Mandated Reporting of Critical Audit Matters
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The Securities and Exchange Commission (SEC) has issued a revised model for public companies’ audit reports. Previously a simple pass-fail statement was sufficient to meet the SEC requirements; but in the interest of investors and stakeholders understanding of a public company’s financial reporting practice, the reporting of critical audit matters (CAMs) is becoming mandatory.
Currently, auditor communication of CAMs is voluntary. This policy will change for fiscal years ending on or after June 30, 2019, for large accelerated filers; and for fiscal years ending on or after December 15, 2020, for all other companies. Disclosure of CAMs will become mandatory.
This new rule does not apply to emerging growth companies (EGCs), which are companies with less than $1 billion in revenue among other requirements. EGCs get several regulatory breaks for five years after becoming public, under the Jumpstart Our Business Startups (JOBS) Act.
The Public Company Accounting Oversight Board (PCAOB) published Release No. 2017-001, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion and Related Amendments to PCAOB Standards, in 2017. The main provision of the rule is the mandatory description of CAMs in audit reports. CAMs include issues that:
- Have been communicated to the audit committee
- Are related to accounts or disclosures that are material to the financial statements
- Involve especially challenging, subjective, or complex judgments from the auditor
By highlighting a CAM, an auditor is saying that it requires closer attention. Some examples are goodwill impairment, uncertain tax positions, complex valuations of indefinite-lived tangible assets, and manual accounting processes that rely on spreadsheets, rather than automated accounting software.
In July 2018, the Center for Audit Quality issued a 12-page guide on implementing the revised model of the auditor’s report. It does not include a checklist of potential issues, or a number of CAMs required on an audit report. Rather, it provides guidelines on determining CAMs on a case-by-case basis. The guide instructs auditors to select CAMs based on:
- The risks of material misstatement
- The degree of auditor judgment for areas such as management estimates
- Significant unusual transactions
- The degree of subjectivity for a certain matter
- The evidence the auditor gathered during the review of the financial statements
Identification of CAMs on the surface of audit reports allows auditors to highlight challenging, subjective, or complex matters to management. PCAOB Chairman James Doty has said that CAMs will “breathe life into the audit report and give investors the information they’ve been asking for from auditors.”
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