How to Communicate an Exclusion From the Statutory Audit of Narrative Reports

This study addresses two potential ways of communicating an exclusion from a statutory audit of narratives, as recently proposed by auditors: (1) an explicit label at the page margin and (2) an appendix to the auditor’s report referencing unaudited information. We conduct an eye-tracking experiment and examine the impact of communicating such an exclusion from the audit on financial report users’ attention, understanding, and credit risk judgment in a lending-decision task. Our results show that the effect of the audit exclusion depends on whether users understand which pieces of information were left unaudited and on the amount of attention they pay to the unaudited information. Specifically, we predict and find that the label increases users’ attention to unaudited information and enhances their understanding of the audit exclusion. For an appendix to the auditor’s report, however, we cannot document similar results. Users subject to the appendix do not direct more attention to the unaudited information and even show a lower ability to distinguish audited from unaudited information. Furthermore, the amount of attention that users pay to the unaudited information and their degree of understanding of the audit exclusion have a direct influence on their credit risk assessment. The results of this study imply a potentially widened expectations gap due to audit exclusions and highlight the need for clear communication of the audit status of narratives.