On October 23, 2017, the SEC approved the PCAOB’s new audit standard and related amendments to other auditing standards that will require audit firms to provide new information about the audit, including disclosure regarding critical audit matters ("CAMs"), auditor tenure and other information intended to clarify the auditor’s role and responsibilities. The new standard will have a significant impact on companies, auditors and audit committees. Early engagement is recommended to comply with the new standard, portions of which will affect calendar-year companies for year-end audits of 2017.
The new standard, AS 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, is the culmination of a PCAOB project to enhance the usefulness of the audit report that began in 2010. In approving the standard earlier this week, the SEC balanced the benefits of more specific information about the auditor’s opinion against concerns that the disclosure of CAMs may result in increased litigation and chill dialogue between auditors and audit committees. Mindful of these concerns, the PCAOB intends to use its planned phased implementation of required CAMs communication to monitor any unintended consequences of the new standard.
Critical Audit Matters
The most significant change to the auditor’s report imposed by the new standard requires auditors to identify CAMs arising from the current period’s audit or state that the auditor determined that there are no CAMs. A CAM is any matter that was communicated or required to be communicated to the audit committee and that:
- relates to accounts or disclosures that are material to the financial statements; and
- involves "especially challenging, subjective, or complex auditor judgment."
To determine whether a matter involves especially challenging, subjective or complex auditor judgment, AS 3101 provides factors to be considered along with those specific to the audit:
- the auditor’s assessment of the risks of material misstatement;
- 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 the 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 consultations outside the engagement team regarding the matter; and
- the nature of audit evidence obtained regarding the matter.
The audit report must identify each CAM, describe the principal considerations that led the auditor to designate the matter as a CAM and how the CAM was addressed in the audit and the relevant financial statement accounts or disclosures the CAM impacts.
Other Changes to the Auditor’s Report
The new standard requires other changes to the auditor’s report, many of which provide additional information about the auditor or are intended to make the report easier to read:
- auditor tenure – a statement disclosing the year in which the auditor began serving consecutively as the company’s auditor;
- independence – a statement regarding the requirement for the auditor to be independent;
- addressee – the auditor’s report will be addressed to the company’s shareholders and board of directors or equivalents (additional addressees are also permitted);
- amendments to basic elements – certain standardized language in the auditor’s report has been changed, including adding 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 misstatement; and
- standardized form of the auditor’s report – the opinion will appear in the first section of the auditor’s report, and section titles have been added to guide the reader.
The new standard, except for the portions related to CAMs, will be effective for all audits of fiscal years ending on or after December 15, 2017. The new rule will therefore apply to the 2017 year-end audits of calendar-year companies. The portions of the new rule related to CAMs will be effective for audits of fiscal years ending on or after June 30, 2019 for large accelerated filers and for audits of fiscal years ending on or after December 15, 2020 for all other companies to which the requirements apply. Among other exceptions, the communication of CAMs in the auditor’s report is not required for audits of emerging growth companies.
Companies and audit committees should discuss the new standard with their auditors to understand any changes in the timing or substance of the audit process necessary for implementation. Early dialogue regarding CAMs, include notice timelines and sample disclosure, will provide companies and audit committees time to consider their own disclosure of these matters prior to the effectiveness of the standard.