Center for Audit Quality shares early lessons from test runs to prepare for expanded audit reports

Accounting firms’ test runs to prepare for the Public Company Accounting Oversight Board’s (PCAOB) new requirement for auditors to provide more insight about their work indicate that they must apply significant judgment to comply with the rule, according to a guide published by the Center for Audit Quality (CAQ).

Many accounting firms have been doing what they call “dry runs” to implement a PCAOB rule that requires auditors of public companies to add critical audit matters (CAMs) on the audit report.

The board defines CAMs as the matters that have been communicated to the audit committee, are related to accounts or disclosures that are material to the financial statements, and require an auditor to make a subjective decision or use complex judgment.

“Numerous factors influence an auditor’s consideration of which matters involved especially challenging, subjective or complex auditor judgment,” the CAQ said. “The determination of CAMs will be unique to each audit.”

The PCAOB rule is described in Release No. 2017-001, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion and Related Amendments to PCAOB Standards. The final rule was issued in June 2017, and it represents a major change to the brief pass-fair auditor report that have prevailed since the 1940s. The critical matters requirement applies to audits of year-end 2019 financial statements for large accelerated filers, which the Securities and Exchange Commission (SEC) defines as companies with market values of $700 million or more. Auditors of smaller companies will get an extra year.

The CAQ’s December 2018 publication, Critical Audit Matters: Lessons Learned, Questions to Consider, and an Illustrative Example, presents early lessons learned from dry runs that certain audit firms have conducted on CAMs. Dry runs are still ongoing, and the CAQ’s guide provides an illustrative example of a CAM along with a set of questions to foster dialogue and understanding of the impact that CAMs will have on the audit process.

The CAQ, an affiliate of the American Institute of Certified Public Accountants (AICPA), said drafting CAMs can be challenging.

“For example, it can be difficult to strike the right balance between the CAM description in the auditor’s report and information in the company’s disclosures, to convey concisely the essence of why a matter is a CAM, and to describe how the CAM was addressed in the audit in a manner that is informative, but not overly technical,” the guide said.

Among other things, the CAQ advised the auditor to communicate with company management and the audit committee “early and often” in the process of identifying and drafting the critical matters.

“This communication can help avoid surprises about the matters that are ultimately determined to be CAMs and the information communicated in the description of the CAMs,” the guide said. “This preparation also allows management to consider the need for modifications to the company’s disclosures in relation to areas likely to be CAMs. Any modifications of a company’s disclosures should be based on management’s reporting requirements and should be independent of the auditor’s identification of CAMs.”

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