On 23 October 2017, the Securities and Exchange Commission (“SEC” or “Commission”) approved the Public Company Accounting Oversight Board (PCAOB) auditing standard which makes significant form and content enhancements to certain public company audit reports to include additional information about the audit. These changes are intended to make the auditor’s report more informative. Certain changes are effective for auditor’s reports for audits of fiscal years ending on or after 15 December 2017. In addition, starting in 2019 for certain audits, auditors will be required to communicate critical audit matters (CAMs) in their reports.
SEC Chairman Jay Clayton noted “I strongly support the objective of the rule to provide investors with meaningful insights into the audit from the auditor. CAMs are designed to provide investors and other financial statement users with the auditor’s perspective on matters discussed with the audit committee that relate to material accounts or disclosures and involved especially challenging, subjective, or complex auditor judgment. Investors will benefit from understanding more about how auditors view these matters.” Clayton continued to say “I would be disappointed if the new audit reporting standard, which has the potential to provide investors with meaningful incremental information, instead resulted in frivolous litigation costs, defensive, lawyer-driven auditor communications, or antagonistic auditor-audit committee relationships – with Main Street investors ending up in a worse position than they were before. I therefore urge all involved in the implementation of the revised auditing standards, including the Commission and the PCAOB, to pay close attention to these issues going forward, including carefully reading the guidance provided in the approval order and the PCAOB’s adopting release.”
Key considerations – effective for audits of fiscal years ending on or after 15 December 2017
Several changes that are intended to clarify the auditor’s role and responsibilities related to a financial statement audit to include the following:
- Independence – explicitly state that the auditor is independent.
- Auditor tenure – disclose the auditor’s tenure.
- Addressee – address the auditor’s report to the company’s shareholders and board of directors or equivalents.
- Enhancements to basic elements – add 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.
- Standardized form of the auditor’s report – insert section titles within the auditor’s report and require the audit firm to disclose the opinion in the first section.
The new auditing standard retains the existing “pass/fail” opinion, meaning that an opinion will continue to conclude, based upon obtaining reasonable assurance, the financial statements either are or are not in accordance with the applicable accounting framework in all material respects.
Key considerations – looking forward
The most significant change to the auditor’s report relates to the addition of CAMs, which are effective (1) for audits of fiscal years ending on or after 30 June 2019 for large accelerated filers, and (2) for audits of fiscal years ending on or after 15 December 2020 for all other companies to which the requirements apply. The PCAOB defines a CAM as a matter that was communicated or required to be communicated to the audit committee and that relates to accounts or disclosures that are material to the financial statements and involved especially challenging, subjective, or complex auditor judgment. An auditor’s report will communicate any CAMs arising from the audit or state that the auditor determined that there are no critical audit matters. The audit report should describe the underlying considerations that led the auditor to determine that certain matters are CAMs, describe the procedures that were performed in relation to the CAMs, and reference the underlying financial statement line item and disclosures. Reporting of CAMs is not required for audits of brokers and dealers reporting under the Securities Exchange Act of 1934 Rule 17a-5, investment companies other than business development companies, employee stock purchase, saving, and similar plans, and emerging growth companies.
Contributing Author: Aaron Shmalo, Manager in Risk & Transaction Advisory