The Auditor’s Report Gets a Makeover
By John Lucas, CPA
Virtually unchanged for nearly 70 years, the auditor’s report has just received a major makeover. Late last year, the SEC unanimously approved the Public Company Accounting Oversight Board’s new auditor’s reporting standard.
The most significant change requires that auditors augment their traditional pass/fail opinion with a discussion of “critical audit matters” (CAMs). The PCAOB says that the new format is a direct response to investors asking for an expansion of the auditor’s report “to include information about the difficult parts of the audit.”
A CAM is defined as any matter that is required to be communicated to the audit committee that relates to accounts or disclosures that are material to the financial statements and involve especially challenging, subjective or complex auditor judgment.
Essentially, CAMs are the kind of things that keep auditors up at night.
Matters required to be communicated to the audit committee that may result in a CAM includes, among other things: significant risks identified by the auditor; matters regarding the company’s accounting policies, practices, and estimates; significant unusual transactions; certain matters regarding related parties; and other matters arising from the audit that are significant to the oversight of the company’s financial reporting process.
A CAM could also be the company’s evaluation of goodwill impairment if goodwill is material, as well as the evaluation of the company’s ability to continue as a going concern. Other factors in establishing a CAM could involve the difficulty of obtaining adequate audit evidence or matters that required outside consultation.
Looking at a simple financial statement, a CAM could include matters related to revenue recognition, management override of controls, receivables, inventories, intangibles, covenants, investment valuations, derivatives, fixed assets, lease accounting, pension accounting, expenses, reserves, and related parties, just to name a few. Indeed, it is a long list from which the PCAOB expects most audits to render at least one CAM.
The change to audit reports has already occurred in many other areas of the world. In its December 31, 2013 audit report on Rolls-Royce, auditors at KPMG identified 18 key matters. Many within the accounting community have pointed to that particular audit report as a good example of additional information that can be disseminated by an auditor.
Some observers however, including the United States Chamber of Commerce, have criticized CAM disclosure requirements arguing that disclosure of such communications could increase the potential liability for issuers and auditors, in addition to disclosing sensitive company information to the public. The PCAOB has acknowledged the concern that it could provide the basis for legal claims, leading to increased litigation costs and audit fees. The PCAOB said it intends to monitor the results of implementation of the new standard, including consideration of any unintended consequences.
The new auditor’s report, which involves such things as auditor independence and auditor tenure, became effective for all audits for fiscal years ending on or after December 15, 2017. However, communication of CAMs will be phased in.
Accelerated filers will need to comply on audits relating to fiscal years ending on or after June 30, 2019. All other companies will need to comply on audits relating to fiscal years ending on or after December 15, 2020.
Though CAM requirements generally apply to all audit reports filed with the SEC, including by foreign private issuers, it will not apply to emerging growth companies, certain brokers and dealers, investment companies other than business development companies and benefit plans.
John Lucas is Director of Assurance & Audit Practice at Weinberg & Company, a multi-office, PCAOB and CPAB-Registered firm specializing in the audit, assurance and tax needs of micro and small cap companies. John has over 25 years of experience in public accounting with extensive experience in auditing SEC reporting companies in manufacturing and distribution, real estate, high technology, and other industries throughout the U.S., Europe and Asia, with a particular expertise in China. John also has experience in due diligence, valuation, expert witness and restructuring engagements. Email John at email@example.com or contact him at 310-601-2200.