Practitioners provide new transparency through critical audit matters

Auditors’ reports on public company financial statements are providing users with a better understanding of company financial information as a result of newly required reporting on critical audit matters, according to a new report by the Center for Audit Quality (CAQ).

The CAQ, which is affiliated with the AICPA, found that the early trends associated with critical audit matters demonstrate that auditors are providing additional transparency within their auditors’ reports.

“Our analysis shows that it’s really the culmination of great work by auditors to implement these requirements, and audit committees and management to do their part as auditors implemented this,” said Dennis McGowan, CPA, senior director, professional practice for the CAQ and one of the authors of the report. “The result of this multiyear journey to implement these requirements is that there is additional information about the audit that’s now available that investors and other users can use to make decisions.”

The PCAOB’s standard requiring inclusion of critical audit matters in auditors’ reports was created to give financial statement users additional information about the audit. The new rule also provided auditors with more opportunities to communicate their insights.

Critical audit matters are defined by the PCAOB as any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee that:

• Relates to accounts or disclosures that are material to the financial statements; and
• Involved especially challenging, subjective, or complex auditor judgment.

Large accelerated filers began communicating critical audit matters in their auditors’ reports in 2019, when there were more than 2,000 large accelerated filers. The CAQ broadly studied critical audit matters from the 2019 reporting cycle, with deeper analysis of auditors’ reports on the financial statements of S&P 100 companies.

The CAQ found that 198 critical audit matters were reported in S&P 100 auditors’ reports. The most common number of critical audit matters reported was two (43 companies), followed by one (32 companies) and three (21 companies). All the S&P 100 audit reports studied included at least one critical audit matter.

Most commonly, critical audit matters cited by S&P 100 auditors referred to:

• Taxes (32 critical audit matters).
• Goodwill and/or intangible assets (28).
• Contingent liabilities (23).
• Revenue (18).

“Those are areas where there is a high degree of judgment by management related to the matter that in turn relates to a high degree of auditor judgment to assess management’s evaluations and conclusions in those areas,” McGowan said.

The CAQ’s analysis found that in addressing a critical audit matter, auditors’ reports often provided a description of the auditors’ response to the matter or a brief overview of the audit procedures performed. Sometimes the reports described the auditors’ response and the audit procedures.

“That does give investors and other users insights into the types of procedures the auditor was performing over that matter,” McGowan said. “So I do think that the total mix of information out there for investors and other users of auditors’ reports has definitely increased.”

Auditors often provided transparency by:

• Describing the internal controls tested;
• Identifying specific audit procedures performed;
• Communicating the evidence evaluated; and
• Noting the use of personnel with specialized skills and knowledge.

“The users are getting more insight into what the auditor did to address that matter, which they may not have known before,” McGowan said. “Audit committees may have known these things because these are all things that are required to be reported to audit committees, and they probably would have had an appreciation for the audit approach. But outside of management and audit committees, the users of the report now have insight into what the auditor did.”

Center for Audit Quality Executive Director Julie Bell Lindsay will be among the presenters at the AICPA Conference on Current SEC and PCAOB Developments, which will be held virtually on Dec. 7–9. For more information, visit the conference website.

— Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is the JofA’s editorial director.