United States: PCAOB Adopts Changes To The Auditor's Report To Require Disclosure Of Critical Audit Matters

On June 1, 2017, the Public Company Accounting Oversight Board (PCAOB) adopted a new auditor reporting standard, The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion (AS 3101) that requires the auditor to provide new information about the audit and make the auditor's report more informative and relevant to investors. The new standard retains the pass/fail opinion of the existing auditor's report but makes significant changes to the existing auditor's report, including the following:

  • Communication of critical audit matters (CAMs) – 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
  • Disclosure of auditor tenure – Disclosure of the year in which the auditor began serving consecutively as the company's auditor
  • Clarify auditor's role and responsibilities – Clarifies standard language about the nature and scope of the auditor's existing responsibilities, including:
    • Disclosure of auditor independence – Disclosure that the auditor is required to be independent
    • New error or fraud language – The addition of the phrase "whether caused by error or fraud," to be used in the description of the auditor's responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements; the existing standard does not require the auditor's report to contain the phrase "whether due to error or fraud"
    • Addressed to shareholders and the board – The audit report will be addressed to the company's shareholders and board of directors, with additional addressees permitted
    • Financial statement notes – Identification of the financial statements, including the related notes and, if applicable, schedules, as part of the financial statements that were audited; under the existing standard, the notes to the financial statements and the related schedules are not identified as part of the financial statements
    • Nature of the audit – The description of the nature of the audit reflected the auditor's responsibilities in a risk-based audit and aligned the description with the language in the PCAOB's risk assessment standards, including:
      • Performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks
      • Examining, on a test basis, appropriate evidence regarding the amounts and disclosures in the financial statements
      • Evaluating the accounting principles used and significant estimates made by management
      • Evaluating the overall presentation of the financial statements
  • More helpful and standardized format – The audit opinion will appear in the first section of the auditor's report, and section titles have been added to guide the reader

Critical Audit Matters

Communicated or required to be communicated to the audit committee

Under the new standard,1] a CAM is defined as any matter arising from the audit of the financial statements that was required to be communicated to the audit committee (even if not actually communicated) and matters actually communicated (even if not required) that are related to accounts or disclosures that are material to the financial statements and involved especially challenging, subjective or complex auditor judgment. It will include auditor communication requirements under AS 1301, Communications with Audit Committees, other PCAOB rules and standards, 2and applicable law, 3 as well as communications made to the audit committee that were not required.

Required communications to the audit committee generally include the areas in which investors have expressed particular interest in obtaining information in the auditor's report, such as significant management estimates and judgments made in preparing the financial statements, areas of high financial statement and audit risk, significant unusual transactions, and other significant changes in the financial statements. The new standard does not limit the source of CAMs to critical accounting policies and estimates, nor does it exclude from the source of CAMs certain required audit committee communications that relate to sensitive areas (e.g., corrected and uncorrected misstatements, qualitative aspects of significant accounting policies and practices, alternative treatments within GAAP, independence considerations, disagreements with management, overall planned audit strategy, delays encountered in the audit, and competency issues of management) and that could result in the auditor communicating information not disclosed by management. To the extent that any such communication qualifies as a CAM (including that it (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective or complex auditor judgment), it will be an appropriate subject for an auditor to communicate.

Relates to Accounts or Disclosures That Are Material to the Financial Statements

The new standard provides that each CAM relates to accounts or disclosures that are material to the financial statements, which means that the CAM could be a component of a material account or disclosure and does not necessarily need to correspond to the entire account or disclosure in the financial statements. For example, the auditor's evaluation of the company's goodwill impairment assessment could be a CAM if goodwill was material to the financial statements, even if there was no impairment. The CAM would relate to goodwill recorded on the balance sheet and the disclosure in the notes to the financial statements about the company's impairment policy and goodwill. In addition, a CAM may not necessarily relate to a single account or disclosure but could have a pervasive effect on the financial statements if it relates to many accounts or disclosures. For example, the auditor's evaluation of the company's ability to continue as a going concern could also qualify as a CAM depending on the circumstances of a particular audit.

On the other hand, a matter that does not relate to accounts or disclosures that are material to the financial statements cannot be a CAM. For example, a potential loss contingency that was communicated to the audit committee, but that was determined to be remote and was not recorded in the financial statements or otherwise disclosed under the applicable financial reporting framework, would not meet the definition of a CAM. The same rationale would apply to a potential illegal act if an appropriate determination was made that disclosure was not required in the financial statements.

Similarly, the determination that there is a significant deficiency in internal control over financial reporting does not qualify as a CAM because it does not relate to an account or disclosure that is material to the financial statements. However, a significant deficiency could be among the principal considerations that led the auditor to determine that a matter is a CAM.

Involved Especially Challenging, Subjective or Complex Auditor Judgment

The determination of whether a matter qualifies as a CAM is principles-based. The new standard does not specify any items that would always constitute CAMs. For example, not all matters determined to be "significant risks" under PCAOB standards would qualify as CAMs because not every significant risk would involve especially challenging, subjective or complex auditor judgment. For example, improper revenue recognition is a presumed fraud risk, and all fraud risks are significant risks; however, if a matter related to revenue recognition does not involve especially challenging, subjective or complex auditor judgment, it will not be considered a CAM. In accordance with the new standard, material related-party transactions or matters involving the application of significant judgment or estimation by management do not qualify as CAMs, unless the auditor determines, in the context of the specific audit, that the matter involved especially challenging, subjective or complex auditor judgment. The PCAOB believes that focusing on the auditor's judgment should limit the extent to which expanded auditor reporting could become duplicative of management's reporting. The PCAOB also believes that CAMs reflecting differences in auditors' experience and competence will also be informative.

In determining whether a matter involved especially challenging, subjective or complex auditor judgment, the auditor should take into account, alone or in combination, certain nonexclusive factors, including:

  1. The auditor's assessment of the risks of material misstatement, including significant risks
  2. 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
  3. The nature and timing of significant unusual transactions and the extent of audit effort and judgment related to these transactions
  4. The degree of auditor subjectivity in applying audit procedures to address the matter or in evaluating the results of those procedures
  5. 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 consultations outside the engagement team regarding the matter
  6. The nature of audit evidence obtained regarding the matter

The new standard requires the auditor to communicate in the auditor's report any CAMs arising from the current period's audit of the financial statements or state that the auditor determined that there are no CAMs. Once an auditor decides that a CAM needs to be included in the report, the auditor would (1) identify the CAM, (2) describe the principal considerations that led the auditor to determine that the matter is a CAM, (3) describe how the CAM is addressed in the audit and (4) refer to the relevant financial statement accounts or disclosures.

Some investors believe that CAMs will highlight areas that they may wish to emphasize in their engagement with the company and provide important information that they can use in making proxy voting decisions, including ratification of the appointment of auditors.

Excluded Companies from CAM Disclosures

The new standard will generally apply to audits conducted under PCAOB standards. Communication of CAMs is not required for audits of brokers and dealers, investment companies other than business development companies, benefit plans, and emerging growth companies; however, auditors of these entities may choose to include CAMs in the auditor's report voluntarily. The other requirements of the new standard will apply to these audits.

Effective Dates

Subject to approval by the Securities and Exchange Commission (SEC), the new standard will take effect as follows:

  • All provisions other than those related to CAMs will take effect for audits of fiscal years ending on or after December 15, 2017.
  • Large accelerated filers – Provisions related to CAMs will take effect for audits of fiscal years ending on or after June 30, 2019
  • All other companies not excluded – Provisions related to CAMs will take effect for audits of fiscal years ending on or after December 15, 2020

This proposed timeline should provide accounting firms, companies and audit committees time to prepare for implementation of the CAM requirements, which are expected to require more effort to implement than are the additional improvements to the auditor's report. Auditors may elect to comply before the effective date, at any point after SEC approval of the new standard.

Expectations of the New Standard

We expect the new standard to present meaningful challenges for public companies and their audit committees with respect to their disclosures and the dynamics of their interactions with the auditors. The new standard recognizes that the audit report may disclose a company's nonpublic information as part of the CAM communications if that information is needed to describe the principal considerations that led to the CAM determination or how the CAM was addressed in the audit. In addition, the auditor's insistence that certain CAM-related disclosures be included in the auditor's report may impact a public company's disclosure in other areas. For example, public companies already provide substantial disclosures regarding their accounting practices, policies and processes, particularly in the risk factors and MD&A section, and often have to contend with the auditor's desire or suggestion to include additional (viewed as either clarifying or unnecessary, depending on your perspective) disclosures.

There is also likely to be additional pressure between management and the auditors to understand how the auditor intends to approach CAM disclosure with respect to the company, which existing accounting policies and practices would be likely to receive a CAM designation, and extensive discussions about what CAM disclosure would look like for those matters. As these discussions evolve, it will be interesting to see whether companies provide additional details of the communications with their auditors in the proxy statement in areas such as the audit committee report (which is furnished rather than filed), ratification of the independent auditor proposal (which is not required but is a matter of good corporate practice), a summary of the audit committee's responsibilities or discussion related to the board of directors' role in risk oversight. In that regard, we are mindful that only a handful of companies have volunteered additional disclosures, whether in the audit committee report or elsewhere in the proxy statement, in light of the SEC's encouragement to do so in its 2015 concept release regarding possible revisions to its audit committee disclosures. We certainly encourage companies to engage in these discussions sooner rather than later to minimize these issues and to allow senior management and the board of directors time to consider these issues well in advance of finalizing their financial statements and substantive disclosures. This is not a discussion a public company wants to wrap up the week its public filing is due.

There is also likely to be additional pressure between management and the auditors to understand how the auditor intends to approach CAM disclosure with respect to the company, which existing accounting policies and practices would be likely to receive a CAM designation, and extensive discussions about what CAM disclosure would look like for those matters. As these discussions evolve, it will be interesting to see whether companies provide additional details of the communications with their auditors in the proxy statement in areas such as the audit committee report (which is furnished rather than filed), ratification of the independent auditor proposal (which is not required, but is a matter of good corporate practice), a summary of the audit committee's responsibilities or as part of the discussion related to the board of directors' role in risk oversight. In that regard, we are mindful that only a handful of companies have volunteered additional disclosures, whether in the audit committee report or elsewhere in the proxy statement, in light of the SEC's encouragement to do so in its 2015 concept release regarding possible revisions to its audit committee disclosures. We certainly encourage companies to engage in these discussions sooner rather than later to minimize these issues and to allow senior management and the board of directors time to consider these issues well in advance of finalizing their financial statements and substantive disclosures. 4 This is not a discussion a public company wants to wrap up the week their public filing is due.

Footnotes

[1] The PCAOB release contains a helpful chart that summarizes the critical audit matter analysis.
[2] See Appendix B of AS 1301, which identifies other PCAOB rules and standards that require audit committee communication.
[3] See, e.g., Section 10A(k) of the Exchange Act;, Rule 2-07 of Regulation S-X;, and Exchange Act Rule 10A-3.
[4] See Possible Revisions to Audit Committee Disclosures, SEC Rel. No. 33-9862 (July 1, 2015) (e.g., Section VI.A.1.).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions