In our recent post, Reasons for an Amended 10-K: 2018, we noted an increase in the number of 10-K/As that were filed citing an auditor’s report as the reason. One possible explanation is the implementation of PCAOB Auditing Standard 3101 (AS 3101): The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion. Adopted by the PCAOB on June 1, 2017, AS 3101 makes significant changes to the auditor’s opinion.
The initial round of changes went into effect for reports on fiscal years ending on or after December 15, 2017, and includes changes to formatting and layout, standardized language, and the addition of an auditor’s tenure disclosure.
For this expanded analysis, we looked at audit opinions filed in amended Annual Reports (Forms 10-K, 20-F, 40-F, N-CSR) for audits of fiscal years ended on or after December 15, 2017, that were conducted in accordance with PCAOB standards. Of the 285 amended opinions, 49, or approximately 17%, were refiled due to issues related to AS 3101 compliance. Of these, only eight explicitly referenced AS 3101 compliance as the reason for the refiled opinion in the explanatory note. One company filed an AS 3101 compliant opinion in response to a SEC comment letter.
Implementation of the standard could be hindered by the size of the company or its auditor. Perhaps unsurprisingly, 67% of audit opinions in amended Annual Reports were filed by non-accelerated filers or smaller reporting companies.
The table below breaks down specific areas of AS 3101 that prompted the refiled opinion. Over half were related to issues of formatting and layout and/or the new standardized language, such as the inclusion of section headers or the statement regarding independence. Around one-third of the refiled opinions replaced pre-AS 3101 opinions.
Possibly the most significant change brought by AS 3101 is the addition of a statement regarding auditor tenure, as discussed in an earlier blog. Nine opinions were refiled due to the tenure disclosure – six because the earlier opinion failed to include the disclosure at all and three to revise the substance of the disclosure due to issues calculating tenure.
This number piqued our curiosity about how many opinions did not include auditor tenure but were not refiled. There were 78 in total and just over half were not AS 3101 compliant at all. We would expect these opinions to be refiled at some point.
These cases make up only a fraction of the total number of opinions filed each year. The next round of implementation — the communication of Critical Audit Matters — is much more complex. The requirement has a phased roll out and takes effect for large accelerated filers for fiscal years ended on or after June 30, 2019 and on or after December 15, 2020 for all other required companies1. If smaller companies and firms struggled with mostly superficial changes, it stands to reason they will have similar difficulties with more complex requirements.
Interestingly, seven opinions from five different audit firms have already been filed with a Critical Audit Matters (CAMs) section, all from companies for whom the requirement does not go into effect until 2020. Of these, only one identifies one or more CAMs; four disclose that “there are no” critical audit matters. Additionally, two do not conform with AS 3101 requirements because they do not contain the correct standardized language.
These new reporting standards bring US disclosure requirements more in line with the rest of the world. Similar rules are already in effect, or are in the process of being implemented, in 124 countries. In Canada, the new reporting standards for the Auditing and Assurance Standards Board (AASB) take effect for audits of years ended December 31, 2018 with Key Audit Matter (KAM) reporting to follow in 2019.
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1. Communication of critical audit matters is not required for audits of (1) brokers and dealers reporting under Exchange Act Rule 17a-5; (2) investment companies registered under the Investment Company Act of 1940 (“Investment Company Act”), other than companies that have elected to be regulated as business development companies;12 (3) employee stock purchase, savings, and similar plans; and (4) emerging growth companies. ↩