The Public Company Accounting Oversight Board has approved a final rule making significant changes to the required language and disclosures in the standard report filed by auditors.
The longstanding auditor’s reporting model, criticized by certain investor groups and others as being overly “boilerplate” and lacking information useful to investors, will retain the age-old “pass-fail” model (i.e., a “clean” or unqualified audit opinion, vs. a qualified opinion). However, new language will be added or modified.
New requirement to discuss critical audit matters
The most striking change to the auditor’s report will be the addition of critical audit matters, or CAMs. These include a narrative discussion of matters that were communicated to the audit committee relating to accounts or disclosures material to the financial statements, which involved challenging, subjective, or complex auditor judgment.
According to the PCAOB, “(w)hen determining whether a matter involved especially challenging, subjective, or complex auditor judgment, the auditor takes into account certain factors, including the auditor’s assessment of the risks of material misstatement.”
Required disclosures for each CAM include the following:
- Identify the CAM.
- Describe the principal considerations that led the auditor to determine the matter was a CAM.
- Describe how the CAM was addressed in the audit.
- Reference the relevant financial statement accounts or disclosures.
The PCAOB agreed to provide an extended effective date for the provisions relating to CAMs.
Other changes to the auditor’s report include:
- Auditor tenure: Include a statement disclosing the year the auditor began serving consecutively as the company’s auditor.
- Independence: Include a statement that the auditor is required to be independent.
- Error or fraud: Include the phrase “whether due to error or fraud” when describing the auditor’s responsibility under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatements.
Opinion statement given more emphasis
The PCAOB is making the auditor’s opinion on the financial statements more prominent by requiring it to appear in the first section of the auditor’s report. Certain section titles will also be required to assist the reader in understanding the report.
Another facet of the focus on investors is that the auditor’s report must now be addressed to the company’s shareholders and the board of directors or equivalents, not just one or the other. This requirement appears aimed at emphasizing that the auditor’s duty extends to all shareholders, not just the board, and that at the same time the board has certain oversight responsibilities.
The report may also be addressed to additional parties, says the PCAOB.
The final standard applies to audits under PCAOB standards. However, the PCAOB has scoped out the requirement for communication of CAMs from the following audits: audits of brokers and dealers, investment companies other than business development companies, employee stock purchase, savings and similar plans, and emerging growth companies.
Commitment to review implementation
The PCAOB states, “The Board intends to monitor the results of implementation, including consideration of any unintended consequences.”
Presumably, necessary tweaks, if any, may come in the form of staff guidance or amendments to the rule after the PCAOB studies implementation and receives feedback from stakeholders, including its Standing Advisory Group. Like other standard-setters, the PCAOB has also established a formal post-implementation review process.
Canada’s KAMs, and other international convergence
In requiring a discussion of critical audit matters, the new standard moves closer to certain international requirements, including those of the International Auditing and Assurance Standards Board. (See Determining and Communicating Key Audit Matters, published by the International Federation of Accountants.)
In the days leading up the PCAOB vote, Globe and Mail columnist David Milstead urged the U.S. to catch up with international auditing standard-setters by establishing a CAM / KAM (or key audit matters) requirement. In Audit Changes are Good News, But the U.S. is Holding Canada Back, Milstead quotes Eric Turner, a principal of the Chartered Professional Accountants of Canada: “Because Canada is such a key player in the U.S. market – we have 300 companies listed in both Canada and the U.S. – they’re going to be put in a difficult spot if there’s a huge divergence in the two models.”
The May 2017 “Message from the Chair” of Canada’s Auditing and Assurance Standards Board addressed this issue as well, which appears to have now been resolved given the PCAOB’s action and pending action by the SEC.
Pending the SEC’s approval, the effective date of the standard is as follows:
- All provisions other than those related to critical audit matters will take effect for audits for fiscal years ending on or after Dec. 15, 2017.
- Provisions related to critical audit matters will take effect for audits for fiscal years ending on or after June 30, 2019 for large accelerated filers, and for fiscal years ending on or after Dec. 15, 2020 for all other companies to which the requirements apply.
Auditors may apply the standard earlier than the above-described effective dates, pending the SEC’s approval and consideration. Read more in the PCAOB’s press release.