Investors are about to get their hands on more information from the auditors of public companies than they’ve previously seen.
Annual financial statements released after June 30, 2019, will feature an expanded audit report, written just for them. The idea is to give investors more information about a company’s most complex financial accounting and steps the auditors took to validate them.
The introduction of the CAM—critical audit matters—will usher in a new era for the auditor’s report, long a boilerplate statement buried deep within the financial report. The audit report has changed little since the 1940s, when the report was standardized.
“It’s the first really big shift in how the auditor speaks with the investing public in 70 years,” said Dave Sullivan, national managing partner for quality and professional practice at Deloitte LLP.
The enhanced transparency provided by the critical audit matters should strengthen investors’ trust in the work of auditors, said Cindy Fornelli, executive director of the Center for Audit Quality.
Adding critical audit matters to the report won’t change how auditors do their work. And the basic pass-fail audit model will remain, Fornelli told Bloomberg Tax.
The audit report has comforted investors by ensuring that the financial statements were reliable. But they want more detail. They want to know what the auditors see, Fornelli said.
That’s why the Public Company Accounting Oversight Board, the U.S. audit regulator, adopted the changes, she said.
What’s in a CAM
To rise to the level of a CAM, the audit matters must meet three criteria, Fornelli said.
The new report will detail only critical audit matters that resulted in communication between the auditor and audit committees. They must be particularly complex or unusual. And they must be material to the financial statement.
CAMs commonly identified through early test runs included goodwill impairment, intangible-asset impairment, business combinations, revenue recognition, and fair value of financial instruments, she said.
Those areas involve subjective estimates and complex accounting, and require the most judgment by the auditor, Fornelli said.
To prepare companies for the reporting change, audit firms have run the equivalent of a dress rehearsal operating as if the new standard were in place for their 2018 audits.
The CAMs that resulted from the dry runs didn’t surprise audit committee members, said Deloitte’s Sullivan.
“These are all things we would have spent a considerable amount of time in the past talking with audit committees about,” he said.
“We talk about dozens of matters with the audit committee. A select few of which will rise to the level of a critical audit matter,” he said.
Expect More Pages
Investors shouldn’t be surprised either by what shows up in the expanded auditor report, which could be several pages long, said Amy Rojik, national assurance partner at BDO USA LLP and director of the firm’s Center for Corporate Governance and Financial Reporting.
The expanded auditor’s report will offer a different view of information that should already be disclosed in the financial statements, Rojik told Bloomberg Tax.
Audit committees have been concerned that shareholders and potential investors might take the expanded audit report out of context or that the report could serve as a road map for legal challenges, she said.
She expects that the reports will evolve over time as companies and their auditors become more comfortable with the disclosures, Rojik said.
Documenting critical audit matters and how they relate to the rest of the financial statement will be the hardest part, Rojik said.
Explaining the thousands of hours of testing that auditors performed in terms that investors would understand was the main challenge for Deloitte audit teams, Sullivan said.
The additional public information shared by auditors has also led companies to review what they include in footnotes and disclosures. In some cases, they’ve had to beef up those disclosures so they are more meaningful for investors, Sullivan said.
Some of those disclosure changes could show up on financial reports even before the new standard takes effect, Sullivan said.
The change in the audit report also provides an opportunity for companies to rethink their critical accounting estimates and the assumptions underlying them, which may overlap with any critical audit matters, said Tom Timko, chief accounting officer for General Electric Co., in remarks at the American Institute of CPAs’ annual SEC-PCAOB conference.
Revisiting accounting estimates can help drive the conversation with their auditors, Timko said.
“Ultimately I think it improves transparency. It can really help improve the focus of the audit as well, and that results in better audit quality and good corporate governance,” he said.
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