About the Panelists
Lisa Smith, managing director of quality and professional practice at Deloitte & Touche LLP; Megan Zietsman, CPA, the chief auditor and director of professional standards, Office of the Chief Auditor, PCAOB; and Jeff Mahoney, CPA, general counsel at the Council of Institutional Investors, were the panelists. Thomas Ray, CPA, professor at Baruch College, moderated the panel. The following is an edited and condensed summary of the panel discussion. The views expressed are the panelists’ own personal views and not necessarily those of their employers or those employers’ boards, management, or staff.
Ray opened the panel by sharing statistics from Audit Analytics on early reporting of critical audit matters (CAM). After noting that he had expected a larger number of CAMs, based on the United Kingdom’s implementation of its similar key audit matter (KAM) reporting requirement, he asked the panelists for their observations. Smith said that the numbers looked consistent with Deloitte’s dry runs. Zietsman agreed, adding that the number of CAMs reported observed by the PCAOB has ranged from one to four. “There’s been a lot of focus on what is the right number of CAMs,” Zietsman said, “and from the PCAOB’s perspective, the important thing is to take the requirements of the standard and apply those, and in different circumstances you’re going to come up with a different number.”
Mahoney spoke from an investor perspective, saying, “I don’t know if there’s something within the standards that would lead to more under the European CAMs than the U.S. CAMs, but generally I think investors would like to see more rather than less.” He also said that investors are likely to compare the number of critical accounting policies and estimates with the number of CAMs and ask about any discrepancies.
Ray then asked Zietsman to talk about the PCAOB’s guidance on CAMs. Zietsman began by outlining the board’s guidance efforts, highlighting its formation of an interdivisional working group to handle questions from auditors performing dry runs of the new audit reporting standard. “We then issued a number of staff guidance documents,” including a “high-level summary” of the requirements and a review of the preliminary methodologies being used by the 10 largest audit firms. Next came what Zietsman called “deep dives” into questions on how to determine and communicate CAMs, such as “What does it mean to have something that relates to an account balance that is material?” and “How do you think about things like control deficiencies?”
“Those documents were more technical in nature,” Zietsman continued, “but then we took a step back and said, we also have audit committees and investors asking questions.” This led the board to create targeted guidance for audit committees and investors, informing them of what to expect and how to best prepare for the implementation of CAMs.
The Auditor Perspective
Ray asked Smith for her views on how CAM implementation is going for practitioners. “There’s a lot of judgment involved,” Smith said. “I think our auditors get confused; when they hear auditor judgment, they think there has to be some form of management judgment for something to be a CAM. We’ve tried to debunk that. … Auditor judgment is just everything the auditor does to perform the audit.”
Smith continued by saying that the facts and circumstances of different audits could lead to something being identified as a CAM on one audit and not another. “We’ve tried to get people to think about what’s unique to their audit,” she said. “Why would you call something a CAM? I don’t think you can legislate auditor judgment, so no one is going to have a bright line.” She also urged audit teams to consider borderline cases as carefully as the obvious ones, saying, “Not all CAMs are created equal.”
Ray asked Smith whether Deloitte had identified any best practices so far. Smith replied that, aside from reading the board’s guidance, the best thing firms can do is have a partner-led process. Zietsman agreed, saying the inspections the PCAOB has completed so far have revealed that the dry runs have paid off for firms that have run them. “Where the teams start to think about the CAMs earlier in the engagement, and not just in terms of what are the CAMs but what the CAM communications might actually look like … that seems to have been helpful,” Zietsman said.
Zietsman did note that the PCAOB’s sample so far is small and mainly limited to larger firms. Nevertheless, she encouraged auditors to think about “all the different ways in which things can go wrong” and how to structure their processes to compensate for unexpected developments, such as the company changing an internal process mid-audit.
Smith then discussed enhancing management disclosures, saying, “Sometimes our teams will write something, and then we look at the disclosures and they don’t quite have all the information, and we don’t want to be the provider of original information. Starting early helps the client get prepared, look at their disclosures, determine whether or not they need any enhancements, and have a back-and-forth with the auditor.” Smith added that early development of management’s discussion and analysis (MD&A) helps audit teams get a head start on developing their end-of-year communications. “We’re not seeing a lot of pushback from the audit committee in terms of what we’ve identified or how we’ve described it. I think they read it to make sure they understand it,” she said, adding that her team consciously makes an effort to write the CAMs in a nontechnical, easily understood manner.
Zietsman said that the PCAOB’s out-reach to audit committees has returned similar results. “They didn’t think that CAMs had had any detrimental effect on their ability or the nature and extent of their interactions with the auditor,” she said, “but they did underscore that preparing well in advance and going through some kind of a dry run process was what made the actual implementation much more straightforward.” Zietsman also said that questions from committees had centered on the number of CAMs and comparisons between companies and across time. She reiterated that “there really isn’t an expectation that there should be a [specific] number. It should be based on an application of the standard.”
Mahoney said that the standard was expected to enhance communication between audit committees, auditors, and management, as well as prompt discussion about disclosures, and that this appears to be happening. “I’ve also been told by at least one audit committee member that the non–accounting/auditing experts on audit committees are finding this very educational,” he added.
Ray then asked about how the actual audits compared to the dry runs. Smith said that the handling of disclosures was different. “In the dry runs, the pressure was off, a lot of times the dry runs were completed after the 10-K was filed,” she said. ”When we went live, disclosures tended to change right up until the point of issuance, and I think that does create some time pressures. ”
Smith also said that staggering the effective dates for large accelerated filers and other filers “allowed us to take a smaller population, do the dry run for that population, roll it out, then do another dry run for those that are going to go live next year.” She then clarified that audit committees were involved with the dry runs. “Part of the last step in the dry run was to provide the audit committee with a draft of the CAMs. Some audit committees asked for more educational materials about the requirements of the new standards, so when we actually got to live implementation, they weren’t looking for a lot of education,” she said.
Ray also asked about how the process can be made more efficient, to which Smith said auditors could do a better job of articulating why a matter was a CAM. “I think sometimes when a team would talk about why they thought something was a CAM, and then you read what they wrote, there was a complete disconnect.”
Smith continued, “It doesn’t mean there’s something wrong with the audit. That just happens to be an area of the audit that the auditor found especially challenging or complex or subjective.”
Zietsman observed that early engagements and planning had been very beneficial to the process. Smith agreed, saying, “A year ago we heard comments like, ‘How do I make this CAM go away?’ from audit committee members … and the purpose is not to make it go away.” She continued, “It doesn’t mean there’s something wrong with the audit. That just happens to be an area of the audit that the auditor found especially challenging or complex or subjective. … So I think it was good to educate them on the fact that most audits, there’s going to be at least one CAM.” Zietsman concurred, saying, “CAMs are information about the auditing of the financial statements, and I think that’s quite an important point for people to focus on and understand.”
The Value of CAMs
Ray then asked Mahoney for a preliminary opinion on the value CAMs would provide to investors. Mahoney noted that it is still very early in the life cycle of CAM reporting, and the real value should be apparent in two to three years. “Any information that an analyst looks at, they typically look at that information over a period of time, and sometimes within an industry over a period of time,” he said. “But I’m optimistic that over time it will be useful.”
Mahoney also noted that the economic analysis for the standard indicated that CAMs would help lessen the information asymmetry between investors and companies, saying, “It helps them understand why the auditor thinks these qualify as CAMs. What did the auditor do? What types of procedures did the auditor perform to try to get comfort? To the extent that empirical evidence is valid, potentially we’ll see over time some benefits to the cost of capital.” Examples include risk evaluation and shareholder oversight. Of the latter, Mahoney said, “Based on our policies, which a number of our members look to, the CAMs will be something that members may look at in evaluating the audit committee and overseeing the audit committee.” This could in turn, he said, give shareholders more information on which to base their votes on ratification of the auditor and reelection of the audit committee. Mahoney also clarified that the Council of Institutional Investors has not yet conducted surveys on CAMs.
Zietsman also addressed the subject of value, saying that the PCAOB’s postimplementation review will take place some years from now. In the meantime, she said that the board will undertake “some initial monitoring of the implementation, which is outreach to investors, surveys, ongoing outreach to audit committees, ongoing talking to the firms, and looking at what our inspectors learn. ”
Asked about how the PCAOB’s inspectors will view CAM disclosures, Zietsman said that the inspectors are currently “thinking through their approach” for 2020, and that the initial round of inspections was more narrowly focused on understanding policies and procedures used by firms. “It had to start with, ‘Where are the audit committee communications, and of those, which were the ones that the firm decided were CAMs, and what was the process?’ When we embed that into the more broad inspection process, we’ll have, at least in focus areas, the benefit of having done a full-blown inspection of the actual audit work.”
Ray then asked Zietsman if she would change anything about the standard as issued, now that she has seen the implementation. While clarifying that she did not work on the standard herself, Zietsman said, “It’s the early days, so I’m not so sure that I can answer that. I think we’ll have to let the postimplementation review actually run its course.” Smith added that the PCAOB continues to issue guidance based on various questions it has received.
Mahoney noted paragraph 14C of the standard, which requires auditors to describe how an identified CAM was addressed in the audit. The standard gives four items auditors can describe: the response to what was most relevant to the matter, a brief overview of the procedures performed, an indication of the outcome of those procedures, and key observations about any of the three previous items. “I’ve seen some robust disclosures around item 1 and item 2,” he said, “but I have yet to see anything in response to item 3 or 4. And that’s a little disappointing to me, because I and many other investors were advocating information disclosures around items 3 and 4.”
Mahoney said, “The CAMs will be something that members may look at in evaluating the audit committee and overseeing the audit committee.”
After Ray opened the panel for questions, an audience member asked whether the panelists think CAMs should highlight the risk of negative results, such as impairments, as well as whether CAMs will increase with a downturn in a company’s economic or operating environment. Zietsman said that, in her view, CAMs are not intended to predict where future problems will arise. “A situation where the impairment analysis involves a close call, that may well be an area of the audit that was especially challenging, especially complex, and involve very subjective auditor judgment, so it may well be a CAM, but it wouldn’t be the CAM because it’s giving an early signal of an impairment to come.” As to the second question, Zietsman allowed that worsening economic conditions might put more pressure on the estimates used in financial statements, “so it is possible that you could see more CAMs.”
Smith agreed with Zietsman’s analysis, saying, “I don’t think a CAM is a future predictor. It’s based on how the auditor went through their risk assessment and what they did to audit the financial statements. And it might be something that’s there this year and not there next year, because maybe something changed, or maybe there’s more historical knowledge. Also a big accounting change could drive a CAM. So different things might impact the CAMs, year to year.”