CRITICAL AUDIT MATTERS

As auditors prepare for a new auditing standard requiring the disclosure of critical audit matters (CAMs) in their reports, they are traveling in uncharted territory and contemplating new information that they will be providing to investors.

The new auditing standard AS 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, adopted by the PCAOB in 2017, is predicated on enhancing the relevance and usefulness of the auditor’s report. The first phase of implementation affects PCAOB audits of companies with fiscal years ending on or after Dec. 15, 2017, and includes disclosing auditor tenure and other changes to the form and content of the auditor’s report.

The second phase of implementation requires CAMs to be disclosed in the auditor’s report beginning with fiscal years ending on or after June 30, 2019, for audits of large accelerated filers, and for all other applicable companies for fiscal years ending on or after Dec. 15, 2020.

The phased implementation date gives audit firms time to develop processes around determining which items they will disclose as CAMs, which are matters that:

• Have been communicated to the audit committee;
• Are related to accounts or disclosures that are material to the financial statements; and
• Involved especially challenging, subjective, or complex auditor judgment.
At present, audit firms are developing processes to ensure all their engagement partners have a consistent method to identify CAMs.

OPPORTUNITIES AND CHALLENGES

AS 3101 requires auditors to identify a CAM, describe the principal considerations that led to its selection as such, describe how the CAM was addressed in the audit, and refer to the relevant financial statement accounts or disclosures in making these determinations. While CAMs may be matters that were traditionally discussed with audit committees, they were not discussed in an auditor’s report.

• Opportunities

o Provide Investors with more comprehensive Information for investment decisions
o Opportunity for auditors to provide more information value during the audit

• Challenges

o The PCAOB did not provide an all- inclusive list of what might constitute a CAM
It’s the auditor’s responsibility to make this determination
o How many CAMs an auditor must detail in the report

A CAM is any matter arising from the audit of the financial statements that is communicated or required to be communicated to the audit committee, that relates to accounts or disclosures material to the financial statements, and that involved especially challenging, subjective, or complex auditor judgment. There is no set number for CAMs for the auditor to communicate.

o Boilerplate language is another that will represent a challenge for auditors.
SEC Chairman Jay Clayton issued a warning of sorts when the new standard was issued. He said he would be disappointed if CAMs result in boilerplate communications that snuff out the potential for the new standard to deliver meaningful information to investors.

GETTING READY

Given these various challenges, the good news is that the phased effective dates give auditors, audit committees, and preparers time to get ready. While other mandatory features of the new auditing standard, such as disclosure of an auditor’s tenure, were phased in on Dec. 15, 2017, the communication of critical audit matters for large accelerated filers is not required until audits of fiscal years ending on or after June 30, 2019, and for all other companies for audits of fiscal years ending on or after Dec. 15, 2020.

In the meantime, engagement teams are endeavoring to consider all the matters that may be CAMs, to determine which ones will be disclosed as such in the auditor’s report. The firm’s internal implementation guidance and model workpapers are guiding engagement teams through the process of considering relevant items and documenting their conclusions as to whether or not each matter is, in fact, a CAM. The firm also expects to engage in frequent dialogues with the audit committee about what might constitute a CAM disclosure.