Investment Company Notebook

Practical insight and analysis on the accounting, audit and tax issues impacting investment companies.

What You Need To Know About Proposed Changes to the Auditors' Reporting Model

Late this summer, the Public Company Accounting Oversight Board (PCAOB) released for public comment drastic changes to the auditors’ reporting model. These changes would be accomplished through two new auditing standards. The first proposed auditing standard- The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion- establishes requirements regarding the content of the auditor’s written report. The second proposed auditing standard- The Auditor’s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor’s Report- establishes requirements regarding the auditor’s responsibilities with respect to information, other than the audited financial statements and the related auditor’s report, in a company’s annual report that is filed with the SEC under the Securities Exchange Act of 1934 and contains that company’s audited financial statements and the related auditor’s report.

The form of the auditor’s opinion has remained relatively unchanged over the last 70 years. The revised opinion would still retain the traditional pass/fail model, namely that the financial statements are fairly presented or they are not and retains other basic elements such as the financial statements being audited, periods audited, management’s and auditor’s responsibilities, basis of opinion and opinion.

The change getting the most attention requires the auditor to disclose in the audit report critical audit matters addressed during the audit. As defined in the proposal, critical audit matters are those matters addressed during the audit that 1) involve the most difficult, subjective, or complex auditor judgments; 2) pose the most difficulty to the auditor in obtaining sufficient appropriate evidence; or 3) posed the most difficulty to the auditor in forming the opinion on the financial statements. The term “most” is not meant to mean “only one” and the proposal indicates that the PCAOB expects most audit reports to contain at least one critical audit matter. Adding to the determination of what is and what is not a critical audit matter, the proposal goes on to further define critical audit matters as matters of such importance that they are required to be 1) documented in the auditor’s engagement completion document, which summarizes significant issues and findings from the audit; 2) reviewed by the Engagement Quality Reviewer; 3) communicated to the audit committee; or 4) any combination thereof.

Other changes to the auditor’s reporting model designed to enhance investors’ understanding about the audit and the auditor are as follows:

  • Requires the auditor to make a statement in the audit report that the auditor is a public accounting firm registered with the PCAOB and is required to be independent with respect to the company.
  • Requires the auditor to indicate in the report the year in which the auditor began serving the company.
  • Recognizes the auditor’s existing responsibility to plan and perform the audit to obtain reasonable assurance that the financial statements are free of material misstatement, and requires that the auditor discloses that such material misstatement is further defined as “whether caused by error or fraud”.
  • With respect to other information in certain documents containing audited financial statements and auditors reports, requires that the auditor evaluate if a material inconsistency with the amounts or information or material misstatement of fact exists between audited financial statements and other information.

An example of the proposed new auditor’s report which includes a critical audit matter is provided here. All bolded language represents a change or addition to the current auditor’s opinion.

The PCAOB’s stated purpose for these proposed changes is to make auditors’ reports more informative and increase auditors’ reports relevance and usefulness to investors and other financial statement users. The PCAOB is accepting comments to this proposal through December 11, 2013. If approved, the changes would become effective for fiscal periods beginning on or after December 15, 2015.