The second session, “Critical Audit Matters” (CAM), addressed this recently implemented requirement, which represents the most significant change to audit reports in decades. The participants included George Botic, director, Division of Registration and Inspections, PCAOB; Jeff Mahoney, general counsel, Council of Institutional Investors; and Dennis McGowan, senior director, professional practice, Center for Audit Quality. The panel was moderated by Thomas Ray, professor, Baruch College.

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Introducing CAMs

Moderator Thomas Ray began by noting that the average number of CAMs reported by large companies was 1.7 per entity. The most popular subjects of CAMs were revenue recognition, business combinations, income taxes, “other assets,” and contingencies. Dennis McGowan related the results of Center for Audit Quality (CAQ) research into the CAMs reported by the Standard & Poors (S&P) 100: “I think it shows those areas where management is making especially challenging judgments and that the auditor is too.”

With regard to the value of CAMs, Jeff Mahoney said: “The information that many investors asked for during the development of the standard specifically referred to two items—both of which are permitted in the standard, but not required—disclosure by the auditor of the outcome of the audit procedure related to the CAM and disclosure of key observations with respect to the CAM. … We haven’t seen much of that yet, but I expect we will over time. And I think that will translate into investors finding these disclosures even more useful than they already do.”

“What we found is that auditors approach and organize their CAM communications in different ways,” Dennis McGowan added. “I think a theme we found was that you know if those areas that required a high degree of judgment by management, that led to a high degree of judgment by the auditor to assess management’s evaluations or conclusions related to that matter.”

“I think there’s a lot to celebrate in the new information that sits in the auditor’s report today that wasn’t there before,” McGowan continued. “I think what this shows us is that there is more information being communicated in the auditor’s report and providing more insights to investors about those procedures that were performed—and how an auditor got comfortable with those matters. I do think that this level of transparency does add to the total mix of information that’s out there and available to users. I think, over time, we’ll see if anything changes with the types of things being communicated in those CAMs.”

Fostering Dialogue

“If I think back to the standard setting process, I think there was some concern that CAMs could stifle dialogue with audit committees,” McGowan added. “And what we found is that, since the matters that have been determined to be CAMs have historically been areas that auditors were already communicating with the audit committee, there hasn’t been a dramatic change to those communications.”

“One of the concerns we had was that the prospect of CAMs would cause a chilling effect,” noted George Botic, providing the PCAOB’s perspective on the research it has done on CAMs so far. “And I’m happy to report that does not seem to be happening. In terms of the feedback from preparers, as well as the audit committee chairs, engagement team, or engagement partners, there really hasn’t been any negative impact.”

“I think,” Botic continued, “when investors or other users and stakeholders can reflect and look back on a trend, I think it’ll put things in a different perspective. When a CAM becomes a new CAM, I think that will have more meaning than in Year One. Not to minimize Year One, but I think over time we will see more of the longer-term benefits from CAMs.” Botic predicted that the benefits will include a better dialogue with management, greater insights for investors, and improved audit quality.

George Botic

“One of the concerns we had was that the prospect of CAMs would cause a chilling effect, and I’m happy to report that does not seem to be happening.”

Ray asked the panel whether CAMs will increase investor confidence in the financial reporting process. Mahoney replied that, “if it ends up being true that the academic research demonstrates that any increase in investor confidence should decrease the cost of capital, it could have huge benefits for all market participants, the capital markets, and the economy generally.”

“I think CAM disclosures are going to be more relevant over time as we have more of these disclosures out there, looked at by the data providers and passed along to the analyst,” Mahoney added. “There is some very interesting research that is already going on with respect to CAMs.”

McGowan noted that CAMs represent a significant change to the auditor’s report. “The profession came together to support this implementation,” he said. “I think that was the biggest challenge, getting everybody in the supply chain up to speed on this new form of report, getting teams up to speed on how to talk about CAMs, what terminology to use. There wasn’t much in auditors’ reports before.”

Analyzing Early Reports

Botic described CAMs as becoming “baked in” to the PCAOB inspection process. In terms of execution, he thinks it is succeeding: “I think that’s a testament to how early the firms started thinking about this and how collectively we were engaging with the chief auditor. Others within the PCAOB were also engaging with the dry run process and the pilots that happened first.”

“I certainly would encourage firms thinking about CAMs for the first time to think about them early in the audit process,” Botic said, looking ahead to next year. “I think it helps it be a smoother process.”

“We had some observations, some things that we noted in the review of CAMs,” he said. “The first was around CAM determinations. We’ve seen cases where a matter was communicated to the audit committee and it relates to a material account or disclosure. So it met the requirement for CAM determination, but we didn’t see it in the auditor’s report. And in some cases, firms have not engaged with the documentation.

“When we look at CAMs from an inspection perspective, as you might assume, in addition to reading the CAM we do have the ability, and we do go back to the underlying audit work. We make sure that there’s consistency between what the CAM says and what was actually done through an audit perspective. In some instances, there’s a disconnect between what’s in the CAM and the underlying audit work.”

Drafting CAMs

“As we get into 2021, we will be having dialogues with the triennially inspected firms,” Botic noted. “The first thing we typically want to understand is what tools, what methodologies, what other aids—either developed internally or through a service provider—is the firm using? And that’s Step One, because without at least some level of tools and guides, it’s a challenge to do this with any large base of issuers.”

“Once you’ve drafted a CAM, put it down, and then pick it back up again to make sure that it’s tailored to your audit—that a user could pick it up cold and read it and understand it,” he advised. “CAMs typically are tailored, at least to some extent, to the facts of the specific audit. That helps make them more user-friendly for investors or stakeholders.”

Dennis J. McGowan

Amplifying this point, McGowan said that “the CAM shouldn’t be boilerplate. Making sure teams have the right tools in order to apply the requirements in a consistent way is something that we hear firms talking about when they think about their methodology and practices they’re giving to their teams. They’re all thinking about this, and thinking about it earlier in the audit.” The panel also discussed the resources and guidance their respective organizations provide to users and the public.

“The CAM shouldn’t be boilerplate. Making sure teams have the right tools in order to apply the requirements in a consistent way is something that we hear firms talking about when they think about their methodology and practices they’re giving to their teams.”

Ray asked the panel about what to expect when a matter doesn’t quite qualify as a CAM. “It’s important to reinforce that the standard does say that as little as one sentence can be the documentation that’s needed for when something isn’t a CAM,” McGowan said. “As we think about the next wave, they’re smaller companies that may be more simplistic, so you could have more reports where there are no CAMs. I think it’s good to have this discussion about near-CAMs, because I would I would hate for CAMs to be forced because auditors feel like they need to have one or it’s going to be difficult to document why something wasn’t a CAM. … I think it is good to reinforce that it is allowed to have no CAMs.”

“We have heard questions around whether or not COVID itself could be a CAM,” McGowan said, “and we did put out a COVID-19–specific resource on auditor reporting. We do mention that we don’t think COVID-19, in and of itself, would be a CAM, but it certainly could be.”

“Here in Washington, there’s a growing interest in climate change risk disclosures from both the SEC and other parties,” Mahoney noted. “An IASB [International Accounting Standards Board] member put out a report on ways that climate risk can be discussed in accordance with existing accounting standards that has gotten a lot of traction in the investor community and elsewhere. The report gave examples, like impairment of long-lived assets, goodwill and intangibles, the valuation of financial instruments, and loss contingencies. These are all areas where climate risk–type disclosures can be incorporated into existing GAAP disclosures.”