Communicating Critical Audit Matters: A Matter of Judgement

New rules for public company audit reports  require auditors to share more information in the audit for investors’ benefit. As auditors have begun adding critical audit matters (CAMs) to their reports, the Center for Audit Quality (CAQ) has found that they must exercise significant judgment and communicate effectively with management and audit committees.

When is an audit matter critical?

Public Company Accounting Oversight Board (PCAOB) 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, was published in 2017 to make the report more useful to investors. It begins taking effect this year for the largest companies.

The main provision of the rule requires auditors to describe CAMs, which are the most complicated issues that arose during the audit of the company’s financial statements. CAMs are defined as matters that:

  • Have been communicated to the audit committee
  • Are related to accounts or disclosures that are material to the financial statements
  • Require an auditor to make a subjective decision or use complex judgment

Although auditors may currently report CAMs on a voluntary basis, they must report them in audits of large accelerated filers for fiscal years ending on or after June 30, 2019. Large accelerated filers are public companies with market values of $700 million or more.

Audits of smaller public companies must follow the new rule for fiscal years ending on or after December 15, 2020. In both cases, auditors must identify each CAM, explain the reasons why it was determined to be critical, and back up their assertions using relevant financial information.

The PCAOB doesn’t provide a list of possible CAMs or prescribe a specific number of CAMs that must be stated in an auditor’s report. In fact, in some audits, it’s possible that an auditor will determine that there are no CAMs to report.

Identifying and reporting CAMs

The new PCAOB rule represents a major change to the brief pass-fail auditor’s report that was originally designed in the 1940s. To get a head start on revising their reports, auditors of some public companies have conducted test runs of the CAM requirement. These auditors have been practicing how to identify and draft CAMs, as well as how to engage with management and audit committees about CAMs, before the effective date.

In December 2018, the CAQ, an affiliate of the AICPA, published Critical Audit Matters: Lessons Learned, Questions to Consider, and an Illustrative Example. The CAQ report presents early lessons from auditors’ test runs. It also provides an example of a CAM (goodwill impairment) and a set of questions to help auditors understand the impact that CAMs will have on the audit process.

The CAQ says, “It can be difficult to strike the right balance between the CAM description in the auditor’s report and information in the company’s disclosures, to convey concisely the essence of why a matter is a CAM, and to describe how the CAM was addressed in the audit in a manner that is informative, but not overly technical.”

Among other things, the CAQ advises auditors to communicate with company management and audit committees “early and often” in the process of identifying CAMs. This communication can help management consider the need for modifications to the company’s disclosures in relation to areas likely to be CAMs.

Any modifications of a company’s disclosures should be based on management’s reporting requirements. Modifications also should be independent of the auditor’s identification of CAMs.

Prepare for investor questions

When these new reports begin to be released, investors and other stakeholders are likely to ask questions about CAMs. Companies should be ready to answer. First, management should discuss the CAMs with their auditor to fully understand why those matters involved especially challenging, subjective or complex auditor judgment. In addition, public companies should consider choosing a liaison who can communicate with outside stakeholders to ensure clear, consistent messaging.

If you have questions about the new audit report requirements for public companies, or any other aspect of the audit, Weaver can help. Please visit our website for more information or contact us to speak with an audit professional.

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