Last week, the Public Company Accounting Oversight Board (the “PCAOB”) convened a series of ten panels as part of a two-day public meeting regarding proposed changes to the auditor’s reporting model. The proposed changes have elicited a range of opinions from various stakeholders and commentators, a majority of which have been critical of the proposals. Individuals invited to appear as panelists at last week’s meeting, however, were generally supportive of the proposed changes and offered various recommendations for ways in which the PCAOB could modify its proposals in order to move forward.
The proposed changes to the auditor’s reporting model are included in two proposals:
- The Auditor’s Report on an Audit of Financial Statements would expand the auditor’s report to include additional disclosures relating both to the auditor and the audit itself, including the disclosure of critical audit matters (“CAM”), defined as those audit-specific matters that involved the most difficult, subjective, and complex auditor judgments; posed the most difficulty to the auditor in obtaining audit evidence; or posed the most difficulty to the auditor in forming an opinion regarding the financial statements.
- The Auditor’s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor’s Report would require the auditor to read and evaluate “other information” included in the annual report, including the MD&A, exhibits and other information incorporated by reference, in order to determine whether the other information contains a material misstatement of fact or a material inconsistency with the audited financial statements included in the annual report, with the auditor’s conclusion reflected in the audit report.
More information on the proposed changes is available at http://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=210.
Interestingly, the meeting showed a heavy focus on international reporting with three panels dedicated to this perspective. Board members often referenced seemingly positive results in the UK and the EU when addressing panelists, particularly panelists who warned about potential negative consequences of the proposals, such as the increased use of boilerplate or greater investor confusion. Some Board members also expressed concern about potential risks to the United States capital markets if disclosure standards for audit reports were to diverge markedly from their counterparts in the UK and the EU.
Panelists with first-hand experience in implementing similar changes to the auditor’s reporting model in the United Kingdom and the European Union were strongly in favor of the proposals. In 2012, the UK Financial Reporting Council adopted changes to the audit report and required additional disclosures by the issuer related to communications from the auditor (specifically, information regarding the evidence the auditor relied on in making significant judgments and the auditor’s communications to the audit committee that are relevant to an understanding of the financial statements). Under the UK audit reporting model, the auditor must include a statement in its report if it believes disclosures provided by the issuer are inconsistent with the auditor’s communications. The audit report must also discuss the assessed areas that provide risk of material misstatement; audit strategy and scope; and the manner in which materiality was assessed and applied. Notably, the UK model is premised in large measure on the issuer – not the auditor – providing disclosure in the first instance, a point about the UK model that did not garner much attention during the PCAOB’s meeting.
Critical Audit Matters
Panelists supporting the PCAOB’s proposals contended that robust CAM disclosures would provide significant value to users of financial statements, satisfying a widely held desire for additional information regarding the audit and providing insights into the auditor’s views of the financial statements. However, even some of the panelists in favor of the CAM disclosures acknowledged that narrowing the scope of CAM disclosures could be warranted (e.g., to restrict CAM disclosure requirements to only those that are material). A few panelists recommended that the CAM disclosure be narrowed to focus on significant estimates and critical accounting policies. Several panelists expressed concern that providing investors with a list of CAM disclosures may undermine the auditor’s pass/fail conclusion regarding whether the financial statements are fairly presented. Some panelists also believed that the threat of litigation may force CAM disclosures to become unwieldy lists over time, obscuring meaningful information. Board members seemed eager to hear about ways to focus the CAM disclosures and present them in a manner that would minimize the concerns being raised, but no apparent consensus emerged for handling these issues.
Although the majority of panelists supported the evaluation and reporting of “other information,” the PCAOB’s proposal on the topic generally received greater criticism than the CAM proposal. In particular, panelists frequently expressed concern that in addressing other information, the auditor could be required to disclose information that the issuer would not otherwise be required to disclose under the securities laws, thus causing the auditor to serve as the original source of information about the issuer rather than attesting to the presentation of the financial statements – a concern that several panelists also echoed with respect to CAM disclosures. Panelists also argued that the evaluation of other information would often involve matters outside the scope of the auditor’s expertise and could cause the cost of audits to increase significantly. One panelist explained that the proposal could encourage issuers to trim their disclosures in MD&A and elsewhere to minimize the prospect for tensions with the auditor in its review of the other information. Some panelists took issue with the wording of the proposal, noting that the requirement that the auditor “evaluate” other information is vague, which could lead to varying levels of disclosure amongst different auditors, which may in turn cause investors to evaluate issuers differently.
Several Board members appeared eager to move forward with changes to the auditor’s reporting model, as evidenced in part by the focus on alignment with audit-related disclosures in the UK and the EU. But the dialogue at the meeting also suggested that the PCAOB is searching for ways to refine the proposals in light of commentary to date. To gather such input, the PCAOB recently extended the comment period on the proposals to May 2, 2014.