In May, the PCAOB issued a proposed standard, “The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion,” which, if adopted, would make significant changes to the standard auditor’s report intended to make it more relevant and informative for investors and other financial statement users. The 2016 proposal represents a modified reproposal of a similar standard issued in September 2013. Although other changes have been proposed, the most significant change would require the auditor’s report to include a discussion of critical audit matters (CAM) and to provide audit-specific information about particularly challenging, subjective, or complex aspects of the audit.
Critical Audit Matters
Under the 2016 proposal, a CAM is defined as a matter that was communicated, or required to be communicated, to the audit committee relating to accounts or disclosures considered material to the financial statements that involved especially challenging, subjective, or complex auditor judgment. This represents a narrowing of the proposed scope of the standard; under the 2013 proposal, matters that 1) posed the most difficulty to the auditor in obtaining sufficient appropriate evidence or 2) caused the most difficulty to the auditor in forming the opinion on the financial statements also qualified as CAMs.
Although it narrowed the definition of a CAM, the 2016 proposal added a requirement for the auditor to describe how each CAM was addressed in the audit. The auditor’s report would thus be required to 1) identify all CAMs, 2) describe the principal considerations that led the auditor to determine that each matter rose to the level of a CAM, 3) describe how each CAM was addressed in the audit, and 4) refer to the relevant financial statement accounts or disclosures. If no CAMs arose, the auditor’s report would have to include an affirmative statement to that effect.
Following the International Lead
Over the past few years, several international regulators and standards setters, including the International Auditing and Assurance Standards Board (IAASB) and the European Union (EU), have adopted requirements to expand the auditor reporting model. While those requirements differ in detail and terminology from those in the PCAOB’s 2016 proposal, their main themes are similar, including the requirement that the auditor’s report contain a discussion of CAMs. In September 2014, the IAASB adopted changes to the auditor’s report that included a new requirement to include a discussion of “key audit matters” (KAM) for audits of listed companies [International Standards on Auditing (ISA) 701, Communicating Key Audit Matters in the Independent Auditor’s Report]. KAMs are defined as matters communicated to those charged with governance that, in the auditor’s professional judgment, were of most significance in the audit. In April 2014, the EU adopted legislation creating a number of new requirements, including an expanded auditor reporting model, for audits of so-called public interest entities (PIE), which include listed companies, credit institutions, and insurance companies, among other entities. Under the EU reforms, the auditor’s report on a PIE is required to include a description of the most significant assessed risks of material misstatement, including those due to fraud, as well as a summary of the auditor’s response to those risks and key observations arising with respect to those risks.