Shedding Some Light on Critical Audit Matters

Auditors of large public companies began to include so-called “critical audit matters” (CAMs) in their audit reports in fiscal year 2019. The Public Company Accounting Oversight Board (PCAOB) had some initial observations about the effort that large audit firms have put into implementing the guidance for the first time.

Quick Rundown

Auditing Standard (AS) 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, represents a major change to the brief pass-fail auditor reports that have been in place for decades. Under the updated guidance, auditors are required to add a discussion of CAMs to the audit report. CAMs are essentially 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

Auditors must now identify each CAM, detail the reasons why it was selected and back up their assertions using relevant financial information. The PCAOB does not provide a list of possible CAMs and it doesn’t prescribe a specific number of CAMs that must be stated in an auditor’s report. In some audits, in fact, it’s possible that an auditor will determine that there are no CAMs to report.

Auditors of large accelerated filers — public companies with market values of $700 million or more — are required to report CAMs for fiscal years ending on or after June 30, 2019. Some audit teams, however, began describing CAMs as early as the second or third quarter of fiscal year 2019.

PCAOB Report

Lessons learned during the first year of implementing the updated guidance were highlighted in a recent PCAOB staff paper, “Critical Audit Matters: Spotlight.” The PCAOB said, “Consistent with the Board’s strategic goal of providing more useful and timely information, we believe that sharing our initial observations from the experiences of the first adopters of CAM requirements could help auditors, companies, audit committees, and other stakeholders.”

Most-frequently communicated CAMs include:

• Goodwill and other intangible assets
• Revenue recognition
• Taxes
• Business combinations

There were 189 auditor’s reports containing CAMs as of November 30, 2019. Based on this sample, the average number of CAMs reported per company was 1.7, and the range was one to four CAMs.

Proceed with Caution

A professional accounting fellow in the Securities and Exchange Commission’s Office of the Chief Accountant, Louis Collins, suggested that investors not read too much into the number of CAMs reported. A higher number of CAMs doesn’t necessarily equate with higher risk (or vice versa). He also warned not to draw firm conclusions by comparing CAMs of companies in an industry or over time.

“Within an industry, among peer companies, or even year-over-year for an individual company there may or may not be similar CAMs,” Collins said. “Ultimately, this will depend on the facts and circumstances of each individual audit and whether matters involved especially challenging, subjective, or complex auditor judgment related to accounts or disclosures that are material to the financial statements in the year under audit. It’s important to remember that CAMs are not intended to be inherently positive or negative, so quantitative comparisons involving the number of CAMs across companies may not be meaningful.”

Get a Head Start

When it comes to reporting CAMs in their audit report, smaller companies have a little extra breathing room: Audits of smaller public companies must follow the new rule for fiscal years ending on or after December 15, 2020.

Reporting CAMs for the first time takes significant effort to develop methodologies, tools and training. In the second or third quarter of 2020, smaller public companies should start working with their auditors to identify CAMs rather than waiting until year end. This proactive approach will help minimize surprises at year end. It’s also important to communicate with investors and other stakeholders about the purpose of reporting CAMs to avoid knee-jerk responses to the auditor’s report.

If you have any questions regarding critical audit matters or need more information regarding audit reports, contact a Weaver professional today.

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