The Public Company Accounting Oversight Board’s (PCAOB) Investor Advisory Group (IAG) has presented three examples of the most decision-useful critical audit matters (CAMs) of 2023 as selected by the panel among those nominated by the public. Two of the three CAMs were by Deloitte & Touche LLP for its audit of Berkshire Hathaway Inc., and the other was by Ernst & Young LLP for its audit of Moderna, Inc.
The two CAMs by Deloitte for Berkshire are goodwill and indefinite-lived intangible assets; and unpaid losses and loss adjustment expenses—retroactive reinsurance contracts. The significant issues with Berkshire had to do with insurance and problems with acquisition related to the Precision Castparts Corp. reporting unit. For Moderna, it was related to the end of pandemic and its COVID-19 vaccine no longer being in hot demand.
The winning CAMs were all nominated by former IAG member Jack Ciesielski, president and portfolio manager of R.G. Associates, who also serves on the FASB’s Emerging Issues Task Force.
During the IAG meeting, Ciesielski said that when he looks at CAMs, it’s to add to his knowledge of the company in question.
“If I am aware of some situation within the company that would seem to have some critical audit potential, I’d like to see that the auditors thought the same thing. And all three of these hit that mark,” he explained. “If you are looking at an insurance company, you know that one of the biggest rubbery numbers on the balance sheet is going to be the reserve for unpaid losses and adjustments to a prior unpaid loss of liabilities.”
Further, he said that goodwill is going to be “a touchy thing,” and the well-known company had both.
“So I was happy to see that the auditors thought the same as me, that these are touchy situations for the balance sheet and entail audit risk.”
And in his view, Deloitte did a good job of presenting those critical issues.
However, the auditors could certainly do a better job of writing CAMs, he said.
While Deloitte avoided “complete boilerplate,” the auditor “could have added a little bit more flesh to the bones.”
Deloitte said that it tested the key assumptions but did not elaborate which ones. The Big Four firm also provided a good outline of their strategy in auditing the balance, “but a little bit more detail would have been more compelling or more comforting to the investor,” Ciesielski said.
On Moderna, Ciesielski said that there was a known risk in the balance sheet or the income statement as expected after the end of the pandemic, and EY picked up on it.
“You knew that a big chunk of their business was going to go away, and the auditors did a fine job, I thought, of describing it,” he said. “Nobody ever had a vaccine like that before, and then had it suddenly become useless. Not a lot of prior experience for the company because the company was pretty new, too.”
However, in all three CAMs, Ciesielski said that those matters disclosed were not unexpected. He said that he looks at CAMs to get information that he might not have known otherwise. But both Deloitte and EY did not deliver on that front.
For Moderna, for example, Ciesielski pointed out on the absence of research and development (R&D) as a CAM. As a pharmaceutical company, a big chunk of its expenses is obviously on R&D.
“How do I know that what’s being represented as R&D is really top quality, or top notch R&D, or has actually been classified properly. Something like 73, 74% of revenues in 2023 were R&D at Moderna,” he said. “It seems to me that that’s a pretty big audit matter, but there was no CAM about it.”
The CAM disclosures are intended to provide more insight into what accountants found while auditing public companies. However, investors and regulators have been worried about the quality and quantity of CAMs disclosed over the years. Critics say that many of the CAMs use boilerplate disclosures. Many are about the procedures of auditing rather than real insight about what auditors found while checking the financials.
This is more concerning today as companies are becoming increasingly more complex with a lot of estimates and judgments involved in putting together a set of financial statements. The business environment is also more complex today.
According to a PCAOB report, there were 1.69 CAMs per audit report on average from June 2019 to June 2020 for large companies. That average went down to 1.61 from June 2020 to June 2021. And this was put on the PCAOB’s research agenda late 2023 following push by the IAG for potential rulemaking down the road.
The public invitation to submit good CAMs or key audit matters (KAMs) under international standard nominations is being led by IAG member Jeffrey Mahoney, general counsel of the Council of Institutional Investors (CII). And he said this would be a yearly event.
“The objective of this annual IAG initiative is to encourage auditors to continually improve the quality of information communicated to investors in the audit opinions of public companies,” Mahoney said.
And this is especially important as investors say CAMs are important.
Almost all, or 92%, of investors say that they rely on CAMs when making investment decisions, according to a July 2024 survey by the Center for Audit Quality (CAQ) of 100 U.S. institutional investors.
Most, or 88%, investors have received training on the utility of CAMs.
Further, 93% of investors read the CAMs section in the auditor’s report, of which 78% say they always or often do. The same percentage of investors also say that CAMs play an important role in their decision-making analysis of a potential investment, the CAQ found.
And 58% of the 100 institutional investors survey said that they want to see more CAMs but said that industry or market conditions also play a role. While 90% were satisfied with the quality and clarify of CAMs, 52% said that increasing the number or detail of CAMs would be beneficial for their investment decisions.
This year, the IAG received submissions from seven individuals or organizations, nominating 26 CAMs or KAMs from the 2023 audit reports of 12 publicly listed companies. After two rounds of voting by IAG members, the three submitted by Ciesielski got the most vote.
This article originally appeared in the October 4, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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