Audit Committees: The Proposed Disclosure of Critical Audit Matters

In August 2013, the Public Company Accounting Oversight Board (“PCAOB” or the “Board”) issued a proposed audit standard which, among other items, would require auditors of public companies to report “critical audit matters” in their audit opinion letters. The nature of the critical audit matters is described further below, but in summary they would include items which may be sensitive and problematic for the company. This requirement would raise many concerns for audit committees. Although the final standard has not been adopted, audit committees should begin considering their response to this expanded disclosure.

The Proposed Standard

The PCAOB issued the proposed standard, “The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion,” (the “Proposed Standard”), on August 13, 2013. The Proposed Standard followed a concept release on reporting which the PCAOB issued in June 2011, and which was followed by an extensive comment process. The Chair of the Board and several other board members have expressed the view that the audit reporting model should be expanded to provide more meaningful information to investors.

The Proposed Standard includes several changes to the form of the audit report for SEC- reporting companies. The Proposed Standard retains the pass/fail model and the basic elements of the current auditor’s report, but would require the auditor to communicate a wider range of information specific to the particular audit. This expanded information includes:

  • Communication of critical audit matters that would be specific to each audit.
  • Addition of new elements to the auditor’s report related to

    • Auditor independence;
    • Auditor tenure;
    • Auditor’s responsibility regarding other information that is included in documents containing the audited financial statements and the related auditor’s report.
  • Enhancements to existing language in the auditor’s report related to the auditor’s responsibility for fraud and notes to the financial statements.

The description of critical audit matters in the auditor’s report would:

  • Identify the critical audit matter;
  • Describe the considerations that led the auditor to determine that the matter is a critical audit matter; and
  • Refer to the relevant financial statement accounts and disclosures that relate to the critical audit matter, when applicable.

If the auditor determines that there are no critical audit matters, then the auditor would state in the auditor’s report that the auditor determined that there are no such matters to communicate.

The comment period expired on December 11, 2013. The PCAOB has received over 230 comment letters, which is not surprising given the scope of the changes.

What Are Critical Audit Matters?

The Proposed Standard defines critical audit matters as those matters addressed during the audit that:

  • Involved the most difficult, subjective, or complex auditor judgments;
  • Posed the most difficulty to the auditor in obtaining sufficient appropriate evidence; or
  • Posed the most difficulty to the auditor in forming the opinion on the financial statements.

Critical audit matters ordinarily are matters of such importance that they are required to be:

  • Documented in the engagement completion document, which summarizes the significant issues and findings from the audit;
  • Reviewed by the engagement quality reviewer;
  • Communicated to the audit committee; or
  • Any combination of the three.

To review the entire document and formatting for this alert (e.g., footnotes), please access the original below: