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SEC seeks comment on PCAOB’s ‘critical audit matter’ rule

Tammy Whitehouse | July 31, 2017

Companies with any lingering worries about the impending effects of a new audit report have one last opportunity to appeal for change.

The Securities and Exchange Commission has posted for public review and comment the final rule adopted by the Public Company Accounting Oversight Board overhauling the standard audit report. The centerpiece of the new rule, which must be approved by the SEC before it can become effective, is a requirement for auditors to list and describe “critical audit matters” that arose during the course of the audit.

The new rule defines CAMs as:

  • any matter that was communicated or required to be communicated to the audit committee
  • relating to accounts or disclosures material to the financial statements, and
  • involving “especially challenging, subjective, or complex auditor judgment.” Auditors will be required to identify and describe such matters in each audit report for each publicly traded company they audit.

The new rule also requires auditors to disclose the year in which the auditor began serving consecutively as the company’s audit firm, to give investors a sense of the tenure of the audit firm. Finally, the PCAOB rule makes some additional tweaks to the audit report intended to clarify the auditor’s role, especially with respect to fraud, and to make the audit report easier to read.

The PCAOB spent several years developing the rule, first exploring the idea of requiring auditors to publish in the audit report an “auditor discussion and analysis,” much like the management discussion and analysis companies provide in financial statements. Peppered with criticism that the requirement would be too broad and burdensome, the board whittled it down to the CAM disclosure.

The auditor tenure disclosure represents an even more pared-down idea, which began with PCAOB Chairman James Doty’s pursuit of mandatory term limits for audit firms. Doty and a few board members championed the idea that auditors would be more diligent and skeptical if they knew their tenure was limited and their work would soon be scrutinized by a new successor firm.   That idea met heavy resistance, even from within the PCAOB, with two board members objecting that there was no evidence to support such an assumption.

The PCAOB says it does not expect the new standard to be burdensome. “The new standard does not impose new performance requirements on the auditor other than the determination, communication, and documentation of critical audit matters, which will be based on work the auditor has already performed and on matters already communicated to the audit committee," said PCAOB Chief Auditor Marty Baumann when the standard was issued. "Additionally, our research has shown that similar auditor reporting introduced in the United Kingdom has not significantly increased audit fees and has not resulted in increased time to issue the auditor’s report.”

Auditors and other audit experts, on the other hand, expect the standard to cause plenty of heartburn. Some say the standard will cause audits to take more time and cost more money. Some predict it will compel disclosures management otherwise wouldn’t have made, even for items that are immaterial, and it may chill communications between audit committees and auditors.