrath, 2008; Gold et al., 2012), which
originated from the work of Libby (1979). In the broadest sense, the
questions allow us to understand what the public expects from an
audit, with a focus on the responsibilities of auditors and the reliability
of the financial statements. All of the questions in our study can
be framed using Porter's (1993) definition of the audit expectation
gap that encompasses two elements: a performance gap and a
reasonableness gap.
The performance gap is defined as the gap between what society
can reasonably expect auditors to accomplish and what they are per-
ceived to achieve, which is associated with auditors' existing duties
(Porter, 1993). In the Appendix, a number of questions in the instru-
ment captures this gap. These questions relate to the extent they
agree the audited financial statements comply with accepted account-
ing practice, whether they agree the financial statements are free
from material misstatement, and their confidence level on the
amounts of unredeemed frequent flyer revenue.
The reasonableness gap is defined as the gap that exists between
what society expects auditors to achieve and what they can reason-
ably be expected to accomplish (Porter, 1993). These questions are
also presented in the Appendix and asked users: the level of assurance
the auditor provides; who should take the responsibilities of preparing
and presenting the financial statements, and making accounting esti-
mates and judgments; who is responsible if the particular revenue
account is materially misstated; and to what extent they agree the
auditee is free from fraud.
CORAM AND WANG
4.4 | Experimental procedures
Each participant was given a link to an online case study hosted by
Qualtrics, which is a web-based tool for creating and conducting
online surveys. Using the outside website helped us to obtain
informed consent and implement additional screening procedures.
The survey's recruiting narrative identified this study as research in
accounting about the informative value of an audit report without men-
tioning anything related to the KAM proposal. Three experimental
treatments (unqualified auditor's report without KAMs, or one subjec-
tive KAM, or one objective KAM) were distributed randomly to the
participants. The task took an average of 15 minutes to complete.
5 | RE SU LT S
5.1 | Manipulation checks
Due to the nature of collecting data using the AMT platform, careful
checking was done to ensure the quality of the data. All participants
answered two manipulation check questions after they had completed
the experimental survey. The first manipulation check related to the
effectiveness of the manipulation of the presence versus absence of
the KAM in the auditor's report. Participants were asked the extent to
which they agreed with the statement, “The auditor's report provided
in the materials explicitly described matters that involved especially
challenging, subjective, or complex auditor judgement in the audit of
the Financial Report” (11-point scale with 0 strongly disagree and
10 strongly agree). Matters that explain the especially challenging, sub-
jective, or complex concerns pertaining to the audit are called critical
audit matters (CAM) in the United States. The frameworks for deter-
mining a CAM/KAM are substantially similar, so the definition of
CAM was adopted to design this manipulation check question. The
rationale for this choice was because the definition of KAM was given
to the participants in the experiment and therefore it had been explic-
itly defined and presented to them.
The second manipulation check was to verify the effectiveness of
the manipulation of the precision of the accounting standard. Partici-
pants were next asked to what extent they agree with the statement,
“the accounting standard excerpt in the materials provide clear guid-
ance on how to account for award credits in customer loyalty
programmes” (11-point scale with 0 strongly disagree to 10 strongly
agree). This question should only be answered if an accounting stan-
dard excerpt was provided in the material (i.e., in either Subjective
KAM or Objective KAM condition). All experimental questions except
this second manipulation check question forced participants to
answer the questions before they could progress to the next page of
the survey.7 It was expected participants would skip this question if
no accounting standard excerpt is provided (i.e., No KAM condition).
However, 29 out of the 83 (34.94 percent) participants who received
an audit report with no KAM disclosed (and therefore no accounting
standard manipulation) answered this question. Forty-eight out of the
157 (30.57 percent) participants did not answer this question when
CORAM AND WANG 277

they were provided with an audit report with KAM disclosed (with an TABLE 1 Descriptive information
accounting standard manipulation) (26 from the Subjective KAM con- Responsibility Questions Manipulation M SD N
dition and the remaining 22 are from Objective KAM). These failures
1. How much assurance does No KAM 7.85 2.49 52
indicated a lack of attention of participants in reviewing the experi- the auditor provide that the Sub KAM 8.40 1.80 35
mental materials, so they were deleted from the main analysis of the financial statements are
free from material Obj KAM 8.00 2.01 51
results.
misstatement? (0 = Limited
To further ensure that the results reflect responses from partici-
assurance; 10 = Absolute
pants who adequately comprehended the experimental material, the assurance)
reported analyses excluded the following participants. First, two par-
2: Who is responsible for the No KAM 4.21 3.32 52
ticipants who answered 9 or 10 for the first manipulation check ques- information prepared and Sub KAM 5.03 3.68 35
tion in the No KAM condition; second, two participants who presented in the financial
statements? Obj KAM 4.33 3.41 51
answered 0 or 1 for the first manipulation check question in the With
(0 = Management solely;
KAM condition; third, 19 participants who answered 9 or 10 for the
10 = Auditor solely)
second manipulation check question in the Subjective KAM condition;
3: Who is responsible for No KAM 5.44 3.21 52
and finally, two participants who answered 0 or 1 for the second making necessary Sub KAM 5.43 3.22 35
manipulation check question in the Objective KAM condition. accounting estimates and
judgements? Obj KAM 5.71 3.31 51
After removal of those who did not pay sufficient attention to the
(0 = Management solely;
case materials and those who failed the manipulation checks, a total
10 = Auditor solely)
of 138 participants were included in the primary analyses. While this
4: To what extent is the No KAM 6.27 3.05 52
is a high number of removals, it is not unusual when using AMT and it
auditor responsible if there Sub KAM 6.23 3.08 35
provides confidence that the group we have analyzed provided appro- is a misstatement in the
value of the Company's Obj KAM 6.43 3.12 51
priate attention to the experimental materials. For participants, the
overall mean response for the first manipulation check question was Unredeemed Frequent
Flyer Revenue?
4.12 for the No KAM condition, 7.20 for the With KAM condition.
(0 = Strongly disagree;
The means in the two different conditions are significantly different at 10 = Strongly agree)
a 1 percent significance level. The manipulation check was also suc- Reliability Questions
cessful when conducted separately for each group (i.e., sophisticated
5: To what extent do you No KAM 7.67 2.12 52
users versus nonsophisticated users). In terms of the second manipu- agree with the statement Sub KAM 7.31 2.60 35
lation check question, the overall mean response was 6.00 for the ‘The entity is free from
fraud’? (0 = Strongly Obj KAM 8.96 1.74 51
Subjective KAM condition and 7.33 for the Objective KAM condition.
disagree; 10 = Strongly
The means are significantly different (p < 0.005), indicating a success-
agree)
ful manipulation. The manipulation check was also successful when
6: To what extent do you No KAM 9.35 1.64 52
conducted separately for each group (largest p < 0.01). agree with the statement Sub KAM 8.94 2.07 35
‘The audited financial
statements comply with Obj KAM 9.63 1.48 51
accepted accounting
5.2 | Main findings
practice’? (0 = Strongly
disagree; 10 = Strongly
To evaluate whether there were any significant effects, MANOVAs agree)
(multivariate analysis of variance) on perceived audit responsibility 7: To what extent do you No KAM 8.02 2.30 52
and reliability were performed. Descriptive statistics of perceived agree with the statement Sub KAM 8.20 2.31 35
measures of audit responsibility and reliability are presented in ‘The audited financial
statements of Flyaway Obj KAM 8.82 1.81 51
Table 1. A MANOVA is only presented in this article that compares
Airline are free of material
perceptions of reliability between subjective and objective KAMs to misstatements’?
address RQ3 in Table 2. (0 = Strongly disagree;
In examining whether inclusion of a KAM affects users' perceived 10 = Strongly agree)
audit responsibility, in the overall model it was found that the four 8: To what extent do you No KAM 8.08 1.94 52
variables associated with auditor responsibility were not affected by agree with the statement Sub KAM 7.97 2.04 35
‘The value of Unredeemed
whether there was a KAM or not (F = 0.27, p = 0.90). Further, none of Obj KAM 9.06 1.74 51
Frequent Flyer Revenue in
the four individual variables were found to be significant. Therefore, the audited financial
in evaluating RQ1, we do not find any evidence that KAMs affect statements is credible’?
users' perceived audit responsibility compared to when no KAMs are (0 = Strongly disagree;
10 = Strongly agree)
included in the audit report.
278 CORAM AND WANG

TABLE 2 Statistical tests on reliability

Panel A

Multivariate Testsa

Effect Value F df Error df Sig.

b
Intercept Pillais Trace .972 710.92 4.00 81.00 .000
Sub_Obj Pillais Trace .149 3.54b 4.00 81.00 .010

Panel B

Tests of Between-Subjects Effects

Source Dep. Var. Type III Sum of Squares df Mean Square F Sig.
c
Corrected Model Q5 56.268 1 56.268 12.39 .001
Q6 9.728d 1 9.728 3.19 .078
Q7 8.070e 1 8.070 1.97 .165
Q8 24.542f 1 24.542 7.07 .009
Intercept Q5 5497.757 1 5497.757 1210.63 .000
Q6 7157.774 1 7157.774 2350.41 .000
Q7 6015.046 1 6015.046 1464.48 .000
Q8 6019.798 1 6019.798 1732.94 .000
Sub_Obj Q5 56.268 1 56.268 12.39 .001
Q6 9.728 1 9.728 3.19 .078
Q7 8.070 1 8.070 1.97 .165
Q8 24.542 1 24.542 7.07 .009
Error Q5 381.464 84 4.541
Q6 255.807 84 3.045
Q7 345.012 84 4.107
Q8 291.795 84 3.474
Total Q5 6349.000 86
Q6 7782.000 86
Q7 6669.000 86
Q8 6701.000 86
Corrected Total Q5 437.733 85
Q6 265.535 85
Q7 353.081 85
Q8 316.337 85
a
Design: Intercept + Sub_Obj
b
Exact statistic
c
R-Squared = .129 (Adjusted R-Squared = .118)
d
R-Squared = .037 (Adjusted R-Squared = .025)
e
R-Squared = .023 (Adjusted R-Squared = .011)
f
R-Squared = .078 (Adjusted R-Squared = .067)
Dependent Variables:
Q5 – To what extent do you agree with the statement “The entity is free from fraud”?
(0 = Strongly disagree; 10 = Strongly agree)
Q6 – To what extent do you agree with the statement “The audited financial statements comply with accepted accounting practice”?
(0 = Strongly disagree; 10 = Strongly agree)
Q7 – To what extent do you agree with the statement “The audited financial statements of Flyaway Airline are free of material misstatements”?
(0 = Strongly disagree; 10 = Strongly agree)
Q8 – To what extent do you agree with the statement “The value of Unredeemed Frequent Flyer Revenue in the audited financial statements is credible”?
(0 = Strongly disagree; 10 = Strongly agree)
CORAM AND WANG
Research Question 2 related to whether inclusion of a KAM
affects users' perceived audit reliability; in the overall model it was
found that the four variables associated with audit reliability were not
affected by whether there was a KAM or not (F = 1.75, p = 0.14) and
none of the four individual variables were found to be significant.
Therefore, for RQ2 we also do not find any evidence of KAMs making
a difference to users' perceptions of the reliability of the audit.
Research Question 3 explores whether users perceive auditors to
have less responsibility when an objective KAM is disclosed compared
to a subjective KAM. In the overall model we find that the four vari-
ables associated with auditor responsibility are not affected by
whether the KAM is subjective or objective (F = 0.60, p = 0.66).
Therefore, we cannot conclude on any differences in addressing RQ3.
Finally, RQ4 examines whether there are differences between a
subjective or objective KAM in the perceived reliability of the audit. A
MANOVA was performed to test for an overall effect on the reliability
measures and then univariate analyses were done for each of the vari-
ables as show in Table 2. In the overall model presented in Table 2,
Panel A, we find that the four variables associated with perceived reli-
ability are affected by whether an objective KAM compared to a sub-
jective KAM was provided. The provision of an objective KAM is
associated with an increase in the perceptions of reliability of the
audited financial statements, which suggests that this disclosure is
actually increasing the audit expectation gap.
In examining the significance of the individual variables, this is
reported in Table 2, Panel B. Two of the four reliability variables are
significant. First, Question 5, which related to the extent users per-
ceived the entity was free from fraud, there was a mean response of
8.96 with an objective KAM and 7.31 with a subjective KAM (10 is
strongly agree) as can be seen in Table 1, and this is significant
(F = 12.39, p = 0.00). Second, Question 8, which related to the extent
that fair value disclosure was credible, there was a mean response of
9.06 with an objective KAM and 7.97 with a subjective KAM (10 is
strongly agree) and this is significant (F = 7.07, p = 0.01). The other
two variables also provided mean response differences in the same
direction but were not significant, although one was marginally
significant.
6 | C O N CL U S I O N S
This study investigates the impact of the new requirement to disclose
KAMs on users' perceptions associated with the audit expectation
gap. We also explore the effect of the nature of the matter that the
KAM relates to. This was done by manipulating the precision of the
accounting reporting topic associated with the KAM so the KAM was
either subjective or objective. The expectation gap is sometimes mea-
sured by comparing the differences in perceptions between auditors
and users (e.g., Gold et al., 2012). However, this study looks at how
these disclosures affect users' perceptions only, based on our experi-
mental manipulations. This is because one motivation for disclosing
KAMs as highlighted by the IAASB is to change users' perceptions to
reduce the audit expectation gap.
279
In our research questions on whether inclusion of a KAM affects
perceived audit responsibility and reliability of the financial state-
ments by users, we do not find any evidence to show that KAMs
made any difference. This is consistent with much of the previous
research on the effect of changes to the auditors' report that has
often been done with the objective of reducing the communication
gap associated with the audit expectation gap (Mock et al., 2013). It is
also consistent with recent archival studies on KAMs that have not
found these disclosures incrementally informative to investors
(Gutierrez, Minutti-Meza, Tatum, & Vulcheva, 2018; Lennox, Schmidt,
& Thompson, 2019).
In relation to the disclosure of subjective compared to objective
KAMs, no difference in users' perceptions is found in relation to audi-
tor responsibility. However, the different nature of KAM disclosures
does have an effect on perceptions of the reliability of the audited
financial statements.
In examining the individual variables we find that an objective
KAM increased the perception of users that the entity was free from
fraud and it also increases the perception of credibility of the fair
value disclosure that was the subject of the KAM. These factors are
part of the reasonableness gap of the audit expectation gap and our
study shows that providing an objective KAM is actually making the
gap larger in that users expect a higher level of reliability from the
audit. This is consistent with the findings from Gimbar et al. (2016)
who show that a CAM disclosure when there is a precise standard
increases auditor liability.
This study shows that closing the audit expectation gap is not
something that can simply be done by extra disclosures. We do not
find evidence that users' perceptions change from inclusion of KAMs
per se or when an imprecise standard is highlighted by an auditor in a
KAM. However, when the auditor highlights an issue associated with
a precise standard, it does change perceptions associated with reliabil-
ity and makes these perceptions even higher than the current percep-
tions. These findings show that alternative methods to reduce the
audit expectation gap are probably going to be more successful, such
as trying to educate users about what an audit actually provides
(e.g., McEnroe & Martens, 2001; Monroe & Woodliff, 1993). The find-
ings from Backof et al. (2018) also provide evidence to support this by
showing the positive effect on perceived auditor liability from addi-
tional clarification given to audit report users. The profession, stan-
dard setters, and regulators should consider greater education and/or
clarifications when enhanced reporting disclosures are proposed and
implemented.
This study is subject to the normal limitations of experimental
research. Other limitations include the fact that we only recruited
graduates and those working in the accounting or finance industry as
participants. We acknowledge there are other stakeholders whose
perceptions may be different from these groups. Further, according to
KPMG's Auditor's Report Snapshot (KPMG, 2017), the average num-
ber of KAMs in the audit reports from 128 entities in the ASX 200 (-
Australian Securities Exchange) was 2.8. To maintain experimental
control we restricted the case study to one KAM, so we cannot con-
clude on the moderating effects of multiple KAMs in the same report.
280
There are many opportunities for future research on this topic.
This is due to the fact that it is a new and important disclosure but
also due to the fact that there are mixed findings on the effect of
KAMs from some of the first behavioral studies on perceived legal lia-
bility that have been performed. This present study is the first one
that we are aware of that has looked at the effect of KAMs on per-
ceptions associated with the audit expectation gap. Future research
could assess other stakeholder groups' perceptions of KAMs and also
the effect of provision of different types of KAMs and multiple KAMs
in audit reports.
DATA AVAI LAB ILITY S TATEMENT
The research instrument is available from the first author upon
request.
ACKNOWLEDGEMEN TS
We would like to thank participants at the Auditing and Assurance for
Listed and Non-Listed Entities Conference held at Deakin Business
School in 2020 for helpful comments on the paper. We also have
presented this paper in the seminar series at The University of Ade-
laide and at the 2019 meeting of the Accounting and Finance Associa-
tion of Australia and New Zealand. Finally, particular thanks for
valuable comments and suggestions from Noel Harding, Pamela Kent,
Ashna Prasad, and Indrit Troshani.
ORCID
Paul J. Coram https://orcid.org/0000-0003-3942-1497
ENDNOTES
1
This was examined in the context of auditor liability by Gimbar
et al. (2016).
2
The information gap relates to the difference between what users desire
and what is available from the audit report, financial statements, and
other information sources. The communication gap relates to the differ-
ence between what is communicated by the assurance provider and
what users desire and understand.
3
Ethics approval for this experiment was obtained from the Human
Research Ethics Committee of the University.
4
AMT offers the ability to qualify workers before they are allowed to
work on the tasks.
5
ISA 700 was not adopted to draft the audit report because the majority
of workers in AMT are from the United States.
6 org/10.1007/s11142-018-9464-0
This is consistent with auditing standard ISA 701 issued by
IAASB (2015).
7
A note was inserted in front of the second question, which said
“Please answer the following question only if you are provided
with an accounting standard excerpt in the material, otherwise simply
skip it.”
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AUTHOR BIOGRAPHIES
Paul J. Coram is a Professor of Accounting in the Business School
at the University of Adelaide. His research focuses on the effect
of auditing and financial accounting information on decision-
making through behavioral research methods. His research has
been published in leading international journals, including
Auditing: A Journal of Practice and Theory and Accounting Horizons.
Leiyu Wang was a research student at the University of Adelaide.
His research related to auditor reporting through behavioral
research methods. He is currently employed as an auditor in a
mid-tier accounting firm.
How to cite this article: Coram PJ, Wang L. The effect of
disclosing key audit matters and accounting standard precision
on the audit expectation gap. Int J Audit. 2021;25:270–282.
https://doi.org/10.1111/ijau.12203
APPENDIX
What This Study Is About
In this study, you will provide some judgements regarding a company's
audit based on an audit report and some background material about
the company. There are no correct or incorrect answers. Rather, we are
genuinely asking for your judgements so that we can understand how
users of financial statements interpret audit reports.
Flyaway Airways is a major United States airline. It offers a fre-
quent flyer program (FFP) for their customers. The FFP has become a
standard marketing tool and helped the airline increase its sales and
the customer loyalty by accumulating mileage points corresponding to
the distance flown on that airline. Normally, the FFP members can
exchange their frequent flyer miles for free air travel, goods, and
282
services such as upgrade class ticket and airport lounge access. Fly-
away recognised an account called Unredeemed Frequent Flyer Reve-
nue in its financial statements as required by relevant accounting
standards.
Like the vast majority of all publicly listed companies, Flyaway
received a standard unqualified (“clean”) audit opinion on its most
recent annual financial statements. The corresponding auditor's report
is shown below:
Independent Auditor's Report
To the Board of Directors and Stockholders of Flyaway Airways
Limited:
We have audited the accompanying balance sheets of Flyaway
Airways Limited (the Company) as of December 31, 2017 and 2016,
and the related statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended December
31, 2017. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion
on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain rea-
sonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evalu-
ating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of the Company as
of December 31, 2017 and 2016, and the results of its operations and
its cash flows for each of the three years in the period ended
December 31, 2017, in conformity with U.S. generally accepted
accounting principles.
(KAM Manipulation) Key Audit Matters.
Key Audit Matters are those matters that, in our professional
judgement, were of most significance in our audit of the Financial
Report of the current period. These matters were addressed in the
context of our audit of the Financial Report as a whole, and in forming
our opinion thereon, and we do not provide a separate opinion on
these matters.
(Subjective KAM)
1) Recognition of Frequent Flyer revenue is a key audit matter due to
the management's judgement involved in the estimation of the
CORAM AND WANG
amount deferred as Unredeemed Frequent Flyer Revenue. This bal-
ance represents revenue for Frequent Flyer points issued to members
that are expected to be redeemed in the future. Auditing these judge-
ments is inherently complex due to the forward looking nature of the
Group's models.
(Objective KAM)
1) Recognition of Frequent Flyer revenue is a key audit matter due to
the high level of audit effort in assessing the Group's assumptions
underlying their estimation of the amount deferred as Unredeemed
Frequent Flyer revenue. This balance represents revenue for Frequent
Flyer points issued to members that are expected to be redeemed in
the future. We mainly focus on the application of the Group's policy
of using actuarial specialists based on historical redemption trends as
an indication of expected future trends in redemption activity.
GMPK.
Chicago, Illinois.
February 22, 2018.
The accounting treatment for frequent flyer program is based on
the following standards:
a. (Principles-based) An entity shall account for award credits as a
separately identifiable component of the sales transaction in
which they are granted (the initial sale). The fair value of the
consideration received or receivable in respect of the initial sale
shall be allocated between the award credits and the other
components of the sale. The consideration allocated to the
award credits shall be measured by reference to their fair value,
i.e. the amount for which the award credits could be sold sepa-
rately. If the fair value is not directly observable, it must be
estimated. Judgement is required to select and apply the esti-
mation technique that satisfies the requirements and is most
appropriate in the circumstances.
b. (Rules-based) An entity shall account for award credits as a sepa-
rately identifiable component of the sales transaction in which
they are granted (the initial sale). The fair value of the consider-
ation received or receivable in respect of the initial sale shall be
allocated between the award credits and the other components of
the sale. The consideration allocated to the award credits shall be
measured by reference to their fair value, i.e. the amount for which
the award credits could be sold separately. If customers can
choose from a range of different awards, the fair value of the
award credits shall be calculated by actuarial specialists based on
historical redemption trends and shall reflect the fair values of the
range of available awards, weighted in proportion to the frequency
with each award is expected to be selected.
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