If auditors are required to begin explaining critical audit matters as proposed by regulators, the disclosures will shake credibility in those areas of financial statements and may even serve as disclaimers to insulate auditors, according to the latest academic research.
CAM disclosures by audit firms might even help auditors chip away at the “expectations gap” that has long dogged the profession. That’s the notion that investors generally expect the audit to provide a higher level of assurance about the soundness of financial statements than it actually does.
The research out of the University of Texas sought to predict the effect of the proposed new CAM requirement being contemplated by the Public Company Accounting Oversight Board. The PCAOB issued a revised proposal in May that would require auditors to describe in audit reports any issues on material accounts or disclosures that were especially challenging, subjective, or complex.
In addition to describing critical audit matters, or CAMs, auditors also would add new standardized language to every audit report indicating their duties to remain independent and to provide reasonable assurance that financial statements are free of material misstatements, whether due to error or fraud. Auditor reports would also say how long the firm has served as the company’s auditor.
The University of Texas study says the changes to the audit report could lead to more skepticism before any misstatement might occur, and reduced litigation risk for auditors. “CAM disclosures lead to less confidence in the CAM area before a misstatement is revealed and less assessed auditor responsibility after a misstatement is revealed in the CAM area,” the authors wrote.
While the PCAOB proposal says CAM disclosures are not intended to alter the auditor’s opinion on the financial statements as a whole, the disclosures will call attention to certain areas of financial statements, creating the potential for “piecemeal assurance,” the study says. That’s what would give rise to different levels of user confident across different areas.
The PCAOB modified its 2013 proposal to address concerns, among others, that it would put auditors in the position of making disclosures that should belong to management. The board narrowed its definition of critical audit matters to make it more operational and focus it on material information. The board accepted comments through August, but has provided no time line on when it will move toward a final standard.