Deloitte names, describes two CAMs at Microsoft

Deloitte says its work auditing the company’s recognition of revenue met the definition of a critical audit matter under a new auditing standard, as did its work auditing the company’s uncertain tax positions. Deloitte provides an explanation of why those areas were identified as critical areas of the audit and how it addressed them.

The Public Company Accounting Oversight Board rolled out a new model for the audit report in 2017, requiring auditors to make some new disclosures, many of which began appearing in financial statements in 2018. The PCAOB gave auditors some extra time to prepare for disclosures of critical audit matters, however, requiring firms to begin disclosing CAMs for large accelerated filers in mid-2019.

Critical audit matters are defined by the PCAOB to include those issues that arise in the audit related to material accounts or disclosures that were communicated to the audit committee, or should have been, and that involved especially challenging, subjective, or complex auditor judgments. Auditors are required to identify those issues in their audit reports, describe the issues and why they were critical, and explain how auditors addressed them.

At Microsoft, Deloitte says revenue recognition was a critical issue because the accounting is steeped in judgment, including determining whether products and services are considered distinct performance obligations, determining stand-alone selling prices for distinct performance obligations that are not typically sold separately, and estimating variable consideration related to factors like credits or incentives. Given the way technology companies often bundle products and services and deliver them over extended periods of time, companies face some inherent complexity under relatively new rules in Accounting Standards Codification Topic 606 to determine when and in what amounts to recognize revenue.

To address that from an audit standpoint, Deloitte says it tested the effectiveness of internal controls related to the identification of distinct performance obligations as well as the determination of the timing of revenue recognition and the estimation of variable consideration. The audit firm says it evaluated management’s significant accounting policies related to those customer agreements and selected a sample of customer agreements to scrutinize more carefully. The audit also involved evaluating the reasonableness of management’s estimates of stand-alone selling prices and testing mathematical accuracy.

With respect to uncertain tax positions, Deloitte says the company’s long-term income tax liability includes positions on transfer pricing that are unresolved with the Internal Revenue Service and issues that still need resolving could be material to the financial statements. “Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating management’s estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists,” Deloitte reported.

To audit through such uncertainty, Deloitte said it relied primarily on evaluating management’s estimates of uncertain tax positions related to transfer pricing issues. That included evaluating management’s methods and assumptions, documentation, accounting policies, judgments, consideration of new information available to management, and management’s estimates related to tax law and other regulations.

Leading up to the live reporting of CAMs, audit firms spent time doing dry runs with companies based on earlier period financial reporting to help them develop a process for identifying CAMs and drafting appropriate disclosures. The PCAOB reviewed some of those results to provide its feedback, advising firms to expand their view of what might be considered a CAM. The firms will report CAMs only for large accelerated filers until reporting for all public companies begins in 2021.