After several years of proposals and feedback from stakeholders, on August 13, 2013, the Public Company Accounting Oversight Board (PCAOB) proposed sweeping changes to the standard audit report in two new auditing standards:
The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion
The Auditor’s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor’s Report.
The most significant of the new rules would require auditors to report on “critical audit matters” and “other information” included in documents that contain the financial statements. The rules would also require additional disclosures from auditors, including auditor tenure. Though the proposed rules represent significant changes to the current audit report, they are less radical than some of the proposals initially considered by the Board. The proposed standards would be effective, subject to approval by the Securities and Exchange Commission (SEC), for audits of financial statements for fiscal years beginning on or after December 15, 2015.
The PCAOB is seeking comment from interested parties on a variety of issues related to the proposed changes as it continues a comprehensive effort to ensure that the proposal achieves a balance between providing investors with the additional information they seek regarding public companies and recognizing the differing roles of the auditor and management with respect to the company’s financial information.
The Lead-Up to the August 13, 2013, Proposed Rules
Over the past three years, the PCAOB has conducted outreach with investors, auditors, financial statement preparers, audit committee members and others with an eye toward changing the auditor’s report to make it more informative. The current pass/fail model of the audit report has remained largely unchanged for 70 years, and while the PCAOB recognizes the benefit of uniformity and comparability achieved with the pass/fail model, there has been significant criticism that the current model fails to provide meaningful information to investors.
The 2011 Concept Release
On June 21, 2011, the PCAOB issued a Concept Release seeking comment on several potential changes to the auditor’s reporting model and a proposal to retain the pass/fail model with some changes to the audit report. The Board received more than 150 comment letters in response to the Concept Release from a wide range of interested parties, including auditors, investors and financial statement users, and academics, among others. The Board also conducted a public roundtable on the alternatives on September 15, 2011, and further discussed the alternatives at the November 2011 and 2012 Standing Advisory Group meetings.
A number of commenters noted the potential expansion in auditor liability that could result from the proposed changes, and that such increased exposure would be counterproductive as it could lead auditors to turn to legally defensive boilerplate disclosures that would not result in the meaningful disclosure desired by investors.
August 2013 Proposed Auditing Standards
Ultimately, the PCAOB did not adopt outright any of the alternatives put forward in the Concept Release. Instead, it included elements of each in the proposed rules. The most significant changes in the proposed rules are outlined below:
Critical Audit Matters
Under the new standard, “critical audit matters” (CAMs) are those issues addressed during the audit “that involved the most difficult, subjective, or complex auditor judgments or posed the most difficulty to the auditor in obtaining sufficient appropriate audit evidence or forming an opinion on the financial statements.” The proposed standard explicitly notes that use of the word “most” is not intended to limit disclosures to a single item in each category. The proposed standard also states that CAMS “ordinarily are matters of such importance that they are included in the matters required to be (1) documented in the engagement completion document, (2) reviewed by the engagement quality reviewer, (3) communicated to the audit committee or (4) any combination of the three,” and provides a list of factors for the auditor to consider in identifying the CAMs.
The proposed standard is not meant to modify the objective of the audit or to impose new audit performance requirements beyond determination, communication and documentation of the CAMs; that is, the communication of the critical audit matters would be based on information known to the auditor from procedures currently performed as part of the audit. The Board expects that in most instances, auditors will determine that there are critical audit matters; if there are no CAMs, that conclusion must be disclosed and documented.
Evaluating and Reporting on Other Information
Under existing auditing standards, the auditor must “read and consider” other information in certain documents that contain the audited financial statements for material inconsistency with the financial statements. The current standard does not contain a corollary reporting requirement to describe the auditor’s responsibility regarding other information. The proposed changes would require the auditor not to “read and consider,” but to “evaluate,” the other information for material misstatements or inconsistencies and would require communication in the auditor’s report regarding the auditor’s responsibilities for, and the results of, its evaluation of other information.
The duty to evaluate “other information” would apply to certain types of annual reports filed under the Securities and Exchange Act of 1934, but not to other information contained in 1933 Act registration statements. The auditor’s evaluation is intended to be based on “relevant evidence obtained, and conclusions reached during the audit.” If, during the audit, the auditor did not gather information or evidence against which to evaluate the consistency of the “other information” the auditor need not perform additional procedures. Consequently, “there may be ‘other information’ in the relevant documents that is important to investors but that the auditor will not evaluate.”
The new standards also require additional disclosures, including statements regarding the auditor’s obligation to be independent of the company and the auditor’s tenure.
PCAOB Board Identifies Concerns and Seeks Feedback about the Proposed Standards
In conjunction with the Proposal Release, individual Board members issued statements explaining the intent of the new standards and identifying elements of the standards that raised concerns for certain members. The Board is seeking comment on all aspects of the proposed changes and has posed specific questions for feedback in Appendices 5 and 6 of the Release. The Board’s Proposal also contains samples of audit reports that include the new components.
The Board explained that in revising the auditor’s report standards, it is attempting to balance several interests, including investors’ need for more useful information and the appropriate boundaries between the responsibilities of management and those of auditors. The proposal does not seek to change what the auditor does, but how the auditor reports about what it has done.
Like the comment letters received in response to the Concept Proposal, the statements by the PCAOB members express a spectrum of views about the new rules, from concern that the proposals are not strong enough to meet the needs of investors to concerns that the burden on auditors imposed by the new rules is disproportionate to any informational enhancement. At least one Board member indicated that there likely will be an additional round of proposals before the new rules are finalized, demonstrating the importance of stakeholder comments as this rulemaking process continues.