by Cydney Posner
Yesterday, as anticipated, the PCAOB adopted, subject to SEC approval, a new auditing standard for the auditor’s report that, while retaining the usual pass/fail opinion, will require auditors to include a discussion of “critical audit matters,” that is, “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.” The new CAM disclosure requirement will apply (with some exceptions) to audits conducted under PCAOB standards, including audits of smaller reporting companies and non-accelerated filers (although at a later phase-in date), but will not apply to emerging growth companies. Here are the press release and related fact sheet.
SoapBox: I don’t think I’d be going too far out on a limb if I predicted that we might see some disputes erupt over CAM disclosure. Essentially, the concept is intended to capture the matters that kept the auditor up at night, so long as they meet the standard’s criteria. But will auditors’ judgments about which CAMs were the real nightmares be called into question? Will the new disclosure requirement precipitate many auditor-management squabbles over the CAMs selected or the nature or extent of the disclosure? And just how enthusiastic will the CFO be about the prospect of the auditor’s sharing with the investing public the convoluted nature or opacity of the company’s policies or the struggles involved in performing the audit or reaching conclusions about the financials? Although the adopting release suggests that the process will be an iterative one between management and the auditors, how much input will auditors really allow audit committees or managements in reviewing the auditors’ selection or disclosure? Will auditors’ use the new disclosure requirement as leverage to compel managements to include disclosure in the notes or MD&A that management may not view as necessary? Because the trigger for CAM consideration is whether a matter has been or is required to be communicated to the audit committee, will the new requirement have the effect of chilling communications among auditors, audit committees and managements, a concern often mentioned in comments on the proposal? Or will the new standard ultimately end up just producing more boilerplate, as auditors (and companies) find comfort in conformity?
Notably, the PCAOB expects little chilling effect: “For matters required to be communicated to the audit committee, the Board believes there should not be a chilling effect or reduced communications to the audit committee because the requirements for such communications are not changing. It would seem that any chilling effect would more likely relate to matters that are not explicitly required to be communicated to the audit committee, although given the broad requirements of [the relevant standard], the Board believes that there may be few, if any, relevant communications affected by that possibility.”
by Cydney Posner
At a meeting yesterday of the PCAOB’s Investor Advisory Group, two working groups reported on topics that might be of particular interest: non-GAAP financial measures and enhanced audit reports. Continue reading
by Cydney Posner
When the PCAOB originally floated the idea of an expanded audit report in 2011, the proposal fueled quite a controversy. Supporters of the concept contended that the current form of the auditor’s report was just boilerplate that “tells investors little of substance about a company’s true condition,” while audit firms were concerned that one consequence of an expanded auditor’s report could be the possibility of increased auditors’ legal exposure. The PCAOB’s recent reproposal, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion (see this Pubco post), which provides for inclusion in the auditor’s report of “critical audit matters,” attempts to address some of those concerns. While the reproposal has generally been viewed favorably by investors, among the groups still crying foul are audit firms and organizations (see this PubCo post).
In that light, it’s somewhat ironic to see the results of an academic study showing, among other things, that disclosure of CAMs could help protect auditors from legal exposure if a misstatement were subsequently discovered in the CAM area. More specifically, the study found that the “types of CAMs illustrated by the PCAOB are more likely to prompt a ‘disclaimer effect’ by warning users of the inherent subjectivity and complexity associated with auditing CAM areas. Specifically, we find that CAM disclosures lead to less confidence in the CAM area before a misstatement is revealed and less assessed auditor responsibility after a misstatement is revealed in the CAM area.” Continue reading
by Cydney Posner
As discussed in this PubCo post, in May of this year, after five years of outreach, the PCAOB once again attempted to make the auditor’s report more relevant and informative to investors by reproposing the auditor reporting standard, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion. While the reproposal would retain the standard pass/fail model, it would also provide for the inclusion of critical audit matters (CAMs) in the auditor’s report, as well as new elements related to auditor independence and auditor tenure. Comment letters to the PCAOB regarding its reproposal of the standard have reflected a predictable split. As discussed in this Bloomberg BNA article, investors generally have approved of the proposed changes, while auditors have continued to express concern that, even under the reproposal, they — not management — remain a primary source for the new disclosures regarding CAMs. Continue reading
by Cydney Posner
Last week, after five years of outreach, the PCAOB once again attempted to make the auditor’s report more relevant and informative to investors by reproposing the auditor reporting standard, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, and related amendments. Typically, as you know, auditors just give companies a pass/fail grade and provide no description of any issues or problems that occurred during the audit process; those problems are instead taken up with the audit committee. However, PCAOB Chair Jim Doty commented, “in today’s complex economy, and particularly in light of lessons learned after the financial crisis, investors want a better understanding of the judgments that go into an opinion – not a recitation of the standard procedures that apply to any audit, but the specific judgments that were most critical to the auditor in arriving at the opinion.” While the reproposal would retain the standard pass/fail model, it would also provide for the inclusion in the auditor’s report of “critical audit matters” and new elements related to auditor independence and auditor tenure. According to the proposing release, the communication of critical audit matters “would inform investors and other financial statement users of matters arising from the audit that required especially challenging, subjective, or complex auditor judgment, and how the auditor responded to those matters.” Here is the press release and a fact sheet. Continue reading