PCAOB Critical Audit Matter Interim Report (Release No. 2020-002)

On October 29, 2020, the PCAOB released its Interim Analysis Report on the initial impact of critical audit matter (CAM) requirements on key stakeholders in the audit process. Included in the 2017 changes to PCAOB Auditing Standard 3101, auditors are required to include CAMs in the auditor’s report, effective for fiscal years ending on or after June 30, 2019 for large accelerated filers, and for fiscal years ending after December 15, 2020 for all other companies to which the requirement applies. The PCAOB notes that “CAM communications are intended to inform investors and other financial statement users about matters that require especially challenging, subjective, or complex auditor judgement, and the auditor’s response to those matters.” The PCAOB analyzed 2,420 audit reports containing CAM communications, and reported an average of 1.7 CAMs per audit report with a range of 0-7 CAMs communicated per report. The most commonly identified CAMs were Revenue Recognition, Goodwill, Other Intangible Assets, and Business Combinations.

As evidence of the PCAOB’s commitment to understanding the impact of the CAM requirements, the Office of Economic & Risk Analysis at the PCAOB focused its analysis on the significant costs, benefits, and unintended consequences of three main areas impacted by CAMs: Audit firm and audit engagement team responses to the CAM requirements; investor use of CAM communications; and audit committee and preparer experiences related to CAM implementation.

Key Findings

1. Audit firms made significant investments to support initial implementation of the CAM requirements. Investments made by audit firms include developing tools, guidance and trained personnel, and establishing networks of CAM subject matter experts. Additionally, audit engagement teams spent 1% of total audit hours “identifying, developing, and communicating CAMs” in the year of implementation. Based on the results of the large accelerated filers implementation, the PCAOB believes that costs related to audit implementation of the CAM requirements were “largely inconsequential.”
2. Investor awareness of CAMs communicated in the auditor’s report is still developing, but some investors are reading CAMs and find the information beneficial. Investors are using CAMs to better understand the work of the auditor and company disclosures, and some have suggested expanding CAM requirements to include the outcome of audit procedures.
3. The staff has not found evidence of significant unintended consequences from auditors’ implementation of the CAM requirements for audits of large accelerated filers in the initial year.

Audit Firm Survey

The Big Four firms estimated that, on average, they spent 23,000 hours developing process and procedures to support CAM implementation (53% at the partner level), in addition to 14,000 hours of firm-wide CAM requirement related training (32% at partner level). The PCAOB estimates that these hours correspond to $6.5M in implementation costs for Big Four firms. Additionally, four “smaller” audit firms with 15 or more large accelerated filers were surveyed, and those firms estimated that they incurred approximately $1.0M of CAM implementation costs each, based on an average of 3,700 hours of process development and 3,100 hours of CAM related training.

Engagement Partner Survey

Engagement partners indicated 1% of total audit hours were spent on CAM matters, with approximately two-thirds of that time incurred before year-end. Prior to implementation by large accelerated filers, engagement partners were concerned that the additional CAM requirements would inhibit communications among the auditors, preparers, and the audit committee, over fears of what communication will be publicly disclosed; however, less than 2% of engagement partners in the survey reported that the new requirements constrained auditor communication with the audit committee, while 41% reported enhanced communications. Additionally, approximately one-third of engagement partners reported that the issuer made changes to the financial statement disclosure or other corporate reporting as a result of CAMs. Lastly, only 3% of partners report making changes to the nature, time and extent of audit procedures due to CAM requirements.

Investor Survey

Investor knowledge of CAMs is widening, with approximately only two-thirds of responders reporting to have heard of CAMs, and less than a third had seen CAMs in an audit report. Investors have reported using CAMs to “better understand the work of an auditor, better understand financial statement disclosures, and develop questions for company management” among other uses.

 Audit Committee Chair and Preparer Interviews

Audit committee chairs and preparers were also interviewed regarding their opinions of CAM implementation, and some responders noted that significant up-front preparation by auditors (including dry run programs) contributed to a generally smooth experience for issuers. Furthermore, none of the 12 audit committee chairs interviewed reported negative impacts to communication with their auditors as a result of CAM requirements. Preparers also noted that CAMs have not significantly changed their company’s financial reporting process or controls.

Moving Forward

The PCAOB expects to issue a similar report in 2022 to provide a prospective on any changes in the communication of CAMs and the initial impact on smaller issuers, in addition to a more comprehensive report in 2024 to provide a complete analysis of CAM implementation, since some of the effects of the new requirements may take several years to manifest.