On June 1, 2017, the Public Company Accounting Oversight Board (“PCAOB”) announced the adoption of a new auditor reporting standard, subject to SEC approval. Although the standard maintains the current pass/fail opinion in auditor reports it does make substantial changes to the report. Most significantly, the new standard requires the auditor to communicate any critical audit matters that arose during the audit.

Critical Audit Matters

The standard defines a critical audit matter (CAM) as “a matter that was communicated or required to be communicated to the audit committee that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex auditor judgment. Note that, under this new standard, a required CAM disclosure may arise from any communication between an auditor and the Audit Committee, not just communications required by PCAOB rules. The PCAOB declined to follow suggestions made through the comment process to apply potential CAM disclosures to a more limited scope of auditor communications.

The standard lists several factors an auditor should take into account when determining whether there needs to be a CAM disclosure. These factors include the risk of material misstatement, nature and timing of significant unusual transactions, degree of auditor subjectivity in applying audit procedures to address the matter, extent of effort required by auditor to address the matter, and the nature of the evidence obtained during the audit. If the matter is determined to be a CAM, the audit report will be required to: (1) identify the CAM; (2) describe the principal considerations that led to the CAM determination; (3) describe how the CAM was addressed in the audit and (4) refer to the relevant financial statement accounts and disclosures.

Disclosure of Auditor Tenure and Other Changes

The PCAOB also made other changes to clarify an auditor’s role and responsibilities during an audit, provide additional auditor information and make auditor reports easier to read. The new requirements for the auditor report include disclosure of the auditor’s tenure with the company; a statement regarding independence; updates to standardized language; and reporting on a standardized form. The auditor report also must be addressed to the company’s board of directors and shareholders under the new standard.

Implementation Timeline

The standard applies to audits under the PCAOB but does not apply to (1) brokers and dealers who report under Exchange Act Rule 17a-5; (2) investment companies (other than business development companies) under the Investment Company Act of 1940; (3) employee stock purchase, savings, and similar plans and (4) emerging growth companies. If the SEC approves this standard, implementation will follow a lengthy, staggered timeline before full compliance is required. The non-CAM disclosures will be required for audits for fiscal years ending on or after December 15, 2017. A large accelerated filer will be required to include CAM provisions on any audits for fiscal years ending on or after June 30, 2019. For all other companies, CAM disclosures will be required in audit reports for fiscal years ending on or after December 15, 2020. Auditors will be permitted, however, to elect early compliance once the SEC approves the standard.

What This Means to You

The PCAOB adopted this new reporting standard in the face of opposition by audit committee members. Assuming it is approved by the SEC, it will be interesting to see if compliance planning procedures may develop to reduce reliance on metrics that could trigger CAM disclosures. Companies may also need to be prepared to share their philosophies regarding auditor rotation in light of the new auditor tenure disclosure. As with any new disclosure requirement, audit fees can be expected to increase, how much remains to be seen.