PCAOB OKs First Big Change to Audit Report in 70 Years

A PCAOB recommendation would require auditors to report on issues that kept them up at night.
David KatzJune 1, 2017

Worrisome matters reported by an auditor to a board audit committee would be disclosed in the auditor’s report under a new standard approved Thursday morning by the Public Company Accounting Oversight Board.

Chairman James R Doty

Chairman James R Doty James R. Doty

Although the standard would retain the current pass/fail model of the auditor’s report on the financial statements of corporate clients, it represents what its chairman thinks are the first major changes in the report since the late 1940s.

“The new auditing standard before the Board today is the first significant change to the standard form auditor’s report in more than 70 years,” PCAOB Chairman James R. Doty said before a unanimous vote by the four current members of the five-member oversight board. “The new standard will breathe new life into a formulaic reporting model.”

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In particular, the standard would require auditors to include in the auditor’s report a discussion of the critical audit matters (CAMs) arising from the audit of the current period’s financials. A CAM is any matter communicated or required to be communicated to the audit committee and that both relates to material accounts or disclosures that are material to the financial statements and involves “especially challenging, subjective, or complex auditor judgment.”

PCAOB member Steven B. Harris said in prepared remarks that today’s action “is a direct response to calls from investors for the Board to expand the auditor’s report to include information about the difficult parts of the audit, and information that the auditor gained from the audit that he or she would like to know as an investor – basically what ‘kept the auditor awake at night.’”

CAMS will likely stem from “areas that have historically been of particular interest to investors, such as significant management estimates and judgments, significant unusual transactions, and other areas that pose high financial statement and audit risk,” Harris said.

The standard, which is subject to Securities and Exchange Commission approval, is expected to be approved by the SEC. The SEC puts out such recommendations for comment before approving or disapproving them, however.

Besides CAMs, the standard made changes aimed at clarifying the auditor’s role and audit responsibilities, providing more details about the auditor, and making the report easier to read:

  • Auditor tenure. The new auditor’s report would include a statement disclosing the year in which the auditor started serving consecutively as the company’s auditor.
  • Independence. It would include a statement that the auditor must be independent.
  • New language. Some standardized language in the auditor’s report would be changed, including addition of the phrase “whether due to error or fraud” in a description of the auditor’s responsibility under PCAOB to get “reasonable assurance about whether the financial statements are free of material misstatements.”
  • Standardizing the form. The auditor’s opinion would be required to appear in the first section of the auditor’s report. Section titles would be added “to guide the reader.”
  • Addressees. The auditor’s report would be addressed to the company’s shareholders and board of directors or equivalents (added addressees also would be allowed).

While the measure was unanimously approved, PCAOB members expressed some qualms about it. Harris, for instance, said he was bothered by the “element of subjectivity” in defining CAMs under the standard. “[A]llowing auditors to decide what matters involved ‘especially challenging, subjective or complex auditor judgment’ grants them too much discretion,” he said.

“I remain concerned about the difficulty of effectively inspecting against and enforcing compliance with such a subjective standard,” he added.

Board member Lewis H. Ferguson expressed a concern among PCAOB members that CAM statements “will quickly deteriorate into boilerplate disclosures that are repeated year after year and shortly provide no additional useful information to financial statement users.”

He predicted that there would be “an inevitable attempt, particularly on the part of large audit firms with many public company clients, to achieve some, and perhaps a very high degree of, uniformity in the disclosure of the CAMs.”

In framing the standard, though, the Board has tried to curb that risk by requiring that CAMs “be tied to the factual situation of the particular audit engagement in which they arise,” Ferguson said.

For her part, the PCAOB’s Jeanette M. Franzel is skeptical about requiring auditors to disclose the duration that they’ve been auditing a public company. She’s concerned that including that information in the auditor’s report may convey may suggest that there’s a “relationship between auditor tenure and audit quality and/or auditor independence, assumptions that may not be valid.”

Some board members traced the impetus for the standard to concerns that audits did not suggest the failing condition of a number of banks during the financial crisis. During the 2007-2008 crisis, “institutions such as AIG, Lehman Brothers, Bear Stearns, Citigroup, and Washington Mutual all received clean opinions from their auditors despite reports of their being on the verge of collapse,” said Harris. Had auditors communicated more information about their observations during their audits, investors might have had a clearer picture of the financial state of those companies, he suggested.

If the SEC approves the standard, the board would adopt a phased approach to the effective dates for the new requirements:

  • All provisions other than those related to critical audit matters would take effect for audits for fiscal years ending on or after December 15, 2017.
  • Provisions related to critical audit matters would take effect for audits for fiscal years ending on or after June 30, 2019, for large accelerated filers and for fiscal years ending on or after December 15, 2020, for all other companies to which the requirements apply.