In Critical Audit Matters: A Year in Review, the Center for Audit Quality (CAQ) analyzes critical audit matters (CAMs) communicated in the auditor’s reports of over 2,000 accelerated filers, including a detailed analysis of S&P 100 CAMs. The CAQ likes what it finds. Its conclusion is that: “The auditor’s reports we reviewed provide straightforward descriptions about those matters that involved especially challenging, subjective, or complex auditor judgment. Within the audit procedures listed in the CAM communications, auditors provided insights into the auditing of the matter that was a CAM and a description of the audit procedures performed to get comfortable with the matter. The result is an increase in the total mix of information available to investors.”
As described in earlier Updates (see, e.g., More PCAOB Advice for Audit Committees on CAMs, July, 2019 Update), the requirement that the auditor’s report include a discussion of CAMs took effect for large accelerated filers (companies with public float of $700 million or more) for fiscal years ending on or after June 30, 2019. A CAM is defined as 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. (For another analysis of large accelerated filer first year CAM disclosures, see Audit Analytics Provides an Update on CAM Disclosures, June 2020 Update.)
The CAQ’s report finds that, for the S&P 100, every auditor’s report contained at least one CAM. For all 2,000-plus companies it reviewed, only 16 auditor’s reports did not include a CAM. For the S&P 100, there were an average of 1.98 CAMs per report. One of these reports communicated five CAMs, while 32 contained only one CAM. Slightly over half of the 198 CAMs in S&P 100 auditor’s reports related to one of four financial statement areas:
Taxes. The 32 tax CAMs identified various judgmental taxation areas, such as the impact of new federal tax laws (e.g., the Tax Cuts and Jobs Act of 2017), deferred tax assets, unrecognized tax benefits, and accounting for income taxes in general.
Goodwill/intangibles. Of the 28 goodwill and/or intangible assets CAMs, eight related to intangibles, 13 related to impairment of goodwill, and seven related to both goodwill and intangibles. Two reports included one CAM for goodwill and one CAM for intangibles, and in seven reports there were CAMs that related to both goodwill and intangibles.
Contingent liabilities. Eighteen of the 23 contingent liability CAMs related to legal and regulatory contingencies. Four CAMs addressed insurance-related liabilities, such as self-insurance programs, and one CAM related to interest and penalties arising from international tax positions.
Revenue. The topics of the 18 revenue CAMs varied. The CAQ observes that “one theme across the majority of the revenue CAMs relates to timing. Software, consulting projects, and long-term contracts can require companies to recognize revenue over time regardless of when the company is paid. Understanding that timing requires management and, subsequently, their auditors, to use well-reasoned judgment in a complicated and material area.”
Companies in the same industry tended to have similar CAMs. For example, in the S&P 100:
All auditor’s reports for financial institutions with banking operations included an allowance for loan or lease loss (ALLL) CAM.
Insurance contract liabilities CAMs were common in the insurance industry.
Petroleum refiners frequently had CAMs related to proven and unproven reserves and to asset retirement and environmental matters.
Regulatory assets and liabilities CAMs were common for energy companies.
Every critical accounting policy disclosed in management’s discussion and analysis (MD&A) did not result in a CAM, and every CAM did not relate to a critical accounting policy. Many S&P 100 companies had “two to three times the number of critical accounting policies in the MD&A section of their Form 10-K than CAMs communicated in the auditor’s report.” Conversely, “12 CAMs in auditor’s reports for S&P 100 companies related to a business combination, and only one company also had a critical accounting policy related to business combinations.”
Contrary to fears expressed prior to CAM reporting implementation, CAMs were not a vehicle for the disclosure of non-public deficiencies in internal control over financial reporting (ICFR). Companies are not required to disclose significant deficiencies in ICFR, and no CAM for the S&P 100 referred to a significant deficiency. Two auditor’s reports for S&P 100 companies included a CAM that mentioned a material weakness in ICFR as a principal consideration for the CAM, and these companies were also the only S&P 100 companies that disclosed a material weakness.
Comment: As noted in prior Updates, the financial reporting areas most likely to generate CAMs tend to be those that are dependent on management estimates and forecasts and therefore require a significant amount of auditor judgment. Audit committees of companies that have CAMs arising in other areas – or that have CAMs that differ significantly in number or nature from those disclosed by other companies in the same industry – should explore the reasons why their company differs from these norms. The PCAOB has provided guidance concerning the types of questions audit committees should raise with their auditor concerning CAMs. See More PCAOB Advice for Audit Committees on CAMs, July 2019 Update.