On October 23, 2017, the SEC approved the PCAOB’s new auditing standard, available here, intended to make the auditor’s report more informative and provide investors with meaningful insights into the audit from the auditor’s perspective. The new standard requires the auditor’s report to disclose critical audit matters (“CAMs”) and the auditor’s tenure, and changes the format and presentation of the auditor’s report. In approving the new standard, the SEC’s order, available here, addresses the concerns raised by commenters in the rulemaking process. The new disclosure requirements and the concerns raised are summarized below.
New Disclosure Requirements in Auditor’s Reports
The new standard requires the auditor to communicate in the auditor’s report any CAMs arising from the audit or state that the auditor determined that there are no CAMs. CAM is defined as any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements; and (2) involved especially challenging, subjective, or complex auditor judgment. In determining whether a matter is a CAM, an auditor should consider certain factors, including: the risk of material misstatement; the degree of auditor judgment related to areas in the financials where management applied significant judgment or used estimates with significant measurement uncertainty; the nature and timing of unusual transactions and the extent of audit effort and judgment related to them; the degree of auditor subjectivity in applying audit procedures; the nature and extent of audit effort required to address a matter (including consulting others outside the engagement team); and the nature of the audit evidence regarding the matter. For each identified CAM, the auditor must describe the principal considerations that led the auditor to determine that the matter is a CAM, how it was addressed in the audit and refer to the relevant financial statement accounts or disclosures.
In addition to disclosing CAMs, the auditor’s report must include the auditor’s tenure and a statement regarding the requirement for the auditor to be independent. Other revisions to the auditor’s report include specifying the addressee parties (the shareholders of the company and its board of directors (or equivalents)), moving the auditor’s opinion to the beginning of the report, and changing certain standardized language.
The new disclosure requirements, with the exception of those paragraphs related to CAMs, become effective for all audits of fiscal years ending on or after December 15, 2017. As such, all calendar-year reporting companies will be required to include these disclosures in their upcoming 2017 Annual Reports on Form 10-K.
For paragraphs related to CAMs, the new disclosure requirements become effective for audits of fiscal years ending on or after: (1) June 30, 2019, for large accelerated filers; and (2) December 15, 2020, for all other reporting companies. Disclosure of CAMs is not required for audits of emerging growth companies.
In its order approving the new standard, the SEC stated that it believes that by limiting the source of CAMs to matters communicated or required to be communicated to the audit committee, adding a materiality component to the definition of a CAM, and narrowing the definition of a CAM to only those matters that involved especially challenging, subjective, or complex auditor judgment, the concerns of commenters about the usefulness of the information in CAMs should be alleviated. The SEC also noted that it did not believe the new requirement will result in the “chilling” of communications among the audit committee, management, and the auditors, as it would be highly unusual for a matter meeting the definition of a CAM to not be required to be communicated to the audit committee under auditing standards.
In addressing the concern that the new standard may, in some circumstances, require auditors to disclose information not previously disclosed by the issuer, the SEC noted that requiring communication of information about the audit, from the auditor’s perspective, should limit the extent to which original information would be provided by the auditor. The SEC also expressed its belief that if original information must be communicated in a CAM, the SEC’s anticipation is that the auditor, management, and the audit committee will engage in a dialogue about such communication. Although acknowledging the potential for increased litigation resulting from disclosure of CAMs, the SEC pointed out that the PCAOB emphasized its intent to monitor the rollout of the new standard for any unintended consequences that may require additional modifications and will complete a post-implementation review as soon as reasonably possible.
Companies should start, if they have not done so already, discussing with their auditors the impact of the new standard on the auditor’s audit process, including any additional time required to complete its audit. Companies may also choose to engage with their auditors to establish a process for auditors to bring any potential CAMs to the company’s attention as early as possible in their review.