The Public Company Accounting Oversight Board has approved a new proposal to expand the current pass-fail audit report in a way that would give investors more information about what auditors do and what they learn during the course of their work.
It is the board’s second try at a standard that would require auditors to identify and explain in the audit report “critical audit matters” that arose during the course of each audit. Concerns over of the first proposal, issued in 2013, centered on whether it would prompt auditors to disclose information that even management is not required to share with investors, and whether it gave auditors too broad of a definition of what they might need to explain.
The new proposal would define CAMs as any matter communicated or required to be communicated to the audit committee that both relates to accounts or disclosures that are material to the financial statements and involved “especially challenging, subjective, or complex auditor judgment,” according to the PCAOB. The standard would provide factors for auditors to consider to help them determine whether a matter should be identified as a CAM. The new definition compared with that in the earlier proposal would limit the potential number of CAMs that auditors would be required to disclosed.
In the audit report, the auditor would be required to identify the CAM, describe the reasons it was identified as a CAM, describe how it was addressed in the audit, and tie the CAM to financial statement accounts and disclosures. In addition to the CAM requirements, the new audit report would contain clarifications around existing auditor duties, especially with respect to independence and fraud. It also would require the audit firm to say how long it’s been the company’s auditor.
Investor feedback to the board’s 2013 proposal confirmed that the board would be wise to retain the current pass-fail model, where auditors do not grade a company’s financial statements but simply assert that they pass or fail in terms of fairly presenting the company’s financial status, said PCAOB Chairman James Doty. “But 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 opinion,” he said. “Not a recitation of the standard procedures that apply to any audit, but the specific judgments that were most critical to the auditor in arriving at the opinion.”
PCAOB member Steve Harris is eager to see the proposal adopted. “It is well past time that investors, the real clients of the auditor, who ultimately pay for the audit and depend upon its veracity, receive a report that meets their legitimate expectations and needs,” he said.
Injecting a measure of humor into the discussion of how audit reports could say more than they do today, PCAOB member Jay Hanson recited a poem credited to Ira McGladrey, founder of the audit firm where Hanson spent his career:
We have audited the balance sheet and here is our report:
The cash is overstated, the cashier being short.
The customers' receivables are very much past due.
If there are any good ones they are very, very few;
The inventories are out of date and practically junk,
And the method of their pricing is very largely bunk.
According to our figures the enterprise is wrecked.
But subject to these comments, the balance sheet's correct.