The Public Company Accounting Oversight Board is taking another stab at overhauling the auditor’s reporting model.
The PCAOB first proposed changes in audit reports in 2013 and heard extensive feedback on the proposals. On Wednesday the board reproposed the standard, offering ways to enhance the auditor's report to make it more informative for investors by requiring auditors to provide information on critical audit matters. The PCAOB is again asking for public comments on the latest proposal.
“In today’s complex economy, and particularly in light of lessons learned after the financial crisis, investors want a better understanding of the judgments that go into an audit opinion,” said PCAOB Chairman James R. Doty in a statement. “This proposal delivers on the intention of Congress to further the public interest in the preparation of more informative audit reports for public investors.”
The PCAOB is reproposing the auditor reporting standard, "The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion," along with related amendments to certain other PCAOB standards.
The revised proposal would retain the pass/fail model in the existing auditor's report, but would provide additional information in the report, such as the communication of critical audit matters arising from the audit and new elements related to auditor independence and auditor tenure.
The PCAOB received a great many comments in response to its original August 2013 proposal on the auditor's reporting model, with some saying the changes went too far and others saying they didn’t go far enough. After analyzing the comments and conducting additional outreach, the concept of critical audit matters has been carried forward from the 2013 proposal although the reproposed requirements have been refined in several respects.
Critical Audit Matters
Those include limiting the source of potential critical audit matters to matters communicated or required to be communicated to the audit committee; adding a materiality component to the definition of a critical audit matter; narrowing the definition to only those matters that involved especially challenging, subjective or complex auditor judgment; revising the related documentation requirement; and expanding the communication requirement to require the auditor to describe how the critical audit matter was addressed in the audit.
“I believe today’s proposal benefits from experience and appropriately addresses comments received,” said Doty. “Most important, the proposal provides a refined description of what would be included as ‘critical audit matters’ as well as a list of six factors the auditor should take into account in determining the CAMs to include. As with the original proposal, the new proposal envisions that auditors describe their critical audit judgments. It does not put them in the position of speaking for management. But by focusing on auditor judgments, it does deliver on the Congress’s intention, expressed in Section 101(a) of the Sarbanes-Oxley Act, to further the public interest in the preparation of more informative audit reports for public investors.”
The latest proposal takes a step back in some ways from the 2013 proposal.
“Many commenters supported the concept of critical audit matters but believed that the 2013 proposal was too broad, because the potential sources of CAMs was unnecessarily broad,” said PCAOB board member Jay Hanson. “Second, there was concern that the definition of CAMs was also too broad and could require disclosure of immaterial information that would not be useful to investors, or, in some cases, information that explicitly does not have to be disclosed by issuers under applicable laws and regulations. Many auditors who commented believed that the documentation requirement also was too burdensome – requiring not just documentation of matters determined to be CAMs but also matters that might be CAMs but later were determined not to be. And while investors were largely supportive of the proposal, some believed the proposal did not go far enough in mandating that auditors share their expert opinions of risks in, for example, the company's accounting, financial reporting or operations.”
Under the reproprosal, critical audit matters would require communication in the auditor's report of any critical audit matters arising from the audit of the current period's financial statements. The definition of a critical audit matter would be any 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.
The auditor would take into account a list of factors in determining whether a matter involved especially challenging, subjective, or complex auditor judgment, such as the auditor's assessment of the risks of material misstatement, including significant risks.
The auditor would identify the critical audit matter, describe the principal considerations that led the auditor to determine that the matter is a critical audit matter, describe how it was addressed in the audit, and refer to the relevant financial statement accounts and disclosures. If there are no critical audit matters, the auditor would state that in the auditor's report.
The auditor would document the basis for its determination of whether each matter that both: (1) was communicated or required to be communicated to the audit committee; and (2) relates to accounts or disclosures that are material to the financial statements, involved especially challenging, subjective, or complex auditor judgment.
The revised proposal would generally apply to audits conducted under PCAOB standards. Unlike the 2013 proposal, however, the requirements regarding critical audit matters would not apply to audits of brokers and dealers reporting under the Securities Exchange Act of 1934 Rule 17a-5; investment companies other than business development companies; and employee stock purchase, savings, and similar plans.
“The refinements to the 2013 proposal presented today address feedback we received, including many of the concerns we heard, while still providing important additional information to investors," said PCAOB Chief Auditor and Director of Professional Standards Martin F. Baumann.
The auditor would also add certain standardized language in the auditor's report, including adding a statement about the requirement for the auditor to be independent; and the phrase "whether due to error or fraud," when describing the auditor's responsibilities under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatements.
In addition, the auditor would add a statement in the auditor’s report about how long it has been the auditor for the company. The standardized form of the auditor's report would require the opinion be the first section of the auditor's report and require section titles to guide the reader.
Back to 2010 and 2013
The project to enhance the auditor's reporting model began in 2010 with PCAOB staff outreach to different stakeholders, including investors, financial statement preparers, and auditors. In June 2011, the PCAOB issued a concept release to seek public comment on potential changes to the auditor's reporting model. The PCAOB also held a public roundtable shortly after issuing the concept release.
“With today’s action, the board is taking another step forward in addressing questions about the relevance and usefulness of the standard auditor’s report,” said PCAOB board member Jeanette Franzel. “This action helps to address the usefulness of the auditor’s report; it deals with one of the many elements contributing to the long-standing and multifaceted expectations gap between what investors and other financial statement users expect of independent auditors and what auditors deliver.”
In August 2013, the PCAOB proposed the auditor reporting standard along with another new auditing standard regarding the auditor's responsibilities for other information outside the financial statements. The board received nearly 250 comment letters on the initial proposal and at a two-day public meeting in April 2014 as well as at PCAOB Investor Advisory Group and Standing Advisory Group meetings.
“I support the reproposed standard because I believe it is important to modernize the auditor's report to expand the information it contains to make it more useful and relevant to investors by narrowing the information gap between investors and auditors that in recent years has steadily been increasing,” said PCAOB board member Lewis Ferguson. “Auditors possess more information about the companies they audit than anyone except company management itself. The traditional pass/fail format of the auditor's report, while useful, gives almost no clue to either the auditor's work on the audit or the extent of the auditor's knowledge about its client's business.”
The idea is to get away from boilerplate language in audit reports.
“The current audit report features boilerplate language—decades old—that largely remains the same regardless of the risks a particular company might be dealing with or the unique problems that auditors encountered in performing the audit,” said PCAOB board member Steven Harris. “Time and again, investors have asked for auditors to provide more information about the difficult parts of the audit, information that the auditor gained from the audit that he or she would like to know as an investor, and, most importantly, those items in the audit that kept the auditor awake at night.”
More on the history of the project, including all documents, can be found in Rulemaking Docket 034. The PCAOB said it is not reproposing the other information auditing standard at this time.
Comments on the proposed standards and related amendments are due by Aug. 15, 2016. A fact sheet on the proposal is also available.
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