Reports prepared by public company auditors will contain more information for investors and other financial statement users as a result of new rules approved Thursday by the PCAOB during an open meeting in Washington.
Under the new PCAOB standard and related amendments, the auditor's report will retain the pass/fail opinion of the existing auditor's report but also will include a new description of "critical audit matters," providing financial statement users with information about the most challenging, subjective, or complex aspects of the audit.
The standard will create the first significant change to the standard form auditor's report in 70 years, according to PCAOB Chairman James Doty.
"It will make the auditor's report more relevant, useful, and informative to investors and other financial statement users in light of the progress of history," Doty said in a published statement. "The new standard will breathe new life into a formulaic reporting model."
Critical audit matters are defined as any matter arising from the current period's audit of the financial statements 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 judgment.
If no critical audit matters arose from the audit, the audit's report must state that there were no critical audit matters.
Communication of each critical audit matter will be required to include:
- Identification of the critical audit matter.
- Description of the principal considerations that led the auditor to determine that the matter was a critical audit matter.
- Description of how the critical audit matter was addressed in the audit.
- Reference to the relevant financial statement accounts or disclosures.
Additional changes to the auditor's report that were approved Thursday include items that are intended to clarify the auditor's role and responsibilities, provide additional information about the auditor, and make the auditor's report easier to read.
Auditor's reports now will include a statement disclosing the year in which the auditor began serving consecutively as the company's auditor and a statement that the auditor is required to be independent. In addition, certain standardized language in the report has been changed, including the addition of the phrase "whether due to error or fraud," in describing the auditor's responsibility under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatements.
The auditor's opinion will be required to appear in the first section of the auditor's report, and the auditor's report will be addressed to the company's shareholders and board of directors. Additional addressees also are permitted.
The standard will apply to audits conducted under PCAOB standards, but communication of critical audit matters will not be required for audits of:
- Brokers and dealers.
- Investment companies other than business development companies.
- Employee stock purchase, savings, and similar plans.
- Emerging growth companies.
The standard is subject to approval by the SEC. If approved, all provisions other than those related to critical audit matters will take effect for audits for fiscal years ending on or after Dec. 15, 2017. Provisions related to critical audit matters will take effect for audits for fiscal years ending on or after June 30, 2019, for large accelerated filers, and for fiscal years ending on or after Dec. 15, 2020, for all other companies to which the requirements apply.
Pending SEC approval of the final standard, auditors may elect to comply before the effective date.
Although the board was generally supportive of most of the measures, board member Jeanette Franzel expressed concerns about the requirement for disclosing auditor tenure in the auditor's report.
"I am concerned that including this information in the auditor's report may convey an implication that there is a generalizable relationship between auditor tenure and audit quality and/or auditor independence, assumptions that may not be valid," Franzel said in published comments.
Center for Audit Quality Executive Director Cindy Fornelli expressed appreciation for the PCAOB's efforts to enhance the auditor's reporting model to provide additional information to financial statement users in an increasingly complex and global business environment. She said the board was responsive to concerns and recommendations of the CAQ and the audit profession during the standard-setting process.
Observations from the CAQ's field-testing of the expanded auditor reporting model were among many comments the PCAOB considered.
"This is a positive step toward continuous improvement of the audit to better serve investors and our capital markets," Fornelli said in a news release.
The CAQ is affiliated with the AICPA.
The PCAOB has been attempting for years to provide auditors with a mechanism to report information that would be useful to financial statement users beyond the practitioner's pass/fail judgment on the financial statements.
A June 2011 concept release marked the start of public comment on the issue, followed by a 2013 proposal and a reproposal in May 2016.
Fair value and specialists
On Thursday, the board also proposed amendments to its standards for auditing accounting estimates and fair value measurements, and for the auditor's use of the work of specialists.
The accounting estimates and fair value proposal would replace three existing standards with a single, updated standard. The proposal is designed to strengthen auditing practices, update the standards in light of recent developments, and provide a more uniform, risk-based approach to these areas.
The proposal on the use of specialists would be designed to strengthen the requirements for evaluating the work of a company's employed or engaged specialists. Meanwhile, the work of specialists employed or engaged by auditors would be subject to application of a risk-based supervisory approach.
Comments can be submitted through the board's website by Aug. 30.
—Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is a JofA editorial director.