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It is unclear at this point, however, how the SEC will proceed under SEC Chair Clayton’s leadership.The SEC is expected to seek public comment on AS 3101 to inform its consideration of whether to approve that standard in the form adopted by the PCAOB.While the SEC now requires that the audit committee report disclose whether or not the independent auditor has discussed with the audit committee those matters prescribed by relevant PCAOB standards and rules, the audit committee report need not disclose these matters, some of which may be what AS 3101 defines as CAMs.Few companies have chosen to volunteer these disclosures, whether in the audit committee report or elsewhere in the proxy statement, despite the encouragement provided in a 2015 SEC concept release.[iv] We believe it is unlikely that the SEC itself will propose mandating such disclosures given the present deregulatory environment.If approved by the SEC, the PCAOB’s new auditor’s reporting model will follow international trends by giving investors insights into the key judgments made by the outside auditor – a glimpse of the deliberations behind the pass/fail veil.On June 1, 2017, the Public Company Accounting Oversight Board voted to adopt a new auditing standard that, if approved by the Securities and Exchange Commission, will significantly expand the current auditor’s report.[i] The new report will augment the traditional pass/fail opinion with a discussion of “critical audit matters” (CAMs), disclosure of the auditor’s tenure and certain other information. The adopted standard, AS 3101, is substantially the same as the standard reproposed by the PCAOB in May 2016.The auditor’s report will be required to disclose the year in which the auditor began serving consecutively as the company’s auditor (which could precede the company’s IPO).
It remains to be seen whether the auditor’s disclosure of CAMs in future audit reports will prompt audit committees to provide more detailed information in their own report, published in the proxy statement, about the substance of communications with the auditor.The proposed phase-in of effective dates will give independent auditors and their registrant audit clients a long runway during which to reflect on and prepare for the most sweeping of the new auditor reporting changes – identification and disclosure of “especially challenging, subjective, or complex” aspects of the audit.Audit committees overseeing ongoing management efforts to comply with new generally accepted accounting principles (GAAP) on the near horizon – including those relating to revenue recognition, leases and financial instruments – should factor in the enhanced level of critical auditor scrutiny that AS 3101 portends with respect to management judgments and assumptions made in applying the new GAAP.According to the PCAOB, the new auditor’s report will give investors and other users of financial statements additional insight into the underlying key judgments that a company’s outside auditor has made and communicated to the audit committee – thereby reducing “the information asymmetry between investors and auditors, which should, in turn, reduce the information asymmetry between investors and management about the company’s financial performance” and lead to more efficient capital allocation.
The PCAOB also pointed out that enhanced auditor reporting is in keeping with international trends.The new standard will apply to all audits conducted under PCAOB standards, although, as discussed below, certain companies will be exempt from the CAM disclosure requirement.