In October 2017, the SEC approved the PCAOB’s proposed new auditing standard for the auditor’s report, which requires auditors to include a discussion of “critical audit matters,” know colloquially as “CAMs.” CAMs are “matters communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements; and (2) involved especially challenging, subjective, or complex auditor judgment.” Essentially, the concept is intended to capture the matters that kept the auditor up at night. As former Commissioner Kara Stein observed in her statement, the new “standard marks the first significant change to the auditor’s report in more than 70 years.” Changes related to CAMs became applicable to audits of large accelerated filers beginning with June 30, 2019 fiscal years and will apply to audits of all other companies to which the requirements apply for fiscal years ending on or after December 15, 2020. (See this PubCo post.) As a first step in analyzing the impact of CAM implementation before the requirement becomes more broadly applicable, the PCAOB undertook an interim analysis of the effect on key stakeholders in the audit process, including preparers (e.g., CFOs) at large accelerated filers, their audit firms, audit partners, audit committees and investors. That report is now available.
When the new standard was proposed, there were a number of concerns expressed—that CAMs might result in disclosure of nonpublic information, that they could lead to some discomfort at companies or disputes with auditors, that they would involve considerable cost, that they might have a chilling effect on auditor communications, that they might simply be boilerplate, or that they might provide roadmaps to baseless litigation. Acknowledging the risks involved, SEC Chair Jay Clayton had framed the challenge this way, urging all involved in implementation to pay close attention to these issues going forward: “I would be disappointed if the new audit reporting standard, which has the potential to provide investors with meaningful incremental information, instead resulted in frivolous litigation costs, defensive, lawyer-driven auditor communications, or antagonistic auditor-audit committee relationships—with Main Street investors ending up in a worse position than they were before.” But did those risks and benefits emerge? Not so much. So far, at least, CAMs haven’t seemed to had much impact at all.
To conduct the analysis, the PCAOB
- Surveyed all U.S. audit firms with at least 15 LAF clients (eight firms in total, including the Big Four) in June 2020 regarding the processes and procedures, such as training and dry runs, they developed;
- In May/June 2020, surveyed 902 engagement partners at the eight audit firms regarding their experiences in implementing the CAM requirements;
- Conducted an investor survey in April/May 2020 regarding investor awareness, perceptions and use of CAMs communications, receiving 97 responses from investors “who (1) research investments for their personal accounts and/or as part of their job, (2) research individual companies, and (3) conduct fundamental or governance analysis of companies”;
- Conducted in-depth interviews between September 2019 and February 2020 of 12 audit committee chairs and 10 financial statement preparers (CFOs, Chief Accounting Officers and Controllers) of 12 LAFs with June 30 year-ends to gain insight regarding issuer experiences with initial CAM implementation;
- Performed “large-sample statistical analyses to investigate the average impact of initial CAM implementation on audit hours, audit fees, time to issue audit reports, and capital markets”; and
- Reviewed 23 comment letters received from stakeholder groups, including auditors, investors, financial statement preparers and academics, in response to the PCAOB’s request for public comment.
CAM data. The report indicated that there were 2,420 audit reports containing CAMs, ranging in number from zero to seven and averaging 1.7 per report. The most common CAMs reported related to revenue recognition (604), goodwill (462), other intangible assets (385) and business combinations (355).
Audit firms. The PCAOB survey revealed that audit firms made substantial investments in tools, training and protocols, and established networks of CAM subject matter experts. According to estimates from the Big Four, they invested, on average, through April 2020, “around 23,000 hours developing processes and procedures to support CAM implementation (53% at the partner level) and 14,600 hours for the firm’s personnel to attend CAM-related training (32% at the partner level).” The PCAOB estimates that, based on hourly compensation rates, these hours correspond to approximately $6.5 million. (Hmmm…) Fewer hours were invested at the remaining four firms that participated in the survey, largely reflecting differences in the number and composition of their audit client bases. “Overall,” the PCAOB concluded, “the staff’s analysis suggests that costs to LAFs related to auditor implementation of the CAM requirements were largely inconsequential.” (Emphasis added.)
Engagement partners. Audit engagement partners indicated that “individual audit engagement teams spent (on average) about 1% of total audit hours identifying, developing, and communicating CAMs,” mostly prior to the company’s fiscal year-end. Extensive upfront preparations—including pilot and dry-run programs—contributed to a generally smooth experience for issuers.
Although, at the rulemaking stage, concern was expressed regarding potential chilling of communications among auditors, audit committees and managements, the PCAOB reported that “[l]ess than 2% of engagement partners who participated in the survey reported that the CAM requirements constrained auditor communications with the audit committee, while 41% reported that the CAM requirements enhanced these communications.” Also prior to implementation, several commentators had advised companies to review their own disclosures to be sure that they would be in sync with CAM disclosure. The PCAOB survey showed that 39% of engagement partners reported issuer changes to financial statement or other corporate reporting as a result of CAMs (although preparers did not report significant changes to company disclosures because of CAMs).
In addition, only 2% of engagement partners reported issuer changes to internal control over financial reporting because of CAMs. Another concern raised during the rulemaking process was that CAMs would cause auditors to spend extra time and resources on audit areas related to CAMs. However, the survey showed that only 3% of engagement partners reported “changes to the nature, timing, or extent of audit procedures because of requirements to communicate CAMs.”
In response to an open-ended question, the PCAOB heard some more pointed responses, including that
“139 engagement partners (15%) provided additional input on the impact of CAMs. About half of these partners asserted that the information presented in CAMs provides little value to investors or financial statement users (67). Others said that there were significant administrative burdens associated with the CAM communication process (26) or that CAM implementation required large amounts of documentation (8). Some engagement partners said that they felt pressure to identify at least one CAM, even though they did not believe that any individual matter met the definition of a CAM (19). Others reported that audit committees expressed a strong preference that their CAMs were similar to other issuers in the same industry (7).”
Investors. Apparently, CAMs have not yet made much of an impression on investors, if they’ve even seen one that is. As the PCAOB describes it, investor “awareness regarding CAMs is still developing.” While 63% of respondent investors “had heard of CAMs,” only 31% had even seen a CAM in an audit report. For those investors who had seen them, they reported using them to “better understand the work of the auditor, better understand financial statement disclosures, and develop questions for company management.” Asked about their impressions of CAMs—including investors who had never seen them, but were shown two representative examples from audit reports—investors responded as follows:
“Overall, most survey respondents viewed CAMs as at least somewhat tailored to the audit (72%) and easy to understand (55%). Participants also reported that they were likely to use CAMs in the future (e.g., 66% reported that they were likely to use CAMs to identify risks associated with a given company). Investors who had seen CAMs were given an open-ended prompt asking them to share two reasons why they would or would not use CAMs in the future. Of 21 responses, eight said they would use CAMs in the future, four said they might use CAMs in the future, and nine said they would not use CAMs in the future. Of those who said they would use CAMs, a common theme was that CAMs helped to highlight areas that were particularly subjective or more difficult to audit. Among those who said they would not use CAMs, participants said that CAMs are not specific enough to provide useful information or do not provide additional value above and beyond what is already included in financial statements.”
Audit Committee chairs and company preparers. Audit committee chairs and company preparers participating in the interview process indicated that the CAM implementation process was a “generally smooth experience” for companies, largely as a result of the significant upfront preparation by auditors. In particular, those interviewed considered the “dry runs” conducted by auditors to be useful.
Notably, the PCAOB reports that concerns expressed during the rulemaking process, such as the potential for chilling of communications with auditors or disclosure by the auditor of nonpublic information, “do not appear to have manifested in practice.” According to the PCAOB, no chairs reported “chilling,” no interviewees reported disclosure of nonpublic information, no preparers reported making significant changes to company disclosures because of CAMs (and they did compare them to auditor’s draft CAMs) and none indicated CAMs drove significant changes to company financial reporting processes or controls. None of the interviewees had heard from investors regarding CAMs, but some indicated that “CAMs contain valuable information for investors.” Almost all preparers reported that costs associated with CAM implementation, such as management time or increased audit fees, “were inconsequential.”
Statistical Analysis. The large-sample statistical analyses do not suggest, on average, an increase in the costs of the audit engagement (audit fees and audit hours) associated with initial CAM implementation or an increase in the time to issue audit reports. The PCAOB suggests that audit firms did not, in general, pass along the costs of CAM implementation to issuers in the initial year. (There is no indication of what that might mean for subsequent years.) In addition, the analyses of stock market data failed to show, consistent with “emerging academic research,” that, on average, investors paid much attention to CAMs in the first year of implementation. The PCAOB speculated that it may take more time for “the full benefits of CAM communications to investors…to materialize” as investors become more aware of CAMs.
Public comment. In general, public comment was consistent with the outreach and data analysis above, and “did not identify significant unintended consequences from initial CAM implementation.”
No significant unintended consequences. In conclusion, the PCAOB staff did not find “evidence of significant unintended consequences from auditors’ implementation of the CAM requirements for audits of LAFs in the initial year. The PCAOB will continue to monitor and evaluate the impact of the CAM requirements, including any significant unintended consequences, as auditors begin to implement the CAM requirements for audits of other public companies.”
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