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 on June 1, 2017, makes significant changes to the auditor’s opinion. Among the new requirements is the disclosure of critical audit matters (CAMs), which took effect for audits of large accelerated filers for fiscal years ending on or after June 30, 2019, and on or after December 15, 2020, for all other required companies.
As of the date of this post, Audit Analytics has collected 120 critical audit matters (CAMs) disclosed by auditors of 65 different companies since the implementation.
On average, there are 1.9 CAMs disclosed in each opinion, with the most frequent being related to goodwill and intangible assets, followed by revenue recognition. It will be interesting to reevaluate these trends once more companies file annual reports containing critical audit matters.
Although it may seem like the disclosure of critical audit matters are new to the auditing world, the story behind how they came to be is far from that.
According to the PCAOB, the idea began in 2010 when PCAOB staff reached out to investors, auditors, financial preparers, audit committees and representatives of academia to gain insight into possible changes that could be made to better the auditor’s reporting model.
As a result of this outreach, the PCAOB was able to gain a significant amount of insight; some of the key takeaways are listed at right.
Responses from the PCAOB’s outreach reinforced the fact that many investors were supportive of changes to the auditor’s report that would make audits more relevant to them and other users of financial statements.
Perhaps unsurprisingly, some auditors, audit committee members, and other preparers of financial statements expressed concerns regarding certain changes to the auditor’s report, indicating that an auditor’s discussion about matters related to the audit might be taken out of context. Most auditors, audit committee members, and other preparers indicated that management or the audit committee – rather than the auditor – should provide additional information about the company. Additionally, some preparers also voiced concerns about the possibility of blurred lines regarding the roles of the auditor, preparer, and audit committee as it relates to financial reporting if the auditor were to discuss the company’s financial statements.
Shortly following the initial outreach, the PCAOB issued a concept release seeking public comment on potential changes in June 2011 .
The Board is issuing this concept release to seek public comment on potential changes to the auditor’s reporting model based on concerns of investors and other financial statement users. Auditors, as a result of the performance of required audit procedures, often have significant information regarding a company’s financial statements and the audit of such financial statement, that is not today reported in the standard auditor’s report to the financial statements users. This information might be useful to investors and other financial statement users and could lead to more efficient markets and improved allocations of capital.
Alternatives presented in the concept release included the idea of an “Auditor’s Discussion and Analysis” section, a different view of financial statements than the “Management’s Discussion and Analysis”. The AD&A concept may have been the most expansive of the proposed alternatives, as it was intended to provide auditor commentary in narrative form on significant matters to the users of financial statements, including information about risks identified in the audit, audit procedures and results, and auditor independence. It was suggested that the AD&A could have included “a discussion of the auditor’s views regarding the company’s financial statements, such as management’s judgments and estimates, accounting policies and practices, and difficult or contentious issues”.
The PCAOB held a public meeting on September 15, 2011, with then- PCAOB Chairman James Doty stating, “we are in the middle of a long public comment process. I am confident today will not be the last public discussion of the concept release, but I encourage participants and members of the public who are interested in the project to follow up on today’s discussion with any additional analysis or evidence they have to inform and help shape this project.”
With a variety of feedback from multiple differing perspectives, the PCAOB had an abundance of input to consider when moving forward with developing a new standard.
The new auditing standard was proposed by the PCAOB in August 2013. Within this proposal were “critical audit matters”, which, according to the PCAOB, replaces the alternative of an “AD&A” section and instead proposes requirements for the auditor to communicate “critical audit matters” in their reports.
“The goal of these proposed standards and amendments is to significantly improve the current auditor reporting model by requiring the auditor to communicate specific information about each audit based on audit procedures performed. Communicating critical audit matters in the auditor’s report will make the report more informative, thereby, increasing its relevance and usefulness to investors and other financial statement users.”
– Martin F. Baumann, PCAOB Chief Auditor and Director of Professional Standards
This proposal was followed by a two-day public meeting, in which the first day was devoted almost entirely to critical audit matters.
In May 2016, the PCAOB released a reproposal stating, “the reproposal has been informed by comments received on the 2013 proposal, the Board’s April 2014 public meeting, analysis of economic considerations, academic research, and international developments. In particular, while the concept of critical audit matters has been carried forward from the 2013 proposal, the reproposed requirements have been narrowed in a number of respects.”
Just over a year later, the PCAOB released the final rule on June 1, 2017, which was proposed to the SEC on July 19, 2017 as AS 3101: The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion.
With significant changes to the auditor’s report, AS 3101 had a phased roll-out, with the initial changes – including formatting and layout, standardized language, and the addition of auditor tenure disclosure – taking effect for reports on fiscal years ending on or after December 15, 2017.
The next round of implementation – the communication of Critical Audit Matters – has a phased roll-out in itself, which took effect for large accelerated filers with fiscal years ending on or after June 30, 2019, and on or after December 15, 2020 for all other required companies.
For more information on Critical Audit Matters, please contact us.