During a public meeting last week, some Public Company Accounting Oversight Board (PCAOB) advisers said they are concerned that auditors may not be fully complying with the critical audit matter (CAM) reporting requirement.
They are worried because the PCAOB adopted the rules in response to investor demand to make the audit report more useful, and many CAM disclosures have not been as informative. The language used in CAMs is at times generic or boilerplate, among other problems.
When the PCAOB adopted the rules in 2017, it represented a major change to the brief pass-fail auditor reports that had been in place for decades. And many investors had said the addition of more information to the report might be one of the most important things the board can do for them. Auditors know many details about a public company client’s financial condition, but the old reporting model from the 1940s provided no opportunity for auditors to offer insight to investors. In the aftermath of the 2008 financial crisis, some regulators and investors observed that external auditors said nothing in their reports about companies that soon failed.
The PCAOB defines CAMs as issues that are communicated to the audit committee, are related to accounts or disclosures that are material to the financial statements and involved especially difficult judgment from the auditor. When the rule was adopted almost six years ago, the board also said that the expanded report was needed to aid investors given the significant increase in the business world’s complexity over time.
To better explain his concern about insufficient CAM reporting, Jeffrey Mahoney, general counsel of the Council of Institutional Investors (CII), pointed to specific provisions in Auditing Standard (AS) 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, which requires CAM reporting.
He cited paragraph .14c which has a note: In describing how the CAM was addressed, “the auditor may describe: (1) the auditor’s response or approach that was most relevant to the matter; (2) a brief overview of the audit procedures performed; (3) an indication of the outcome of the audit procedures; and (4) key observations with respect to the matter, or some combination of these elements.”
In particular he noted items (3) and (4) because they “are consistent with the types of disclosures that many investors requested that CAMs provide in connection with the development of the standard.”
CII’s Mahoney shared his views during a meeting of the PCAOB’s Standards and Emerging Issues Advisory Group on March 30, 2023.
Mahoney looked at more than 100 CAMs. While only a small portion of all CAMs, he did not find any disclosures that are responsive to items (3) and (4). “So, I just question, isn’t it evidence of a significant unintended consequence if two of the disclosures that many investors wanted to see in CAMs do not appear to be provided by the CAMs?”
He was questioning the conclusion that the “staff has not found evidence of significant unintended consequences from auditors’ implementation” in an interim post-implementation review (PIR) published in December 2022.
Fewer CAMs
Some advisers’ criticisms also come amid a statistically significant decline in the number of CAMs.
For example, there were 1.69 CAMs per audit report on average frome June 2019 to June 2020 for large companies. That average went down to 1.61 from June 2020 to June 2021, according to the PIR report.
“I am surprised and disappointed actually that the number of CAMs are decreasing rather than increasing,” said Jennifer Joe, an accounting professor at the University of Delaware. “It just seems to me that business risks and the complexity of audits are increasing. And so, I see this as a major disconnect.”
The PCAOB staff also found that foreign auditors communicated more CAMs than U.S. auditors, “suggesting that firms may have heterogenous approaches to applying their judgment in determining whether a matter is a CAM, perhaps because non-U.S. auditors have greater familiarity” with Key Audit Matters (KAMs) that are required by the International Auditing and Assurance Standards Board (IAASB).
Thus, Preeti Choudhary, an accounting professor at the University of Arizona, said that it would be useful for PCAOB staff to take a closer look at why there may be differences between CAMs and KAMs. While similar, the two standards are not identical.
A deeper analysis “would be … helpful to understand whether those differences are intended or not,” Choudhary said. “I know the rules are different, but should they be different and are people behaving and responding the way you want them to?”
CII’s Mahoney said that this may also be evidence of an unintended consequence of CAMs.
Dane Mott, an accounting analyst with Capital Group Companies, believes that analysts should not have to go to two different filings to get information.
If KAMs have lower threshold, he said the PCAOB should consider lowering the threshold for CAMs because more information is helpful to investors.
“The fact that we are getting one to two CAMs per company, from fundamental analysis perspective, doesn’t make much sense to me because companies aren’t one dimensional,” he said. “There is always going to be more than one key thing.”
While he is disappointed to see incrementally fewer CAMs, “the cynic in me is not surprised by that either, though, because I think often with disclosure becomes a race to the bottom. Companies are benchmarking against their competitors, and they wait to see what disclosures come out from their competitors. And if they see that their competitors were able to get by with more legalese, less disclosure and they don’t get any kind of slap on the wrist for it, then that tells the others in the system that they can do the same, so you get less disclosure the next round.”
Sandra Peters, senior head for global advocacy for the CFA Institute, agreed that not all important CAMs are being reported. When CAMs first started to appear three to five years ago, her organization compared CAMs to the 10 top areas of Securities and Exchange Commission staff comment letters. SEC staff routinely reviews company disclosures, and if they find insufficient or misleading information, they send comment letters to companies to address it.
Nine of the top 10 staff comments were in CAMs, but one item—segment—was not. Segment reporting has been a perennial topic of SEC staff comments.
“And people were like ‘well, segments are very complicated, lots of estimates, lots of judgment, lots of management flexibility,” she said. “So, that relative to other things that are discussed about the company are particularly important. As we have seen in the last couple of weeks, a lot of investors have looked at the CAMs of the institutions which have had troubles and said the most important risk was not disclosed.”
She was referring to recent bank failures.
“So, I think what’s not there is going to be important to consider in a more complete” PIR, she said.
Auditors’ Views
In the meantime, auditors on the panel had a different take on CAMs.
Brian Croteau, a partner with PricewaterhouseCoopers LLP, said when CAMs were first implemented, it made management focus more on disclosures.
“We did see improvements or more transparency in management disclosure around the areas that are most challenging, subjective or complex,” said Croteau, who was previously a deputy chief accountant at the SEC. “I think that there is a benefit to that all in the context of the financial reporting framework.”
But Croteau found it disappointing that not many investors surveyed for the PIR report had seen CAMs. About three quarters, or 76 percent, had heard of CAMs, and only 57 percent had seen CAMs.
Another auditor, Steven Morrison, focused on the cost-benefit aspect of CAMs, stressing that it is difficult to really quantify costs.
While there have been some benefits, he believes that the PIR should go beyond asking questions about should the requirements be refined, are CAMs implemented correctly, “but their existence altogether” because not all investors want CAMs.
“There was also a comment made about of someone does not read the financial, they’re just looking at the report,” said Morrison, a partner with CohnReznick LLP. “I don’t think that should really drive our standard setting and our implementation of this because people really should be reading the actual financials.”
“If something is especially challenging, subjective or complex, it really should be called to attention in the financial statements themselves, ‘hey, this fair value was very hard for management to come up with and they had to think through it a lot or this impairment analysis was very subjective and so forth.’”
In terms of the low number of CAMs, he said that auditors can put 10 CAMs, but there are a lot more than 10 risks of material misstatements.
“Those CAMs are not the only events that are out there,” he said.
This article originally appeared in the April 7, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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