For over 40 years, the Securities and Exchange Commission (SEC) has required only a simple pass-fail statement in public companies’ audit reports. But the deadline for mandatory reporting of critical audit matters (CAMs) in audit reports is fast approaching. The revised model will provide insight to help investors and other stakeholders better understand a public company’s financial reporting practices — and help management reduce potential risks.
Under existing SEC standards, auditor communication of CAMs is permissible on a voluntary basis. However, disclosure of CAMs in audit reports will be required for audits of fiscal years ending on or after June 30, 2019, for large accelerated filers; and for fiscal years ending on or after December 15, 2020, for all other companies to which the requirement applies.
The new rule doesn’t apply to audits of emerging growth companies (EGCs), which are companies that have less than $1 billion in revenue and meet certain other requirements. This class of companies gets a host of regulatory breaks for five years after becoming public, under the Jumpstart Our Business Startups (JOBS) Act.
In 2017, the Public Company Accounting Oversight Board (PCAOB) published Release No. 2017-001, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion and Related Amendments to PCAOB Standards. The main provision of the rule requires auditors to describe CAMs in their audit reports. These are issues that:
- Have been communicated to the audit committee,
- Are related to accounts or disclosures that are material to the financial statements, and
- Involve especially challenging, subjective or complex judgments from the auditor.
By highlighting a CAM, an auditor is essentially saying that the matter requires closer attention. Examples might include complex valuations of indefinite-lived intangible assets, uncertain tax positions, goodwill impairment, and manual accounting processes that rely on spreadsheets, rather than automated accounting software.
In July 2018, the Center for Audit Quality issued a 12-page guide on implementing the revised model of the auditor’s report. The guide instructs auditors to select CAMs based on:
- The risks of material misstatement,
- The degree of auditor judgment for areas such as management estimates,
- Significant unusual transactions,
- The degree of subjectivity for a certain matter, and
- The evidence the auditor gathered during the review of the financial statements.
The guide doesn’t say how many CAMs are required in an audit report or provide a checklist of potential issues. Instead, CAMs will be determined on a case-by-case basis.
PCAOB Chairman James Doty has promised that CAMs will “breathe life into the audit report and give investors the information they’ve been asking for from auditors.” By identifying CAMs on the face of the audit report, auditors highlight challenging, subjective or complex matters that also may warrant closer attention from management.