Are you, your audit committee, or your auditor unclear about critical audit matters and their inclusion in the new auditor’s report? On Tuesday, the Center for Audit Quality published a “key concepts and FAQs” document addressing compliance with critical audit matters reporting.
A critical audit matter, or 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.”
How does an auditor figure out whether a matter involves especially “challenging, subjective, or complex judgment?”
According to the CAQ paper, the auditor should take into account, alone or in combination, the following factors:
- The auditor’s assessment of the risks of material misstatement
- The degree of auditor judgment related to areas in the financial statements that involved the application of significant judgment or estimation by management, including estimates with significant measurement uncertainty
- The nature and timing of significant unusual transactions and the extent of audit effort and judgment related to these transactions
- The degree of auditor subjectivity in applying audit procedures to address the matter or in evaluating the results of those procedures
- The nature and extent of audit effort required to address the matter, including the extent of specialized skill or knowledge needed or the nature of consultations outside the engagement team regarding the matter
The CAQ provides a couple of examples. For instance, if the company has goodwill that is material to its financial statements, the auditor’s evaluation of the company’s goodwill impairment assessment could be a CAM, even if there is no impairment.
On the other hand, a potential loss contingency that was communicated to the audit committee, but that was then determined to be remote and not recorded in the financial statements, would not meet the definition of a CAM.
Under AS 3101, which goes into effect for accelerated filers for fiscal years ending on or after June 30, 2019, the auditor’s report has to identify the CAM; describe the main considerations that led the auditor to deem that the matter is a CAM; and describe how the audit addressed the CAM. The auditor’s report also has to refer to the relevant financial statement accounts or disclosures that relate to the CAM.
in the FAQ, the CAQ stresses that not all audit matters will rise to the level of a CAM. For example, not all significant risks will be a CAM. That’s because not every one involves challenging, subjective, or complex auditor judgment. As to the number of CAMs that are likely to appear in an auditor’s report, the CAQ says that will depend on the complexity of the issuer’s financial reporting. In most audits, the CAQ says, at least one matter will meet the standard.
As to the impact CAMs will have on the communications between the auditor and the auditor committee, according to the CAQ, the Public Company Accounting Oversight Board does not expect there to be a “chilling effect.”
As the CAQ’s publication points out, PCAOB auditing standards “already require a wide range of topics to be discussed and communicated with the audit committee,” therefore, “most matters that will be CAMs are already being discussed.”