Frontiers in Business, Economics and Management ISSN: 2766-824X | Vol. 5, No. 3, 2022 167 Study on The Governance Effect of Key Audit Matters Disclosure on Surplus Management Ziang Zhao1, * 1School of Accounting, Anhui University of Finance and Economics, Bengbu, Anhui 233030, China * Corresponding author: Ziang Zhao (Email: 1617817051@qq.com) Abstract: With the help of audit Standard No.1504, the impact of key audit matters on earnings management is analyzed from the theory of corresponding inferences and from the perspective of auditors and management. Select the data of mainland and Hong Kong listed companies before and after the criteria, and design the PSM-DID model to test the policy effect. Empirically test the governance effect of key audit matters disclosure on earnings management. It is further found that the more key audit matters are disclosed, the more obvious the governance effect of the accrued surplus management and real surplus management of listed companies; among them, the governance effect of sample companies is the most obvious through the key audit matters at the account level. In addition, from the perspective of the specific types of asset impairment, the key audit matters related to inventory impairment, goodwill impairment and receivables impairment all reduce the surplus management of listed companies to a certain extent. The study shows that audit Standard No.1504 has improved the information quality of listed companies and promoted the development of high-quality capital market by suppressing surplus management behavior. Keywords: Key audit matters, Surplus management, Corresponding inferential theory, Text analysis. 1. Introduction The disclosure of key audit matters in the audit report is a prominent change in the reform of the audit report in recent years. In order to increase audit transparency, improve the value of financial report communication and close the information gap. In December 2016, the Ministry of Finance of China issued the audit Standards No.1504, and then continuously issued the guidelines to supplement the guidelines. The core of the guidelines is that certified public accountants need to disclose the most important matters in their manuscripts about the matters that they have communicated with the management according to their own professional judgment in the audit report. With different audit reforms in other countries and organizations, the guidelines are implemented in batches in the A-share market, that is, after being implemented in A+H companies from January 1,2017, while other listed companies were implemented in 2018. The purpose of adding key audit matters is to provide additional information to information users through increasing the transparency of their work. At the same time, promote the communication of auditors with management and governance layer to improve the quality of financial statement information [1]. Surplus management is an opportunistic behavior of for the management to control the company's surplus in order to seek personal interests[2]. Therefore, the disclosure of key audit matters should have a governance effect on the surplus management behavior of listed companies. With the full implementation of the guidelines, can the auditors accurately capture the most important matters in the current audit process and disclose them independently and objectively in the audit report, and can the management be more cautious and fair in preparing more readable financial reports. In other words, has the original intention of the audit report reform been realized? This paper uses the data of A shares and Hong Kong shares before and after the criteria, and uses the method of PSM-DID, starting with the corresponding inference theory (CIT), empirically explores the impact of key audit matters on earnings management, and verifies the impact path of key audit matters on earnings management. The study has proved that adding key audit matters to the audit reports can significantly reduce the company's earnings management. It also supports the corresponding inferential theory (CIT) hypothesis that auditors will increase their professional suspicion of management behavior during the audit process due to the existence of earnings management. Based on this, it is found that auditors will appropriately increase the number of key audit matters more independently and professionally, deal with major misstatement risks and audit-related risks, and improve the audit quality to reduce the company's earnings management. Through text entry analysis, it is found that corporate earnings management; specifically to asset impairment items, inventory, goodwill and receivables disclosure have more significant impact on earnings management. This paper studies the perspective of selecting surplus management, links key audit matters with earnings management, and proves that the implementation of this policy can help to reduce corporate earnings management, improve the quality of corporate information, and promote the effectiveness of capital market operation. In addition, the existing research focuses on the influencing factors of key audit matters [11][21]. The economic consequences of key audit matters still need to be improved. This paper expands the impact of the implementation of empirical inspection standards on audit practice and management, and expands the research on the areas of key audit matters and the influencing factors of surplus management. Finally, the research supports the relevant assumptions of the corresponding inference theory, and expands the application and understanding of the corresponding inference theory in the auditor behavior. 168 2. Literature Review and Hypothetical Study Previous studies have found that in [5], auditors tend to use the ambiguity inherent in expertise and accounting standards to justify the use of the audited unit management of accounting methods. But when faced with higher customer pressure of [6], namely the audit process and results will make the third party doubt the auditor, the auditor will out of "reputation maintenance" [25], the auditee to invest more resources and energy, show a more cautious attitude to the auditee strictly implement audit procedures, solve the problem of independence [25]. As a typical opportunistic behavior, surplus management usually does not violate the accounting standards provisions, but it is likely to bring a greater litigation risk to the auditor[36], so the auditor will identify and request the management adjustment as much as possible. In conclusion, although the auditors seem to tend to accept the accounting treatment with customer preferences, they will show a more prudent professional attitude under certain pressure. And the disclosure of key audit matters is actually placed in the "internal" visible draft content open and subject to social supervision. This will inevitably increase the external pressure on certified public accountants, and then when there are differences of opinions with the management on the application and management of accounting methods, they will communicate with a more independent attitude to avoid possible legal and reputational risks[25]. In the face of highly complex and uncertain key matters such as law, insurance, tax and actuarial law, audit teams often need a highly professional qualified [34] and diligent CPA or hire an expert, [33]. This also means that auditors are more tough and more professional by considering the existence of key audit matters, and they deal with issues cautiously to reduce audit- related risks and improve audit quality. Many literature at home and abroad has noticed that high-quality audit often has a good inhibitory effect on surplus management [37][18]. Disclosure of key audit matters will promote the communication between auditors and the company's management and governance layer, help the governance layer to understand and pay attention to specific matters, and improve the willingness to make risk disclosure and the quality of surplus. Sun (2019)[7] study management behavior found that management behavior is mainly affected by controlling shareholders and regulation; Yao [43] found that the market will "reward" companies willing to disclose risk, the more total risk, the lower the IPO premium, the higher the liquidity, the efficiency of new issues; some scholar [8] found that forced disclosure of corporate data assets will significantly reduce corporate earnings management. After the implementation of the 1504 guidelines, the Ministry of Finance has issued several guidelines to promote the establishment of a long-term mechanism for the healthy development of the industry. At the same time, the company's disclosure of matters of supervision is becoming increasingly strict, in 2021, the CSRC issued a huge fine of 4.9 billion yuan, information disclosure violations are the worst-hit areas. Of the 34 punished companies, 21 listed companies and two accounting firms, one securities firm and six private equity funds were fined. In 2021, the CSRC responded to the criminal provisions of intermediaries as stipulated in the Amendment to the Criminal Law (11), clarifying the criminal responsibility and the sentence of up to 10 years. In this general environment trend, accounting firms and auditees generally do not commit crimes against the wind. Therefore, based on the above analysis, it is assumed that auditors will pay more attention to related matters for "reputation maintenance" and "reduce related audit risk"; and management will also reduce corporate earnings management for positive feedback. That is to assume that H1: H1: The disclosure of key audits has a governance role in the company's earnings management. The content of key audit matters is decided by auditors through professional judgment according to the specific situation of the enterprise. So as a relatively personalized information, how do the key audit matters issued by auditors affect the earnings management of enterprises? Corresponding inferential theory (CIT) [9] refers to the intention and motivation of behavior through personal behavior and results when summarizing the cause of the problem, which can be used to explain the response of auditors to perceive the management of corporate earnings. Corresponding inferential theory suggests [10] that the auditor's response to management surplus management may be due to concerns about individual management. The past research[10] has believed that , when the following three characteristics are observed, the greater the correctness of the tendency inference: (1)the social expectation, the closer a person's behavior to the social expectation activity, the more difficult to judge the true attitude, otherwise can judge; (2) behavior free choice, the goal of the behavior originator is to get the result of the behavior; (3) non-common results, the originator of the behavior knows the result of the behavior. Management's surplus management behavior just meets these three characteristics. Surplus management is freely chosen by the governance layer (i. e. feature (2)), changing the reporting earnings (i. e. feature (3)) for opportunistic purposes, usually harming the company owners and the public interests (i. e. feature (1)). Therefore, after discovering the management surplus management behavior, the auditor will make a stronger inference to the management at the same level of importance: the management has the intention to manipulate the surplus, is the management credible, and is there any other misconduct? Thus to evaluate the audit project has a higher audit risk. This also means that there are more important matters to communicate with management to ensure the objectivity of the disclosure. The means that more matters may need to be disclosed in accordance with the guidelines[35]. In this case, on the one hand, in order to accurately identify the risk of major misstatement and reduce the inspection risk, the auditors will invest more audit resources in response to the management of the surplus management. On the other hand, auditors will strengthen the disclosure in the audit reports to reduce the audit responsibility [35], such as using more of the disclosure of key audit matters to warn the information users to reduce the relevant responsibility [39]. For the management level, Adding separate key audits to respond to management surplus management may attract the attention of institutional investors [20], regulatory [42], and analysts [8][41], who have an important impact on the capital markets, Put performance pressure on management [41], integrity, and legal crisis, Then reduce the management self- interest behavior [7]; on the other hand, The key audit matters style of the same accounting firm has a certain similarity [28], The governance layer can improve the internal control of the company by accurately identifying and finding the internal control defects, Reduce Surplus Management[12], Improve 169 the corporate governance level [23].In summary, the second hypothesis of this paper is proposed: H2: The more the number of key audit matters is disclosed, the lower the surplus management degree of listed companies. 3. Research Design 3.1. Model and Estimation Method The guidelines for key audit matters stipulate that A+H- share companies have disclosed key audit matters in their annual audit reports since 2017, and other A-share listed companies began to implement the guidelines in 2018, which can be regarded as a quasi-natural experiment in China's capital market. Evaluation of its effect is usually analyzed using constructing a PSM-DID model. While effectively evaluating the effect of policies, we can alleviate the difference problem caused by some missing variables changing over time. Drawing on the research of YX Li [13], A + H-share listed companies and other A-share companies that voluntarily take the lead in implementing the standards are taken as the processing group, and other mainland companies serve as the control group. Set two virtual variables, Post and Year, where Post=1 represents A + H share listed companies and A + H share companies that voluntarily implement the guidelines, Post=0 represents other companies that implement the guidelines later; year=1 represents the year after the new guidelines, 2017, and year=0 represents 2016. The DID regression model is set as follows: absDA=α0+α1Postit+α2Yeari,t+α3Posti,t×yeari,t+α4EMflexi,t+α5KAM _numi,t+α6CFOi,t+α7ROAit+α8Levit+α9equityit+α10Avolossit+α11Gro wthit+α12 FCFEAit+α13TATit+α14Soeit+εit (1) In model (1), surplus management (absDA) is the explained variable, and the Jones model is used, using Kothari (2005) [14] and Zhou Meihua's (2018) [15]. According to the principle of the DID model, the main explanatory variable is the coefficient of the cross-multiplication item Post Year, whose coefficient α 3 indicates the impact of the policy on the surplus management of listed companies. The expected α 3 <0 means that key audit policies have governance on earnings management, supporting hypothesis H1. Variable definitions are detailed in Table 1. Table 1. Variable definitions type of variable Variable name variable symbol Variable calculation explained variable Countable surplus management absDA The modified cross-section Jones model was used with reference to Dechow et al Real surplus management absREM According to Roychowdhury's research, the real surplus management is calculated from three aspects of abnormal sales control, abnormal control of production costs and abnormal disposable expenses by year and industry explanatory variable Annual virtual variable Year Take 1 in 2017, or take 0 otherwise Group Virtual Variables Post The processing group is 1, and the control group is 0 Number of number of key audit audits KAM_num Manual number of items from the annual report disclosing key audit matters controlled variable Surplus management flexibility Emflex (Accounts receivable + inventory) / operating income Net cash flow from operating activities CFO The ratio of the net cash flow from operating activities to the total assets return on assets ROA The ratio of net profit to total assets financial risk Lev The ratio of total liabilities to total assets net asset equity Net assets divided by 100000000 net margin netprofit Net profit divided by 100000000 Company's motivation to avoid losses Avoless When 0