As US public companies file their 2017 financial statements, the auditor’s report looks different.
To understand the changes and for context on what further adjustments lay in store for 2019, I sat down with James A. Doty in December, when he was chair of the Public Company Accounting Oversight Board (PCAOB), a post he held through 1 January 2018, to get his insights.
Auditor’s Report Changes
The US Securities and Exchange Commission (SEC) gave final approval to the new PCAOB standard, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion (New Audit Reporting Standard), in October 2017.
Doty said this standard represents the first change to public company audit reports in more than 70 years. The changes can be divided into two categories.
- Form and Scope of Audit Report and Auditor Tenure: Beginning with reports on the 2017 financial statements issued in 2018, the auditor’s report will:
- Be reordered to put the opinion paragraph first and include titles to guide the reader;
- Be addressed to the companies’ shareholders and board of directors;
- Include a statement regarding the auditor’s independence;
- Clarify the auditor’s responsibility regarding fraud; and
- Provide the tenure of the auditor.
- Critical Audit Matters: The second, and more significant change, related to the 2018 financial statements for large accelerated filers, will first appear in 2019 and then for all other companies for their 2020 financials. This change will require auditors to disclose critical audit matters (“CAMs”) that describe the audit matters that relate to material accounts or disclosures and involve especially challenging, subjective, or complex auditor judgments.
Disclosure of Engagement Partner and Other Auditors Involved in Audit
Doty and I discussed another PCAOB standard, Auditor Reporting of Certain Audit Participants (Audit Participants Standard), which was approved for release by the SEC in 2016 but will become fully effective this month (March 2018).
With this standard, investors can now not only identify the audit firm issuing the opinion, but also the partner assigned to the engagement, and to what degree other auditors were used by the primary auditor in reaching its conclusion on the financial statements. This information will be available to investors on the PCAOB’s AuditorSearch database.
The Objective of the Changes
The New Audit Reporting Standard and the Audit Participants Standard seek to increase the transparency for investors as to who is involved in the execution of the audit, the duration of the auditor’s relationship with the company, and the key issues the auditor faced when executing the audit.
The PCAOB’s due process over the last eight years found that investors wanted to know more about those involved in the audit and what the auditor’s key issues were during the performance of their procedures. Doty said that the changes sought to increase the credibility and relevance of the audit report to investors. The due process had shown that investors, in a post-financial crisis era, wanted more than the pass/fail model of reporting and to hear directly from the auditors on the results of their work.
We’ve written extensively about improvements in the auditor’s report internationally over the last five years (May 2014, February 2016, July 2016) as investors have seen significant changes in the reporting and relationship with auditors in other regions of the world in the post-financial crisis era.
I asked Doty whether these new standards were meant to create greater comparability with information investors see internationally. He noted that greater alignment between international markets was a key consideration. While not identical to its international counterparts, the PCAOB’s requirements will help to harmonize the information investors see globally.
Investors Input in Due Process
Finally, Doty highlighted how critical stakeholder input is to the PCAOB’s standard process, singling out investors, as the consumers of the information, for their singular influence on the PCAOB’s due process.
Our commentary on US and international auditing standards has been shaped through several member surveys (2010, 2011, 2012) over the last eight years. The time, attention, and insight investors have dedicated to completing these surveys have been vital to our commentary and to the standard setters’ due process.
If you liked this post, don’t forget to subscribe to the Enterprising Investor.
All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: ©Getty Images/retrorocket