Now is The Time to Prepare (for Critical Audit Matters)!

The year 2020 has been anything but typical and filled with change. So smaller public companies should be ready to embrace the first substantive changes to the standard auditors’ report in more than 70 years. For years ending after December 15, 2020, for the first time ever, the audit report of smaller public companies will be required to disclose Critical Audit Matters, or CAMs for short. Given that this is a significant change from current practice, and given the inherent sensitivity of certain CAMs, public companies, audit committees and auditors should be preparing for CAM implementation now.

The PCAOB (regulator of public company audit firms) defines a Critical Audit Matter as “any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements; and (2) involved especially challenging, subjective, or complex auditor judgment.” In simple terms, think about your recent audit committee meetings and the topics and issues discussed. Those will likely be your CAMs and will now be required to be disclosed in the auditors’ report. While the determination of CAMs is based on the facts and circumstances of each audit, the PCAOB has stated that “it is expected that, in most audits to which the CAM requirements apply, the auditor will determine at least one CAM.”

The Basic Process

When a CAM is identified, what exactly is required to be disclosed in the auditors’ report? Once again, the PCAOB has provided specific requirements to satisfy. For each CAM communicated in the auditors’ report, the auditor must:

  1. Identify the CAM;
  2. Describe the principal considerations that led the auditor to determine that the matter is a CAM;
  3. Describe how the CAM was addressed in the audit; and
  4. Refer to the relevant financial statement accounts or disclosures that relate to the CAM.

As you might imagine, providing this information in the auditors’ report about an issuer’s revenue recognition practices, income tax reporting, or asset impairment assessments will likely result in some spirited conversations between issuers and their auditing and assurance services firm.

Most Common Critical Audit Matters

Issuers that are categorized under the SEC’s rules as Large Accelerated Filers (generally those public companies with more than $700 million in non-affiliated market capitalization) and their audit firms have already adopted the CAM reporting requirements. A recent study by data firm Audit Analytics examined 333 CAMs from the audit reports of 193 Large Accelerated Filers, with an average of 1.7 CAMs per audit report. The top five topics most commonly identified as Critical Audit Matters thus far have been Business Combinations, Goodwill, Revenue Recognition, Income Taxes, and Contingencies.

For Emerging Growth Companies

Issuers that satisfy the SEC’s requirements as an Emerging Growth Company (EGC) are not required to disclose CAMs in their audit reports. However, auditors may early adopt CAM requirements or apply them voluntarily to audits for which they are not required. Last year, law firm Cooley LLP reported that 39% of surveyed EGCs responded that they plan to apply the CAM requirements voluntarily, while 39% are undecided and 22% will definitely not apply them voluntarily.

No Surprises

With most small public company’s Q3 reporting season still weeks away, the time to prepare your company for CAM implementation is now. Your first step should be to educate and inform key stakeholders, such as financial management, audit committee members, and even key investors. Next, request a dry run or a sample audit report from your auditing and assurance services firm to facilitate an open and honest discussion about your company’s likely CAMs. Taken now, these simple steps will help ensure a seamless transition to CAM reporting so that your business can focus on some of 2020’s many other challenges.

If you would like to learn more about Haskell & White’s experience assisting public companies with new requirements, contact us today to speak to our team.