Delayed Revisions to the Audit Report

The Public Company Accounting Oversight Board (PCAOB) had planned to issue a revised proposal to change the auditor’s reporting model in the fourth quarter of 2015. Now it’s slated for release sometime in 2016. To the relief of many public companies — and the disappointment of many investors — the board may scale back the requirements to disclose the most difficult, subjective and complex auditing issues known as “critical audit matters” (CAMs). 

Background

The auditor’s report is the primary way an external auditor communicates to investors and other users of financial statements. For several years, the PCAOB has been trying to move beyond the pass-fail format of this report. 

In August 2013, it issued Release No. 2013-005, Proposed Auditing Standards on the Auditor’s Report and the Auditor’s Responsibilities Regarding Other Information and Related Amendments. Under the proposal, the auditor’s report would retain the pass-fail model. But it would also ask auditors to communicate what they determined to be the CAMs.

In many ways, the CAM requirements are similar to the Securities and Exchange Commission’s (SEC’s) requirements for the management’s discussion and analysis section of quarterly and annual reports. The introduction of this section has become a valuable resource for investors, and it has improved the relationship between management and investors at many companies. The PCAOB hopes an expanded auditor’s report will someday achieve similar results.

Controversial issue

However, the PCAOB’s proposal is unpopular among external auditors, audit committee members and company management, who worry that any changes could result in confusion and blur the lines regarding the roles of auditors, financial statement preparers and audit committees. Critics also worry that the proposed changes would cause auditors to reveal matters the company hasn’t disclosed, which is not the job of auditors but of management. They believe that such a fundamental shift in regulatory reporting could result in negative consequences.

For example, disclosures could include confidential or privileged information, material that would be harmful or detrimental to the company’s operations, and information the SEC’s reporting requirements don’t address. The disclosures could also result in perceived weaknesses in the auditing process, management’s abilities or the effectiveness of the company’s internal control environment.

Re-proposal in progress

Earlier this summer, the PCAOB announced plans to issue a revised proposal before the end of the year. In a September meeting of the Investor Advisory Group, however, PCAOB Chairman James Doty revealed that the project has been delayed until 2016 to allow the board to focus on other projects, including the identification of the lead partner in an audit, updates to the going concern guidance, supervision of other auditors and accounting estimates. The PCAOB has been deliberately taking its time to garner sufficient support for the requirements.

The revised audit report requirements will likely be narrower and more focused than the version that was released in August 2013. PCAOB Chief Auditor Martin Baumann said the revised proposal is likely to define a CAM as an issue arising from the audit of the financial statements that was communicated (or required to be communicated) to a client’s audit committee. The information would have to be considered useful or “material” to investors.

Stay tuned

Investors consider the move beyond the traditional pass-fail format of the audit report to be one of the most important and useful changes the PCAOB can implement. But it’s important for the board to weigh the immediate benefits to investors against the potential negative effects that a more robust audit report could cause public companies over the long run. After all, if the changes inadvertently leak confidential information or trade secrets to competitors, investors could be hit with lower stock prices.  

© 2015