What Lawyers Should Know About the New Auditor’s Report Revisions

After more than six years of deliberations, it looks like the revised auditor’s report is about to become reality. On June 1, the PCAOB adopted a new auditing standard that substantially modifies the long-familiar content of that venerable report. Now the SEC must consider and act on the PCAOB’s recommendation, a process that typically involves another public comment period.

What’s changing?

CAM disclosure. The biggest change will be communication in the report by the auditors of “critical audit matters” applicable to the current period covered by the report. CAMs are defined as:

“any matter … that was communicated or required to be communicated to the audit committee and that relates to accounts or disclosures that are material to the financial statements and involved especially challenging, subjective, or complex auditor judgments.”

The new standard notes that the determination of a CAM is principles-based, though it also provides a non-exclusive list of factors for the auditor to consider in its determination. The PCAOB emphasizes that this disclosure should be client-specific and should not be boilerplate.

CAMs will be described in a separate section of the auditor’s report. The auditor must identify the CAM, describe the principal considerations that led the auditor to determine it was a CAM, describe how the CAM was addressed in the audit and reference the accounts or disclosures related to the CAM. In the unlikely event that a report contains no CAMs, it must affirmatively so state.

Emerging growth companies and employee stock purchase, savings and similar plans are excluded from the CAM disclosure requirements.

Additional changes. The modified auditor’s report also must:

  • State the year the auditor began serving as the company’s auditor,
  • Provide an enhanced description of the auditor’s role, responsibilities and independence, and
  • Satisfy certain format requirements designed to enhance readability.

When are the changes effective?

Subject to the SEC’s expected approval, all changes to the report except for communication of CAMs is effective for audits of fiscal years ending on or after December 15, 2017.

Communication of CAMs becomes effective for large accelerated filers for fiscal years ending on or after June 30, 2019 and, for all other companies, for fiscal years ending on or after December 15, 2020.

Auditors may, however, elect to comply with the new standards at any time after SEC approval.

What should you be doing now?

It is likely that your auditors have already communicated this development to your finance department. It is not too soon to begin a dialogue around the types of matters expected to be CAMs in the future and how the auditor will engage with management to identify and describe CAMs in the report.

The legal department should:

  • Be sure that the audit committee (a) is informed of the new standard, (b) is kept apprised of relevant discussions as they arise and (c) understands that all future communications with auditors may impact whether an issue is treated as a CAM and, therefore, may affect the company’s other public disclosures.
  • Consider how CAM determinations and disclosures might impact such bigger picture issues as materiality analyses, MD&A disclosures and critical accounting policy disclosures.
  • Inform the disclosure committee and other responsible personnel about this new development and its potential impact.
  • Guard against CAM disclosure creep (similar to risk factor creep) as auditors include more and more disclosure over time to minimize liability risk.
  • Understand how CAM disclosure processes will impact the timing of the audit and, therefore, the audit committee review, earnings release and SEC filing schedules.
  • Anticipate increased audit costs related to CAM disclosures.
  • If the company’s auditors have a long tenure, consider whether to include disclosure in the proxy statement (perhaps in the Audit Committee Report) describing the corresponding benefits to the company.

All the best,

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