PCAOB Re-Proposes Standard to Enhance Information Provided in Auditor’s Reports

On May 11, 2016, the Public Company Accounting Oversight Board (the “PCAOB”) has re-proposed the standard The Auditor’s Report on an Audit of the Financial Statements When the Auditor Expresses an Unqualified Opinion. The PCAOB’s original proposal was made in 2013 and has been re-proposed as a result of the extensive feedback received from investors and other users of financial statements.

The PCAOB recognizes that the auditor’s report has remained relatively unchanged over the course of time while accounting rules and businesses have continued to become more complex. Investors and financial statement users are seeking the auditor’s report to become more informative and provide more relevant information. The objective is to provide the visibility into communications between audit firms, audit committees and management regarding the significant audit issues and procedures that have occurred. The current format of the auditor’s report does not provide any such insight into this process. It has also been noted that other international standard setting bodies have adopted similar disclosure requirements for their auditors, such as the International Auditing and Assurance Standards Board, the European Union and the Financial Reporting Council in the United Kingdom.

The auditor’s report opinion and conclusion will remain relatively unchanged under its current pass/fail format, however the proposal does provide for additional information to be included; most significantly a section on “Critical Matters”.

“Critical Matters” will be required to be disclosed for the most current period covered by the auditor’s report and is to be applied using a principles-based approach by the audit firm. A critical matter is defined as those matters that meet the following criteria as prescribed by the new proposed standard:

• Limited to those matters already communicated to the audit committee by the auditor;
• Matter is considered to be material to the financial statements;
• Matters deemed to be challenging, subjective and complex.

The PCAOB’s direction is that “challenging, subjective and complex” matters should be determined as a result of the auditor’s risk of material misstatement, subjectivity of the audit procedures performed, situations that require great effort (i.e. use of a specialist), level of audit evidence obtained and judgment used by the auditor. Audit firms will provide information in their report that defines the critical matter, the principal considerations made in identifying the matter, a description of the audit procedures performed and a reference to the relevant accounts and disclosures in the financial statements. It is widely anticipated that audit firms will vary significantly on the number of critical matters identified and the extent of documentation that is provided in the auditor’s report.  It would be expected that every auditor’s report would include at least one “Critical Matter”. Although there may be possibilities in which an audit had no critical matters, these instances should be infrequent.

Optimists will view this as value-added information and a transition from the perceived boilerplate audit report language from the past. Pessimists contend that there are a number of concerns, which include the additional time and costs involved, the level of duplicative information now being disclosed, and unnecessary confusion on the part of the users of the financial statements. There is also a question as to whether it is appropriate for the auditors to disclose information on a matter on behalf of the company.  Audit firms are particularly concerned about the potential increased risk of liability that this publicly disclosing elements of the audit process might bring to the profession. This may result in audit firms being overly conservative and including and identifying too many critical matters that would not otherwise be appropriate based on the framework established by the standard, or by failing to disclose a matter that through hindsight was deemed to be critical.

The re-proposed standard also includes other required changes to the auditor’s report, which include:

• Inclusion of a statement that the audit firm is independent with respect to the company;
• Disclosure of the tenure of the audit firm;
• Changes to the addressee of the auditor’s report;
• Conclusion on audit opinion to be the lead paragraph;
• Other basic elements and “cosmetic” changes.

There has already been concern raised regarding the requirement to disclose the tenure of the audit firm as this would inappropriately imply a connection between audit quality and tenure. In addition there are a variety of considerations which cause difficulties determining the exact tenure of an audit firm as a result of audit firm mergers and acquisitions.

The PCAOB is still seeking comments on this proposal and the effective date of the re-proposed standard has not been finalized.

For more information, the proposed auditing standard – The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion is available on the PCAOB’s website as follows: https://pcaobus.org/Rulemaking/Docket034/Release-2016-003-ARM.pdf.