Beginning in fiscal year 2019, public companies will start seeing expanded reports from their financial auditors. The Securities and Exchange Commission (SEC) and Public Company Accounting Oversight Board (PCAOB) are requiring these changes to audit reports for large accelerated filers in 2019, then for smaller publicly traded companies in fiscal 2020. Private companies are not subject to the new requirements, but some may nevertheless ask their auditors to follow PCAOB standards, in preparation for a future merger or public offering.
Although only the largest public filers will be required to have the new, expanded report in 2019, some companies are having their accounting firms conduct dry runs on previous years’ financial statements to ensure they can comply with the new-and-improved auditor’s report. By testing the standard before the effective date, both auditors and companies can understand what the audit report might look like with the new information.
No longer just pass/fail
Back in 2017, the PCAOB unanimously adopted a rule to expand auditor’s reports in SEC filings. The purpose of the new report is to provide investors with more useful information.
The current pass-fail model for an auditor’s report has been used since the 1940s. Although auditors know many details about a client’s financial condition, the current reporting model provides no opportunity for auditors to share insights with investors. In the aftermath of the 2008 financial crisis, some regulators and investors observed that external auditors said nothing in their reports about companies that were on the brink of failure.
Sharing critical matters
In response, the PCAOB now requires auditors to discuss critical audit matters (CAMs) that arose during an audit and to provide information about the company’s financial reporting practices. CAMs are defined as issues that:
- Have been communicated to the audit committee
- Are related to accounts or disclosures that are material to the financial statements
- Involved especially challenging, subjective or complex judgments from the auditor
Essentially, CAMs are the most difficult issues the audit team faced as they examined a company’s financial statements. They could include such issues as complex valuations of indefinite-lived intangible assets, uncertain tax positions, goodwill impairment and manual accounting processes that rely on spreadsheets, rather than automated tools.
More than just CAMs
Beyond these new disclosures, the new rule requires that audit reports include the phrase “whether due to error or fraud” in describing the auditor’s responsibility to ensure that the financial statements are accurate. An auditor’s report also will include a statement that the auditor must be independent.
The new auditor’s report will also take a standardized form, with the opinion appearing in the first section. The report will be addressed to the company’s shareholders and board of directors, and it will be organized with section titles.
Finally, the PCAOB now requires accounting firms to disclose how many years they have audited the company. Why? Some investors believe long-term relationships between an accounting firm and a company can lead auditors to identify too closely with the company, rather than the investors they’re supposed to represent. Some investors believe this creates a conflict of interest that undermines the reliability of the auditor’s work.
Other people argue that long-term relationships between an accounting firm and a company can make audit fieldwork more efficient and cost effective, as well as improving the auditor’s understanding of the company’s operations. The PCAOB already requires regular rotation of audit partners — though not firms — every five years.
Phasing in requirements
Under existing SEC standards, auditor communication of CAMs is voluntary. In the future, audit reports must disclose CAMs in audits of fiscal years ending on or after June 30, 2019, for large accelerated filers with market values of $700 million or more. For smallerpublic companies, CAMs must be disclosed for fiscal years ending on or after December 15, 2020.
The new rule doesn’t apply to audits of emerging growth companies, which 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 Act.
If you have questions about the new audit report requirements and how they might affect you, Weaver can help. Contact us to speak with one of our public-company audit professionals.
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