New rules for financial statement audit reports

The Public Company Accounting Oversight Board (PCAOB) began in May 2016 to compose new audit report-related rules. In announcing the review, the PCAOB noted that the auditor’s report was the main source of information for various interested parties, investors among them.

As the PCAOB said in 2016,

“As currently designed, however, the auditor's report conveys very little of the information obtained and evaluated by the auditor as part of the audit. And while the auditor's report has generally remained unchanged since the 1940s, companies' operations have become more complex and global, and the financial reporting frameworks have evolved toward an increasing use of estimates and fair value measurements.”

The results issued by the PCAOB within the last few weeks focus much attention on three areas, as described by the summary statement in the new rules:

  • Communication of critical audit matters—matters communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements; and (2) involved especially challenging, subjective, or complex auditor judgment
  • Disclosure of auditor tenure—the year in which the auditor began serving consecutively as the company's auditor
  • Other improvements to the auditor's report—a number of other improvements to the auditor's report to clarify the auditor's role and responsibilities, and make the auditor's report easier to read

The new rules in various ways put new pressures on two entities, the organization being audited and the auditors themselves. The CAM sections of the auditor’s report will include the auditors assessments of “significant management estimates and judgements” made in financial statement preparation; areas of high risk for the organization; reporting of unusual transactions and other “significant” changes in the financial statement. Finally, the auditors must provide the effort to which they had to go and the evidence they found to support that the CAM. If no CAM is identified the auditor must state that as well.

After identifying a CAM, auditors will have to explain the reasons why they define the issue as a CAM; how they addressed the CAM within the audit; and refer to the financial statement accounts and disclosures that relate to the CAM.

The PCAOB rules don’t require that CAMs be identified and communicated through the auditor’s report for “audits of emerging growth companies; brokers and dealers; investment companies other than business development companies; and employee stock purchase, savings, and similar plans.”

Auditor’s report formats are also standardized under the rules, another means by which the information should be easier to read.

The PCOAB is giving affected organizations time to gear up for the changes. The new format, along with tenure disclosure and other information goes into effect for audits for fiscal years ending on or after Dec. 15, 2017; the reporting of CAMs for large accelerated filers apply to audits of fiscal years ending on or after June 30, 2019; CAMs communication for all other companies audits for fiscal years ending on or after Dec. 15, 2020.

This is likely to be the last such change for a good while, but unlikely to be the last changes on this subject. What tends to occur is that rules meant to improve the system prove over time to need to be changed again to improve the system. That’s the way the system works.

The PCOAB’s new rules can be found here.

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Tagged PCAOB, Assurance