The New PCAOB Auditor Report Requirements

Posted by on March 12, 2018

The New PCAOB Auditor Report Requirements- Today is the first in a LawCast series talking about the new PCAOB auditor report requirements. In October 2017, the SEC approved a new rule by the Public Company Accounting Oversight Board (PCAOB) requiring significant changes to public company audit reports. Among other additions, an audit report will need to include critical audit matters (CAMs) and disclose the tenure of the auditor. The new rule and requirements related to audit reports are significant as the audit report is the document in which the auditor itself communicates to the public and investors.

The new standard will require auditors to describe CAMs that are communicated to a company’s audit committee. Critical audit matters are those that relate to material financial statement entries or disclosures and require complex judgment. One of the purposes of the proposed change is to require the auditor to communicate to investors, via the audit report, those matters that were difficult or thought-provoking in the audit process and that the auditor believes an investor would want to know.

The new audit report standard also adds information related to the audit firm tenure, and the auditor’s role and responsibilities. Tenure can be an important factor in an audit, including an auditor’s experience and thus understanding of a company’s business and audit risks.

The process in finalizing the rule has been lengthy, having begun in 2010 in response to investor- and public-initiated comments. Once proposed, the rule went through three rounds of public solicitation for comment. Of particular concern is whether the new requirements will result in increased nuisance shareholder litigation, costing the company and its investors, and whether it will result in a chill on auditor-company communications. In a statement related to the new auditor report, SEC Chairman Jay Clayton expressly addressed this concern, stating:

“I would be disappointed if the new audit reporting standard, which has the potential to provide investors with meaningful incremental information, instead resulted in frivolous litigation costs, defensive, lawyer-driven auditor communications, or antagonistic auditor-audit committee relationships — with Main Street investors ending up in a worse position than they were before.

I therefore urge all involved in the implementation of the revised auditing standards, including the Commission and the PCAOB, to pay close attention to these issues going forward, including carefully reading the guidance provided in the approval order and the PCAOB’s adopting release.”

As an aside, as with any rule making, SEC rules and regulations can and do result in unintended consequences. This is an issue I’ve raised many times over the years in my blogs, including, for example, the multitude of differences between requirements for smaller reporting companies and emerging growth companies, a topic the SEC is now working on addressing and rectifying. It is great to see Chair Clayton discuss this phenomenon directly and for the rule itself to take measures to monitor and initiate changes based on implementation analysis.

There are certain carve-outs from some of the rule requirements, including the CAM requirements. In particular, the CAM reporting does not apply to emerging growth companies (EGCs), broker-dealers, investment companies, business development companies or employee stock plans; however, they do specifically apply to smaller reporting companies. Moreover, the rule requires extensive post-implementation review, in light of the potential for negative unintended consequences, and such review could result in changes to the rule itself and its implementation schedule.