The PCAOB has just published new guidance on auditors’ communication of critical audit matters in the auditor’s report. The guidance includes some new FAQs related to how auditors should describe their principal considerations in determining CAMs, how they should describe audit procedures and the outcome of audit procedures, as well as the relationship between CAMs and company disclosures and the treatment of recurring CAMs. While the FAQs are intended for auditors, they can provide some insight for company management into the process and the resulting auditor communications.
Under the new auditing standard for the auditor’s report (AS 3101), CAMs are defined as “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 the matters that kept the auditor up at night, so long as they meet the standard’s criteria.
For each CAM, the auditor is required to identify the CAM, describe the principal considerations that led to the determination that the matter was a CAM, describe how the CAM was addressed in the audit, and refer to the relevant financial statement accounts or disclosures that relate to the CAM. In describing how the auditor addressed the CAM, auditors are advised to provide a “useful” summary, not a detailed play-by-play, and may look to any or all of these four points: “(1) the auditor’s response or approach that was most relevant to the matter; (2) a brief overview of the audit procedures performed; (3) an indication of the outcome of the audit procedures; and (4) key observations with respect to the matter.” The PCAOB emphasizes that auditors may not include any disclaimer or qualifying language or “imply that the auditor is providing a separate opinion on the CAM or on the accounts or disclosures to which the CAM relates.”
The PCAOB also offers some CAM communication tips, including, be informative and specific and avoid boilerplate and overly technical language. If a matter is described as especially challenging or subjective, or involving complex auditor judgment, the auditor should explain why that is the case. If the CAM reads as “so generic that it could be applied to any audit of a company within that industry,” the auditor should consider revising it.
Compliance is required for audits of large accelerated filers for fiscal years ending on or after June 30, 2019, and for audits of all other companies to which the requirement apply (not EGCs) for fiscal years ending on or after December 15, 2020. In approving the new CAM rule, the SEC observed that the new requirement “will add to the total mix of information available to investors by eliciting more information about the audit itself— information that is uniquely within the perspective of the auditor, and thus, not otherwise available to investors and other financial statement users.”
Below are the PCAOB Staff FAQs and summarized responses:
- How should auditors describe the principal considerations that led them to determine a matter is a CAM?
The description of the principal considerations should be clear and concise, and include “the especially challenging, subjective or complex auditor judgments made in the context of the particular audit.” The description should help users understand what “stood out” to the auditor. For example, in the context of a CAM related to goodwill impairment, the PCAOB provides the following questions to be addressed in the auditor’s description of the principal considerations:
- “What type of valuation technique is used? Is the valuation technique especially complex and, if so, in what ways? What factors specific to the company and the audit contribute to the complexity?
- “Is the valuation based on assumptions that are especially subjective (e.g., revenue projections where there is a lack of operating history, new product lines, potential changes in the business environment, or other potential changes from prior periods)?
- “Are there underlying factors related to the reporting unit’s operations that contributed to the need for especially challenging, subjective, or complex auditor judgment in auditing the impairment analysis, such as prevailing or expected market conditions, changes in product demand, or new product regulations?
- “What was the nature and extent of specialized skill or knowledge needed in addressing the CAM? If using a specialist, what was the specialist’s area of expertise and for which aspects of auditing the impairment analysis was the specialist used?”
- If describing audit procedures as part of communicating how a CAM was addressed in the audit, what considerations apply?
The description of audit procedures should “be specific to the CAM and to the audit,” not general statements that might apply in any audit or “to most significant areas of the audit, such as ‘testing the operating effectiveness of the company’s controls’ in the case of an integrated audit.” Most useful would be descriptions of procedures that are tied to the considerations that led to the matter being identified as a CAM. For example:
- “If a matter was determined to be a CAM because of the degree of auditor judgment involved in evaluating significant assumptions made by management in developing a particular estimate, the description of how the matter was addressed may focus more directly on the procedures the auditor performed to evaluate those assumptions.
- “For a CAM related to an acquisition that required auditor judgment in relation to the valuation of assets acquired and liabilities assumed, if control testing is described, the description would focus on the testing of controls addressing the risks related to the valuation assertion (e.g., controls over the assumptions used to value acquired intangible assets or controls over the selection of a discount rate for a discounted cash flow analysis).
- “In situations where the use of a specialist was an aspect of how a CAM was addressed, the description could include information about the nature and extent of the specialist’s involvement in performing the audit procedures.”
- If describing the outcome of audit procedures or key observations with respect to a matter, what considerations apply?
Although the auditor may choose to include findings as an indication of the outcome of audit procedures or as key observations about a matter, the auditor should not use language that implies “that the auditor is providing a separate opinion on the CAM or on the accounts or disclosures to which it relates. For example, a CAM should not indicate that the auditor concluded that the financial statement accounts and/or disclosures related to the CAM are fairly presented in accordance with the applicable financial reporting framework.”
- How do CAM communications relate to company disclosures and other information the company has made publicly available?
While CAMs are about the company’s financial statements, the communication about the CAM reflects the auditor’s considerations. As a result, CAM communications will not be duplicative of company disclosures. Note also that, when communicating CAMs, the auditor is not expected to provide information about the company that the company has not made public, unless the information is necessary to describe why the auditor determined a matter was a CAM or how the CAM was addressed in the audit. “Publicly available” means any kind of public statement, including SEC filings and press releases, and is not limited to the financial statements.
- If a CAM is recurring, how should auditors apply the CAM communication requirements?
Even if a CAM recurs, it may be determined to be a CAM for different reasons or addressed in a different way than previously. In any event, the auditor would consider the specific facts and circumstances of the CAM for the current period and “tailor the communication of the CAM as necessary.”
- Is there a specific order in which CAMs should appear in the CAM section of the auditor’s report?
No. The auditor could organize them in any order, for example, based on relative importance or consistent with the order of presentation of the company’s financial statements.
- How do the CAM requirements apply to a dual-dated auditor’s report?
The “new information for which the auditor’s report is dual-dated may give rise to one or more additional CAMs or may necessitate modifications to previously communicated CAMs. For example, if an auditor’s report is dual-dated because of a subsequent event, the report would include, as applicable, any new CAMs or any modifications to previously issued CAMs arising from the impact of the subsequent event on the audit.”
Over the past year, some auditors have been working with audit committees at large accelerated filers to conduct CAM “dry runs” to get a better handle on how the new CAM disclosures will look and how the process will affect financial reporting. One consequence has been that audit committees are considering the impact of CAM disclosures on companies’ own disclosures. Why? Because, generally, audit committees much prefer that the company get a jump on the disclosure so that the auditors will not need to resort to the creation of original material and the company can best frame the discussion from its own perspective. Although the adopting release suggested that the process would be an iterative one between management and the auditors, time will tell whether, once the auditors have crafted a CAM disclosure, they might just be a bit reluctant to allow much input by audit committees or managements. To best position the company, a former Director of Corp Fin (cited in this article from Compliance Week) advised, audit committee members should be revisiting the company’s own disclosures now, as soon as they have an inkling of which CAMs the auditor plans to identify: the “best CAM disclosure…will be one that cross references a disclosure in the financial statements.” (See this PubCo post.)