Pass-fail auditors’ reports have been in place for decades, but in 2019, a major change was made, as auditors of public companies began to report critical audit matters (CAMs) in audit opinions.
Accounting rule makers are now making an assessment of how well this project has performed its function over the last two years, in order to decide whether changes are required to provide financial statement users with more cost-effective, useful information.
Auditing and CAMs
Auditors are required to include a discussion of CAMs in the audit report under Auditing Standard (AS) 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion. For these purposes, a CAM is defined as any matter that:
- Is related to accounts or disclosures that are material to the financial statements
- Has been communicated to the audit committee
- Requires an auditor to use complex judgment or make a subjective decision
Under this new guidance, auditors are required to identify each CAM, detail the reasons they selected it, and provide support for their assertions by citing relevant financial information. There is no specific list of possible CAMs provided by the Public Company Accounting Oversight Board (PCAOB), and there isn’t a prescribed number of CAMs that auditors must state in their report.
Auditors working with large public companies that have market values of $700 million or more must report CAMs for fiscal years ending on or after June 30, 2019. Auditors for smaller public companies are required to report CAMs for fiscal years ending on or after December 15, 2020.
Recent developments
The Center for Audit Quality (CAQ) issued a new review of the audit rules for CAMs in December 2020.
Critical Audit Matters: A Year in Review reported that for S&P 100 companies, the most frequent categories of CAMs were taxes (at 16%), goodwill and/or intangibles (at 14%), contingent liabilities (at 12%), and revenue (at 9%).
The remaining 49% were split among 23 different categories including sales, returns, and allowances, business combinations, asset retirement, environmental obligations, and pensions and other post-employment benefits. CAMs are expected to continue changing from year to year.
The COVID-19 pandemic was one of 2020’s biggest developments. Although the virus itself doesn’t qualify as a CAM, auditors may need to report COVID-19’s impact on material accounts or disclosures as a CAM. For instance, market volatility caused by the pandemic could trigger a complex impairment analysis for goodwill.
Stay tuned for possible changes
The Financial Accounting Standards Advisory Council (FASAC) met in June 2021 to evaluate whether updates needed to be made. On the whole, FASAC members concluded that the accounting areas most frequently referenced as CAMs were generally aligned with FASAC’s expectations.
However, there isn’t much information in financial statement disclosures for some accounting areas like loss contingencies. Research has also suggested that CAMs may have a greater impact on less sophisticated investors because they may highlight accounting areas the investor was previously unaware of.
So far, AS 3101 hasn’t triggered any immediate changes to accounting rules—but it may take several years for some effects of the CAM requirements to fully stabilize or manifest. The PCAOB has plans for a more thorough post-implementation review of the CAMs rules, to be published in 2024. For the latest news on the rules involving CAMs and auditing, contact your auditor.