Despite objections from many audit committees, last year the PCAOB adopted a requirement for auditors of SEC-registered companies to include in their audit opinions discussion of critical audit matters (CAMs) – the most challenging or judgmental aspects of the audit. See PCAOB Adopts New Auditor’s Reporting Model, May-June 2017 Update. While this requirement will not begin to take effect until mid-2019, the International Auditing and Assurance Standards Board (IAASB) adopted a similar requirement in 2015, which is already effective in some countries. (The IAASB refers to the matters that must be disclosed under its standard as “key audit matters” or KAMs).
The Association of Chartered Certified Accountants (ACCA), a global accounting organization, recently released a study on the effects of KAM reporting. ACCA’s report, Key audit matters: unlocking the secrets of the audit, concludes that “the impact of KAMs was not limited to improving the quality of information for investors” but also improved auditor communications with those charged with governance, improved audit quality, and strengthened financial reporting.
ACCA reviewed 560 expanded audit reports under the IAASB standard in eleven countries (Brazil, Cyprus, Greece, Romania, Kenya, Nigeria, Oman, Romania, South Africa, the UAE, and Zimbabwe). ACCA found that, in addition to providing more information to investors, KAM reporting had three collateral benefits:
- Disclosure of KAMs stimulates better governance. “Publication of KAMs has provided new focus for discussions between the auditor and the audit committee. For the first time, there is transparency in the most important audit issues that were discussed between the audit engagement partner and the audit committee. As a result, feedback from audit committee members shows that disclosure of KAMs has resulted in improvements in corporate governance.”
- Disclosure of KAMs supports better audit quality. “The process of reporting outputs from the auditor’s reporting to the audit committee appears to have had a positive impact on audit quality.”
- Disclosure of KAMs encourages better corporate reporting. “[R]eporting by the auditor in relation to part of the financial statements has, in some cases, led companies to add to the disclosures in the financial statements made in previous years. In this way, KAMs have catalysed better financial reporting.”
The ACCA report also provides information concerning the frequency of KAMs and the audit areas that caused them. There were 1,321 KAMs reported in the 560 audit reports ACCA reviewed (roughly 2.4 KAMs per audit). Asset impairment was the most common KAM; this issue was cited in slightly over 25 percent of the disclosures. Revenue recognition was the second most common KAM area, followed by allowance for doubtful receivables, goodwill impairment, and taxation, including the valuation of deferred tax assets.
Comment: It is far from clear that the experience in the eleven emerging market countries ACCA studied is a good predictor of the likely impact of CAM reporting in the United States. Further, while some of the participants in the roundtable discussions ACCA describes in its report expressed reservations about the expanded auditor reporting requirement, the overall tone of the report is supportive of – almost to the point of advocacy for – auditor reporting concerning audit challenges. In any event, the ACCA study is a good reminder that CAM reporting in the U.S. is likely to be closely scrutinized by both proponents and opponents. Audit committees should be taking advantage of the phase-in period in the U.S. and should be working closely with their auditors to understand what the company’s CAMs will be, whether they can be mitigated before reporting begins, and how the auditor’s discussion of CAMs will compare to the company’s disclosures regarding the same issues. See SEC Approves New Auditor Reporting Model and Shifts the Discussion to Implementation, November-December 2017 Update.