With the Public Company Accounting Oversight Board’s (PCAOB) new auditor reporting standard finally pending before the U.S. Securities and Exchange Commission (SEC) after nearly a decade in the making, Protiviti has published a Flash Report summarizing the changes and examining possible consequences.
The Auditor’s Report on Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion is intended to make the auditor’s report more relevant to investors by requiring more information about the audit. In a nutshell, the new standard requires auditors to communicate in the report any critical audit matters (CAMs) — that is, matters that were 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) involve especially challenging, subjective or complex auditor judgment.
The latter distinction takes into account certain factors including, but not limited to:
- The auditor’s assessment of the risks of material misstatement, including significant risks
- The degree of auditor judgment related to areas in the financial statements that involved the application of significant judgment or estimation by management, including estimates with significant measurement uncertainty
- The nature and timing of significant unusual transactions and the extent of audit effort and judgment related to these transactions
- The degree of auditor subjectivity in applying audit procedures to address that matter or in evaluating the results of those procedures
- The nature and extent of audit effort required to address the matter, including the extent of specialized skill or knowledge needed or the nature of the consultations outside the engagement team regarding the matter; and
- The nature of audit evidence obtained regarding the matter
The distinguishing factor in determining whether something is a CAM is the degree to which it involves challenging, subjective or complex auditor judgment during the audit process. The audit report must include identification of each CAM, a description of the principal considerations that led the auditor to determine that the matter was a CAM, description of how the CAM was addressed in the audit, and reference to the relevant financial statement accounts or disclosures.
Because CAM determinations are subjective, some say it will give auditors leverage to encourage additional management transparency to the benefit of investors. Others see it as a significant cost, and, potentially, a competitive threat, depending on the kinds of issues discussed and disclosed.
The final standard includes other changes to the auditor’s report intended to affirm the auditor’s independence, clarify the auditor’s role and responsibilities related to the audit, provide additional information about the auditor, and make the auditor’s report easier to read.
The new standard applies to audits conducted under PCAOB standards. In addition, it specifically concludes that the communication of CAMs is not required for audits of brokers and dealers; investment companies other than business development companies; employee stock purchase, savings and similar plans; and emerging growth companies.
Subject to SEC approval, the final standard and amendments will take effect as follows (although the PCAOB allows auditors to comply with the standard before the effective date, at any point after SEC approval):
- All provisions other than those related to critical audit matters will take effect for audits of fiscal years ending on or after December 15, 2017.
- Provisions related to CAMs will take effect for audits of fiscal years ending on or after December 15, 2020.
One consequence to watch for is whether auditors will require disclosure of original information in articulating CAMs encountered during the audit. Limitations of the auditor’s knowledge and expertise, potential liability implications, and friction in the relationship with the company may become influencing factors that could discourage auditors from going beyond management disclosures. No doubt, this will place companies, their SEC counsel and their auditors on a collision course when it comes to deciding how much disclosure is enough disclosure.
We will continue to follow this issue and advise clients on best practices as they develop. For more detail, you can download the full flash report free from our website.