Critical audit matters: Why you should care and what to ask now
The auditor’s report is changing significant-ly for the first time in decades. A new Public Company Accounting Oversight Board (PCAOB) requirement to disclose critical audit matters (CAMs) in the auditor’s report will have substantial ramifications for auditors and the companies they audit.
A CAM is defined as a matter that was communicated or required to be communicated to the audit committee, and that both relates to accounts or disclosures that are material to the financial statements and involves especially challenging, subjective, or complex auditor judgment. The communication of each CAM in the auditor’s report will include public disclosure of information that heretofore has never been publicly released:
- identification of the CAM;
- the principal considerations that led the auditor to determine that the matter was a CAM;
- a summary of how the CAM was addressed in the audit; and
- reference to the relevant financial statement accounts or disclosures.
The requirement to disclose CAMs applies to audits conducted under the PCAOB’s standards. However, communi-cation of CAMs is not required for audits of brokers and dealers; investment companies other than business development companies; employee stock purchase, savings, and similar plans; or emerging growth compa-nies. The disclosure of CAMs will be effective for audits of fiscal years ending on or after:
- June 30, 2019, for large accelerated filers; and
- Dec. 15, 2020, for all other companies to which the requirements apply.
Audit firms are still determining the im-pact of this new standard on their audit methodology, reporting guidelines, and communications with audit committees. However, it is clear that the determination and communication of CAMs will require more time on the part of the auditor, management, and the audit committee.
When determining whether a matter involved especially challenging, subjective, or complex auditor judgment, the auditor will take into account numerous factors that are unique to each engagement. The determination of CAMs to be disclosed in the auditor’s report will involve the exercise of seasoned professional judgment by the most senior professionals assigned to the engagement, and could involve others, including national office consultants. Additional time will be incurred by experienced audit professionals in drafting the description of the CAMs for inclusion in the auditor’s report, as well.
We believe auditors will engage with management and the audit committee throughout the process of determining and communicating CAMs. It will be important for management and the audit committee to determine whether the disclosures the auditor plans to make about the company are disclosed, as appropriate, elsewhere in the financial statements and management’s discussion and analysis (MD&A) in Form 10-K, and to deter-mine whether the company’s disclosures need revisions as a result of the CAM disclosures.
It is important to think through the ramifications of new CAM disclosures. What questions will investors have about CAMs? What might the audit committee do to anticipate investor questions regarding CAMs? In answering investor questions, it will be helpful to have a deep understanding of the CAMs and why they involved especially challenging, subjective, or complex auditor judgment.
CAMs could result in increased focus on the auditor’s report and management’s related disclosures in the financial statements and MD&A. How do the CAMs disclosed in the company’s auditor’s report compare with those disclosed in competitors’ reports? Does management plan to review the CAMs disclosed in the audit opinions on the financial statements of its competitors?
The audit committee should think about how the CAM requirements will affect the company’s audit process, and may need to be involved with the decision of whether the auditor should attempt a practice run of identifying, documenting, and communicating CAMs in advance of the effective date for the disclosures. A good game plan will help avoid surprises in the communication of CAMs. Ongoing dialogue among auditors, management, and audit committees will be critical for the effective implementation of the requirement to disclose CAMs in the auditor’s report.
This article originally appeared in the March/April 2019 issue of NACD Directorship magazine.