A prominent investor group is applauding the Securities and Exchange Commission’s approval this week of the Public Company Accounting Oversight Board’s new standard expanding the scope of the audit report.
The SEC commissioners unanimously approved the PCAOB standard Monday, which would be the most significant change to the format of the audit report in over 70 years (see SEC approves PCAOB expanded audit report standard). The new standard adds a discussion of so-called “critical audit matters” that have been communicated by auditors to the audit committee, particularly those that involve “especially challenging, subjective or complex auditor judgment,” and requires a disclosure of auditor tenure, or which year a firm began auditing a company.
The CFA Institute, an organization for Chartered Financial Analysts, welcomed the new standard. “This is something we had long advocated for,” said Sandy Peters, head of the CFA Institute’s Financial Reporting Policy Group. “We were happy to see the change. While we don’t think that it had everything in it that we want, the CAMs and the tenure were certainly things that we have long wanted to see to give investors insight on what things that the auditors think are critical and ensuring there’s a discussion of those things between the auditors and the audit committee. Many people have said you just need to hear more from the audit committee, but we want to hear from both people because we pay for both, so we’d like to know as much as possible.”
She hopes the new CAMs section of the audit report won’t just contain some standard legal boilerplate. “It’s interesting to see what it actually turns out to be, and whether it’s boilerplate or not,” said Peters.
Although the disclosures don’t go as far as in the International Auditing and Assurance Standards Board’s new audit reporting standard, she still believes the information will be useful. “Investors have been pretty happy with the key audit matters under the IAASB,” said Peters. “They’re a bit different, but we were happy to see the changes. We had heard earlier in October that there was some doubt about it because there has been a pretty heavy advocacy effort against it in an era of reducing regulations.”
The SEC typically rubberstamps any new standards approved by the PCAOB, but in the case of the new audit reporting model, a set of powerful industry trade groups, including the U.S. Chamber of Commerce, and major corporations banded together and asked the SEC to reject the new standard (see Business groups object to new standard). They claimed that the requirements for disclosure of critical audit matters, or CAMs, would result in the disclosure of immaterial information, replace management as the source of original information, and create a chilling effect on the audit committee—auditor relationship, creating liability for businesses and auditors, and imposing additional expenses on firms. The SEC also received an unprecedented number of comment letters on the proposed rule, and Peters noted that a number of other investor groups had weighed in with their feedback to the SEC.
Jay Knight, who spent five years in the SEC’s Division of Corporation Finance and is currently the head of the Capital Markets practice group at the law firm Bass, Berry & Sims, believes the new standard has the potential of being helpful for investors.
“One of the reasons cited by the commission in why it could be helpful is it may allow investors to focus their attention on the key financial reporting areas and identify areas that deserve more attention,” he said. “There’s all sorts of language in the release that says it shouldn’t be boilerplate, and you have to disclose how and why. It could be meaningful to investors to see where the focus is by the auditors. It’s interesting that this is not issuer disclosure. This is auditor disclosure. Typically the SEC’s purview is: what does the issuer say and what does the company have to say? There’s already discussion in the MD&A about critical accounting estimates and matters related to that. Management already speaks about critical accounting matters, but this is really an auditor-focused disclosure item. That’s an interesting development.”
He also sees some value in the disclosure of auditor tenure. “I think that can be useful information,” said Knight. “For some of the larger companies, that has been a trend anyway to disclose auditor independence and tenure, so I think this just accelerates that and makes it a global practice that’s required. I have clients whose audit committees have considered adding in information about independence and tenure. I think a lot of the larger companies have started to include a more robust disclosure on that topic.”
Peters compared the auditor tenure disclosure to the requirements in the European Union for mandatory auditor rotation and retendering. “In Europe they’ve had mandatory rotation, and historically we’ve had mixed views on that, but I think in some cases it’s information with respect to whether a fresh look may be needed if there’s other things going on, and whether or not there might need to be a change,” she said. “That change can be really expensive and sometimes unnecessary because everybody looks at the end cash price and not the intangible price of all the time it takes internally for the organization to acclimate a new auditor. I have mixed views on it, but certainly it’s a piece of information that investors don’t know and would like to know because at times it’s good to have a second or a new look at things.”
The PCAOB plans to conduct a post-implementation review of the new standard once it has been in place for a while, and that could prove to be helpful.
“I do think that it will be whenever the critical audit matters starts to go into effect and there’s a connection between that and what is disclosed to the audit committee, this rule could potentially help communication at the audit committee level or hinder communication at the audit committee level,” said Knight. “My view is that it should help, but it really depends on how it’s implemented in the boardroom because the critical audit matter says that it’s really any matter that is disclosed to the audit committee that satisfies the criteria, not just those that are required to be communicated to the audit committee. Most of the time, it will overlap, but not always. “