The PCAOB has released Interim Analysis Report (October 29, 2020) (Interim Analysis), an assessment of the initial impact of auditor reporting on critical audit matters (CAMs). The Interim Analysis finds that audit firms devoted considerable time and effort to CAM reporting implementation, but that, at least so far, investors have shown only limited interest. In addition, there is no evidence of significant unintended consequences, such as a chilling of auditor/audit committee communications.
As described in earlier Updates (see, e.g., Audit Analytics Provides Two Updates on CAM Disclosures, June, 2020 Update), the requirement that the auditor’s report include a discussion of CAMs took effect for large accelerated filers (companies with a public float of $700 million or more) for fiscal years ending on or after June 30, 2019. A CAM is any matter arising from the audit of the financial statements that was (1) communicated or required to be communicated to the audit committee, (2) relates to accounts or disclosures that are material to the financial statements, and (3) involved especially challenging, subjective, or complex auditor judgment. The auditor’s report must identify each CAM, describe the main considerations that led the auditor to determine that the matter was a CAM, describe how the auditor addressed the CAM in the audit, and refer to the financial statement accounts or disclosures related to the CAM.
The PCAOB’s Office of Economic and Risk Analysis performed several studies to gain an initial understanding of audit firm and engagement team responses to the CAM requirements, investor use of CAMs, and audit committee and preparer experiences. The PCAOB staff also evaluated whether the initial evidence suggested significant costs, benefits, or unintended consequences from CAM reporting. Some highlights of the findings include:
Audit Firms. The PCAOB surveyed the eight accounting firms that have 15 or more large accelerated filer audit clients. The four largest firms estimated that, on average, each devoted around 23,000 hours (53 percent at the partner level) to developing processes and procedures to support CAM implementation and 14,600 hours (32 percent at the partner level) to attendance at CAM-related training. The other four firms surveyed estimated spending, on average, 3,100 hours each. The PCAOB staff estimates that this corresponds to approximately $6.5 million of implementation costs for each Big Four firm and $1 million for each of the other four firms.
Engagement partners. The PCAOB also surveyed 902 engagement partners at the eight firms. They reported that, on average, about one percent of total audit hours were spent identifying, developing, and communicating CAMs. The impact on the audit seems to have been limited; only three percent of engagement partners reported spending additional effort on audit areas related to CAMs. The impact on company disclosure was more significant. Thirty-nine percent of partners said that a client made changes to its financial statement disclosures or other reporting because of CAMs. In addition, 139 engagement partners responded to an open-ended question about CAM reporting. These responses were somewhat critical of the new requirement:
o Sixty-seven of these partners said that the information in CAMs provides little value to investors or financial statement users.
o Twenty-six partners said that there were significant administrative burdens associated with the CAM communication process, and eight reported that that CAM implementation required large amounts of documentation.
o Nineteen partners reported that they felt pressure to identify at least one CAM, even though they did not believe that any individual matter met the definition of a CAM.
o Seven partners reported that audit committees expressed a strong preference that their CAMs be similar to those of other companies in the same industry.
Investors. The PCAOB staff also conducted an investor survey. Sixty-three percent of the 97 investor respondents had heard of CAMs, but only 31 percent had seen a CAM in an audit report. Those who had seen a CAM were asked about their future use of CAMs. Of the 21 who responded, eight said they would use CAMs, four said they might, and nine said they would not. Those who said they would not use CAMs thought that “CAMs are not specific enough to provide useful information or do not provide additional value above and beyond what is already included in financial statements.”
Audit Committee Chairs and Preparers. The staff interviewed twelve audit committee chairs and ten financial statement preparers (e.g., CFOs) at large accelerated filers. These interviews disclosed that:
o None of the audit committee chairs thought that CAMs had negatively impacted audit committee communications with the auditor. (Two percent of the engagement partners reported that the CAM requirement constrained auditor communications with the audit committee, while 41 percent reported that the CAM requirement enhanced communications.)
o None of the interviewees were concerned that CAMs had disclosed information that the company had not previously made public.
o None of the interviewees reported receiving any direct investor feedback on CAMs.
o Preparers reported some costs associated with CAM reporting (e.g., management time, increased audit fees), but most said that these additional costs were inconsequential.
Statistical Analysis. The PCAOB staff performed statistical analyses of the impact of initial CAM implementation on audit hours, audit fees, time to issue audit reports, and capital markets.” These analyses found that, on average:
o CAM reporting did not increase engagement costs (audit fees and audit hours). In general, auditors did not pass along the costs of CAM implementation to issuers in the initial year.
o CAM implementation did not increase the time required to issue the audit report.
o Stock market data provided no evidence that investors responded to the information in CAMs.
The PCAOB released two white papers that provide technical details of the staff’s work. See Staff White Paper Stakeholder Outreach on the Initial Implementation of CAM Requirements and Staff White Paper Econometric Analysis on the Initial Implementation of CAM Requirements. The staff’s underlying data set, an Excel spreadsheet of over of over 4,000 CAMs, is also available on the PCAOB’s website.
Comment: CAM reporting is still at an early stage. It is, however, encouraging that the PCAOB’s interim analysis suggests that fears that CAM reporting would chill auditor/audit committee communications do not seem to have materialized. See Audit Committee Members Are Still Dubious About the PCAOB’s Proposal to Expand Audit Reports, September 2016 Update. On the other hand, expectations concerning the value of CAM disclosure to investors also do not seem to have been realized – at least so far.
As noted above, the Interim Analysis found that 39 percent of engagement partners reported company changes to financial statement or other disclosure because of auditor CAM reporting. For audit committees, this underscores that most companies will want to make sure that the substance of any issue that gives rise to a CAM is disclosed in the company’s filings. This enables the company to present the issue from its perspective and avoids the risk that the CAM will disclose new information or might seem to imply that the company ignored or concealed a reporting challenge. As part of their oversight of financial reporting, audit committees should compare potential CAMs to the company’s disclosures regarding the same issue.