On October 23, 2017, the SEC approved a new PCAOB auditing standard (AS 3101) and related amendments that will require significant new disclosures of “critical accounting matters,” or CAMs, while still preserving the traditional pass-fail audit report that accompanies a public company’s financial statements. A CAM is defined as a matter 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) involve especially challenging, subjective, or complex auditor judgment.
In determining whether a matter involved especially challenging, subjective, or complex auditor judgment, the auditor must consider, alone or in combination, certain factors, including, but not limited to:
- the auditor’s assessment of the risks of material misstatement, including significant risks;
- 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.
Under AS 3101, audit reports must:
- identify the CAM (or state that there are no CAMs);
- describe the principal considerations that led the auditor to determine that the matter is a CAM;
- describe how the CAM was addressed in the audit; and
- refer to the relevant financial statement accounts or disclosures.
For each matter in the audit that was communicated or required to be communicated to the audit committee and relates to accounts or disclosures that are material to the financial statements, the auditor must document whether or not the matter was determined to be a CAM and the basis for that determination.
The new standard becomes effective for fiscal years ending after June 30, 2019 for large accelerated filers, and December 15, 2020 for all other covered companies. These changes do not apply to emerging growth companies.
In anticipation of the new CAM requirements companies should consider:
- discussing with their auditors their approach to the new standard, the types of matters they may consider as CAMs and the impact on the audit schedule
- the timing for determination of CAMs during the audit process and whether the auditor can provide prior notice and examples of CAM disclosures, particularly in light of potential liabilities
- the consistency of any CAM disclosures with the company’s other public reports and statements.
The new standard also includes certain other changes to audit reports intended to clarify the auditor’s responsibilities related to the audit and to make their reports easier to read, requiring that the opinion appear in the first section of the report and adding section titles. Additional disclosures include a statement of the auditor’s tenure, a statement regarding the requirement for the auditor to be independent and that the report is addressed to the company’s shareholders and the board (with additional addressees permitted). These changes are effective for audits of fiscal years ending on or after December 15, 2017, including for emerging growth companies.