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CPAs Expect Audits to Come with Bigger Price Tags under New PCAOB Rule

Chris Gaetano
Published Date:
Oct 3, 2017

More time, more risk and more expense—this is what auditors expect will be the effect of a recent Public Company Accounting Oversight Board (PCAOB) measure expanding the standard auditor’s report. Under the rule, formally approved by the board on June 1, the standard auditor’s report will include, among other things, the communication of “critical audit matters (CAM),” or information that the PCAOB believes investors and other users would find relevant.

A CAM for this standard, AS (Auditing Standard) 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, is defined as an issue that is communicated or required to be communicated to the audit committee, and relates to both accounts or disclosures that are material to the financial statements and involved especially challenging, subjective or complex auditor judgment. When auditors disclose a CAM in their reports, they must identify the CAM and describe the principal considerations that led them to determine that the matter was a CAM, describe how it was addressed in the audit, and refer to the relevant financial statement accounts or disclosures.

“[The PCAOB is] expecting auditors to provide a lot more color and clarity around those issues of audit significance, whether because they’re complex or material or both,” said Michael A. Cohen, a partner with Friedman LLP who works in the firm’s SEC Services Group.

These additional considerations mean that the audit report itself will take longer to compile, which also means that it will become more expensive to produce, as firms will need more time to perform the documentation requirements as well as review the work. Firms will likely pass these costs on to the client, increasing fees for public clients. Depending on the size of the audit, he said, this increase could be “anywhere from 5 to 15 percent of what the quoted fee currently is,” at least in the middle market.

Another factor driving the additional time needed to draft the audit report, CPAs said, is litigation exposure. In both of the NYSSCPA’s comment letters on the then-proposed standard—one issued in 2013 and the other in 2016—there were concerns expressed that the new rules would increase firms’ legal liabilities. Jonathan Zuckerman, an audit partner at PKF O’Connor Davies, LLP, said that an effect of this rule might be that auditors will become more careful when drafting the report, as they will need to meticulously weigh what does and does not rise to the level of a CAM. Auditors will need to consider the scenario where they omit something that a later user of the financial statement thought was important.

“It will be drafted as almost a part of the risk assessment process. I think auditors will have to ask themselves what a scenario of a failure to disclose a CAM [looks like]—if they omitted something that [would make someone ask,] ‘Why didn’t you consider this a critical audit matter?’ I think that’s the biggest risk,” he said.

This heightened scrutiny, he noted, will lead to an increased use of experts to handle matters such as the valuation of a company in order to make sure that the report doesn’t miss something, as well as increased input from the firm’s legal counsel in determining the proper wording of critical audit matters. The firm’s quality control team will also increase its input, he added. Zuckerman raised the possibility that legal risks might lead some firms to give up on public company audits altogether, although he said they would mainly be firms that only dabble in this arena.

Another possible effect, according to Cohen, is that auditors will try to protect themselves by listing as many items as possible as CAMs.

“Because if everything is in there, no one can accuse you of not saying enough,” he said.

David M. Rubenstein, an audit partner with Mazars USA LLP and a member of the NYSSCPA’s Chief Financial Officers Committee, added that the rules will likely change how the auditors interact with the audit committee as well. While the audit opinion today, he said, is largely a boilerplate document that the committee examines for 30 seconds and then moves on, Rubenstein anticipates that the inclusion of CAMs will drive a more active discussion of the audit opinion, and even lead to the committee asking for early draft opinions more frequently; today, that’s an uncommon occurrence. This back-and-forth discussion, however, will be more careful and considered on both sides, given the centrality of audit committee communications to the new standard.

“I think the auditor—and I’m merely now speaking for myself—but I would think they would be very careful as to what they say and how they say it and how they present these issues or critical audit matters,” he said. “I think audit committees will also be very careful in their response because, obviously, they don’t want to say anything to trigger [in the auditor’s mind] their requirement to disclose a critical audit matter, based on communication with the audit committee.”

Joan C. Conley, senior vice president and corporate secretary with Nasdaq, brought up a similar issue in an Aug. 24 comment letter to the Securities and Exchange Commission (SEC). She expressed concern that companies could become overly cautious in their communications with the auditor, cutting off the frank exchange of views that she said was necessary to a healthy relationship between the two.

“The CAMs disclosure requirement would overhang every communication between a company’s audit committee and the audit firm. We believe this would lead the audit committee to limit or curtail communication with the auditors and, thereby, adversely impact appropriate exercise of the audit committee’s oversight responsibilities,” said Conley in the comment letter.

There is also a more fundamental concern about how the new framework alters the relationship between the auditors and the company they audit. A joint comment letter written by senior executives at Aetna Inc.; Anthem, Inc.; Cigna Corporation; Humana Inc. and UnitedHealth Group Inc. said that the new report could lead to the auditor saying one thing in a CAM and management saying another in its report, which could damage the relationship between the two.

“Any unreconciled ‘inconsistent or competing information’ could be a source of tension and disagreement between management, audit committees, and auditors and could lead to breakdowns in communication that would diminish the quality of financial reporting and auditing as a whole,” said the comment letter.

The possibility of a more adversarial relationship with the auditor was also raised by Robert A Klug, vice president, corporate controller and chief accounting officer of Quest Diagnostics, who noted that similar conflicts could arise over the auditor’s decision to disclose at all. He expressed worry that, because auditors have discretion over what is disclosed as a CAM, the report could contain information that management did not think needed to be disclosed at all, thereby increasing tension.

“[I]t is also likely that there will be instances where the auditor will make a conclusion to disclose information that the company has concluded is commercially sensitive, inappropriately timed or otherwise unnecessary to disclose. Such conflict is unavoidable because the Proposed Standard provides that the auditor has the authority to disclose such information if ‘such information is necessary to describe the principal considerations that led the auditor to determine that a matter is a critical audit matter or how the matter was addressed in the audit,’" said Klug in his letter.

He also noted that both auditors and companies, over time, may develop a minimalistic approach to disclosure so as to reduce potential legal exposure. This, Klug said, will mean that the new language in the audit report would devolve into boilerplate language that reveals little to investors that they didn’t already know. He added, too, that the new expanded auditor’s report will “result in significant additional costs to shareholders given the extra time and resources required to meet the requirements from the auditor and the company.”

Another possible change is the relationship with investors. Rubenstein said that the expanded auditor’s report might lead to more questions from investors during shareholder meetings. While the proxy materials generally require that someone from the auditing firm be at the meeting, Rubenstein said that, in his experience, he’s generally received very few questions. The expanded audit report, though, may open the door to more of a back-and-forth dialogue between the auditor and the investors over the CAMs discussed in the report.

“Let’s say I’m writing an opinion on a client, and I have very significant critical audit matters, and we go into great depth and discuss it and disclose it and talk about it and how it will be resolved. … No matter how much we put in, it will probably raise questions in investors’ minds as to, ‘Well, how did you get comfortable with it?’” he said.

Jan Herringer, NYSSCPA president-elect and an audit partner at BDO USA, LLP, noted that the new expanded audit report plays into larger changes happening within the profession as a whole, with CPAs today expected to possess both technical and social skills in order to meet the changing business environment.

“While it is true that quantitative skills have traditionally been the foundational skill set of the accounting profession, the profession now is so dynamic and multifaceted that the skill set of the CPA has moved beyond that to encompass much more. In particular, communication skills, both written and verbal, are increasingly important,” she said.

The PCAOB rule must be approved by the SEC before it takes effect.

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