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PCAOB Passes Expanded Auditor's Reports

Chris Gaetano
Published Date:
Jun 1, 2017

The Public Company Accounting Oversight Board (PCAOB) unanimously passed a measure today that will expand the auditor's report to include, among other things, certain Critical Audit Matters (CAM) that investors and other users should know. 

"In today’s complex economy, and particularly in light of lessons learned after the financial crisis, investors in our public capital markets want a better understanding of the judgments that go into an auditor’s 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," said PCAOB Chair James Doty in his statement during today's meeting. 

The standard, the Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, defines critical audit matters as an issue that was communicated to required to be communicated to the audit committee and relates to both accounts or disclosures that are material to the financial statements and involved especially challenging, subjective or complex auditor judgment. When auditors disclose a CAM in their reports, they must identify the CAM, describe the principle considerations that led the auditor to determine that the matter was a CAM, a description of how it was addressed in the audit, and its relevance to financial statement accounts or disclosures. 

"Disclosure of these critical audit matters should give users of financial statements a window into the audit process itself without giving away whatever subjective view an auditor might have of the specific financial information being audited. The CAMs can also alert users of financial statements to those areas of the statements to which they should pay particular attention," said PCAOB member Lewis Ferguson in his own statement. 

Ferguson added that the inclusion of CAMs could actually help auditors, as they present an opportunity for auditors to "show their skills."

"If auditors want to distinguish themselves, and give the public some insight into their work and judgment, this standard provides an opportunity for them to do so," he said. 

Beyond the CAM provision, the new standard also requires that the audit report include a statement disclosing the number of years the auditor has consecutively served as the company's auditor and a statement that the auditor is required to be independent. The new standard also updates certain standard language in the auditor's report, such as including the phrase "whether due to error or fraud" when describing the auditor's responsibility under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatements. It also requires that the report be explicitly addressed to the company's shareholders and board of directors, at minimum. The audit report will retain the standard pass/fail model, with the opinion to appear in the first section. 

PCAOB member Jeanette Franzel, while supporting the measure overall, was skeptical about the requirement to disclose the length of an auditor's tenure, saying it may give users the wrong idea. 

"I am concerned that including this information in the auditor’s report may convey an implication that there is a generalizable relationship between auditor tenure and audit quality and/or auditor independence, assumptions that may not be valid. If information about auditor tenure is important and relevant for investors and other users, then I would support an analysis of alternatives for the best party to make the disclosure and the mechanism for doing so," she said in her statement. 

While board member Steven Harris also support the overall measure, he also pointed out areas that he felt could use improvement. The definition of a CAM, he said, contains an element of subjectivity that grants auditors too much discretion; this subjectivity, he said, could make it difficult to effectively inspect entities and enforce compliance. Investors, he said, had recommended more specific things that the auditor would discuss, such as assessment of management's estimates and judgments, unusual transactions, or restatements and other changes, but these were not included. Investors, he said, also were against the board's inclusion of a "materiality" threshold for what constitutes a CAM. Harris himself noted that he'd have preferred the standard to also address the issuer's ability to continue as a going concern, and lamented that Emerging Growth Companies are exempt from the CAM requirements, as these companies can present some of the greatest risk to investors. 

"Having said that, I reiterate that I am pleased that we have reached this moment after so many years of effort. I would encourage the Securities and Exchange Commission (SEC) to act quickly to finalize it. Then I think we must monitor its implementation carefully to ensure that the report is not reduced to boilerplate language," he said in his own statement. 

The final measure represents eight years of effort to expand the standard audit report to include additional information, with investors believing that auditors have a more intimate knowledge of the company's financial health than most people. It began in 2008 with the U.S. Treasury Department's Advisory Committee on the Auditing Profession issuing a report recommending improvements to the standard reporting model. This was followed by outreach conducted in 2010 and 2011, concluding in a concept release in June 2011 seeking public comment on the potential changes. After two years of input, the PCAOB released the first version of the proposal in 2013. 

The Society was generally against this proposal, writing in its 2013 comment letter that the inclusion of CAMs "would not be relevant and useful to investors and other financial statement users." The Society did not feel it was appropriate or productive for the auditor to provide information that is intended to help investors or other users in assessing the audit, nor did it think that users would get much out of the additional information if it was included in the first place. It would only serve to muddy the waters, as the user does not have access to the factual and technical knowledge available to the auditor. Further, it expressed concern that the expanded audit report would increase legal liabilities for auditors. 

Following similar critiques of the idea, the PCAOB withdrew the 2013 proposal and released a revised version, the one that was voted on today, in 2016. The Society, in a comment letter written in response, was still skeptical about the measure. 

"We continue to believe that the inclusion of CAMs in public reports would not help users in making investment, voting, or credit decisions or enhance transparency in a meaningful way, but would dilute the pass/fail message and diminish the value of an audit report," said the Society. 

All provisions other than those related to critical audit matters will take effect for audits
for fiscal years ending on or after December 15, 2017; and, Provisions related to critical audit matters will take effect for audits for fiscal years ending on or after June 30, 2019, for large accelerated filers; and for fiscal years ending on or after December 15, 2020, for all other companies to which the requirements apply.

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