6 tips for developing critical audit matter disclosures

December 22, 2018

 

A new standard for public company auditing is bringing the stress that accompanies any significant change, but it also is giving auditors the opportunity to communicate more about the audit.

New PCAOB rules for the auditor’s report require auditors to disclose “critical audit matters” that are encountered in each engagement. These are matters that:

• Arise from the financial statement audit;
• Are communicated or required to be communicated to the audit committee;
• Relate to accounts or disclosures that are material to the financial statements; and
• Involve especially challenging, subjective, or complex auditor judgment.

The requirements take effect for audits of large accelerated filers for periods ending on or after June 30, 2019, and for audits of other applicable companies for fiscal years ending on or after Dec. 15, 2020. With the implementation date approaching, firms that audit large accelerated filers are conducting “dry runs,” which are exercises to help auditors figure out how best to comply with the standard when they implement it.

Dave Sullivan, CPA, national managing partner of the Quality & Professional Practice for Deloitte & Touche LLP, is optimistic about the value that auditors can bring through the critical audit matter disclosures.

“Investors want more information about these challenging and subjective areas of the audit. Now, auditors have the opportunity to expand on these areas in the auditor’s report,” Sullivan said. “This is a significant advancement to the audit reporting process.”

The dry runs have been a positive step forward for audit firms as they learn more about how they want to disclose critical audit matters. Here are six suggestions that Sullivan has derived from the dry run process:

• Starting early and communicating often with management and the audit committee will make the process smoother. This will put them at ease with the new process. “We’ve found that as we’ve worked through the dry runs with our clients, even those who were not supportive of the critical audit matter disclosure requirement are … really stepping back and saying, ‘Oh, that makes sense,’” Sullivan said.
• Make sure the right people throughout the clients’ organization understand critical audit matters. Dealing with the chief accounting officer and CFO isn’t enough. Investor relations may need to explain the new disclosures to investors, for example. “It’s making sure they’ve brought along the right team,” Sullivan said.
• Communications with the audit committee are the key. “There’s a standard [Auditing Standard 1301] that requires the auditor to discuss certain matters with the audit committee, and generally those are around the most significant risks in the audit and how the auditor is going to address them,” Sullivan said. “And those communications with the audit committee are the starting point for determining what might be a critical audit matter.”
• Be thorough but judicious in drafting the disclosures. “There’s a certain amount of information you need to put into a critical audit matter in order to tell the whole story,” Sullivan said. “You also need to think about the reader of the critical audit matter, so you can’t just go on and on for pages. You need to be concise as you describe this.”
• The critical audit matters tend to come from areas that you would expect. “They’re areas that involve a lot of subjectivity or estimation and would include things like goodwill impairment; accounting for intangible assets; acquisitions; accounting for income taxes; certain elements of accounting for revenue, especially accounting for revenue over time; and hard-to-value investments,” Sullivan said.
• Smaller firms can benefit from examining larger firms’ work. Generally, audits of the large accelerated filers are performed by the largest audit firms. The delayed implementation date for audits of smaller public companies allows practitioners from smaller firms to study and learn from the critical audit matters disclosed by larger firms. “There will be hundreds of those reports out there on the large accelerated filers that the entire profession can learn from as other firms have to adopt this and start drafting the critical audit matters,” Sullivan said.

—Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is the JofA’s editorial director.