In what were surely unprepared remarks to the American Institute of CPAs conference on SEC and PCAOB developments, as reported by Bloomberg BNA, SEC Chair Jay “the Dude” Clayton commented on the impact he expects the new form of auditor’s report could have on his mood: “‘If it results in quality, I’ll be happy….And if it results in boilerplate, I’ll be really bummed out.’”
He was speaking of course about the new requirement in AS 3101 to include in the auditor’s report a discussion of “critical audit matters,” which will be required for audits of fiscal years ending on or after June 30, 2019 (for large accelerated filers) and December 15, 2020 (for all other companies to which the requirements apply). As discussed in this PubCo post, the new auditing standard for the auditor’s report will require auditors to include a discussion of CAMs, that is, “matters communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements; and (2) involved especially challenging, subjective, or complex auditor judgment.” Essentially, the concept is intended to capture those matters that kept the auditor up at night, so long as they meet the standard’s criteria. But Clayton is not alone is expressing concern that the new standard could ultimately end up just producing more boilerplate, as auditors (and companies) find comfort in conformity.
Commenters on the proposed new standard had indeed raised doubts regarding, among other things, the usefulness of the information in CAMs, in particular, that they would fall into overly standardized prose. The SEC acknowledged that, as with “Risk Factors,” standardization was a possibility, but contended that the narrower definition of CAMs and related disclosure requirements should mitigate that risk. Notably, an earlier PCAOB staff study of expanded auditor reporting in the UK did not find standardization, at least for the first year of implementation: “the descriptions of the risks of material misstatement in the auditor’s reports in the first year of implementation were not presented in standardized language, but included variations in content length, description, and presentation. The most frequently described risk topics related to revenue recognition, tax, and goodwill and intangible assets.”
Although the adopting release suggests that the process related to CAM disclosure will be an iterative one between the company and the auditors, the level of input the auditors will allow audit committees or managements in reviewing the auditors’ selection or disclosure remains an open question. In his remarks before the same conference, SEC Chief Accountant Wesley Bricker provides some advice as to what audit committee should expect from their auditors in that regard:
“expectations for timely, ongoing communication will continue to be an important element to the auditor-audit committee relationship as the auditors implement this new auditor reporting standard. In that regard, audit committees should have reasonable expectations that auditors prepare to take members through the application of the standard on their engagement. For example, what would the critical audit matters be this year? What would be the close calls? When could those matters have been raised, and which ones could have been identified at the start of the audit cycle? What does the auditor expect to say about those matters? When would we expect to see a draft report or at least a draft of the critical audit matters? These are illustrative examples of the communication planning and expectation setting that audit committee members may wish to consider as part of the transition period.”
He also observed that, particularly for the first phase of reporting CAMs by large accelerated filers, he expects the PCAOB to “conduct a timely and effective post-implementation review on the requirements of the new standard.” In addition, the SEC staff “will review carefully the results of the post-implementation procedures and work with the PCAOB as it considers whether additional changes to the requirements are needed, including to the implementation date for non-large accelerated filers.”
Some of the less challenging aspects of AS 3101 will be effective for audits of fiscal years ending on or after December 15, 2017. To assist in that regard, the PCAOB has posted new staff guidance regarding changes to the auditor’s report, which addresses recent changes “that are primarily intended to clarify the auditor’s role and responsibilities related to the audit of the financial statements, provide additional information about the auditor, and make the auditor’s report easier to read.” These changes include required disclosures related to the following:
- auditor tenure;
- a statement that the auditor is required to be independent;
- a requirement to address the report to the board and shareholders;
- standardization of the format, including location of the opinion in the first section of the report; and,
- in describing the auditor’s responsibility to obtain reasonable assurance about whether the financial statements are free of material misstatements, inclusion of the phrase “whether due to error or fraud.”
The new guidance provides a model of the new auditor’s report implementing these changes (other than CAMs), as well as further guidance on specific issues. For example, with regard to auditor tenure, the guidance provides that tenure “is calculated taking into account firm or company mergers, acquisitions, or changes in ownership structure. When a company acquires another company, if the acquirer’s current auditor continues serving as the combined company’s auditor, auditor tenure would continue. If the acquired company’s auditor is selected to serve as the combined company’s auditor, auditor tenure would begin at that time.” As many companies also disclose auditor tenure, companies may want to coordinate for consistency.