Critical Audit Matters
A Year in Review
In 2019, auditors began communicating critical audit matters (CAMs) in their auditor’s reports. The Public Company Accounting Oversight Board (PCAOB) defines a CAM 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. With these new PCAOB requirements, auditors now communicate in their auditor’s report information about those areas of the audit that involved especially challenging, subjective, or complex auditor judgment.
There were over 2,000 large accelerated filers for the 2019 reporting cycle. With the first phase of CAM implementation complete, all large accelerated filers have had the opportunity to issue financial statements with auditor’s reports containing CAMs. This publication presents observations from the CAQ’s analysis of the CAMs communicated in the auditor’s reports for companies broadly, as well as a deeper dive into the S&P 100, which comprises 100 public companies across multiple industry groups. Our observations demonstrate the impact the public company audit profession has had on providing investors and others more information about the audit by complying with the new requirements. The auditor’s reports we reviewed provide straightforward descriptions about those matters that involved especially challenging, subjective, or complex auditor judgment. Within the audit procedures listed in the CAM communications, auditors provided insights into the auditing of the matter that was a CAM and a description the audit procedures performed to get comfortable with the matter. The result is an increase in the total mix of information available to investors.
Early Trends in CAMs
It is important to remember that the auditor’s assessment of the risks of material misstatement and related audit response vary based on a company’s unique processes and controls. While CAMs are specific to each audit, auditors of companies in the same industry could identify and communicate similar matters as CAMs. However, the principal considerations that led the auditor to determine a matter was a CAM and the way the matter was addressed in the audit may differ. As such, the content of the CAM communications differs.
How many CAMs were communicated?
Within the S&P 100, every auditor’s report in the population contained at least one CAM. There were 198 total CAMs in the population, for an average of just under two (1.98) CAMs per report. There was a single auditor’s report that communicated five CAMs, while 32 auditor’s reports communicated only one CAM.
Approach to CAM communications
Auditors approached and organized their CAM communications in different ways. For example, some auditors used bullets and headings while others organized the components of the CAM communication in paragraph form. Regardless of style, we were able to navigate through each required element of the CAM communication in auditor’s reports for S&P 100 companies to understand the following:
what matters were determined to be a CAM
the principal considerations that led the auditor to determine that the matter was a CAM
how the CAM was addressed in the audit
the relevant financial statement accounts or disclosures that related to the CAM
What were some of the principal considerations for matters being a CAM?
In the auditor’s reports we analyzed for companies in the S&P 100, one common driver for matters being a CAM appeared to include a high degree of judgment by management related to the matter that led to a high degree of auditor judgment to assess or evaluate management’s conclusions. Some CAM communications also described the audit effort and involvement of professionals with specialized skills and knowledge as principal considerations for the matter being a CAM.
How were CAMs addressed in the audit?
To describe how CAMs were addressed in the audit, we observed that auditor’s reports for S&P 100 companies included the following:
a description of the auditor’s response or approach that was most relevant to the matter
a brief overview of the audit procedures performed
some combination of both
Auditors had different approaches to how they organized and described this information. The auditor’s description of the procedures or audit response most relevant to the CAM was specific to each audit. For example, we observed that auditors described that how they addressed the CAM in the following ways:
describing the internal controls tested
identifying specific audit procedures performed
communicating the evidence evaluated
noting the use of personnel with specialized skills and knowledge
This level of transparency allows users to understand more about the areas of greater risk and how the auditors developed their testing approaches to audit those areas.
The PCAOB standard states that language that could be viewed as disclaiming, qualifying, restricting, or minimizing the auditor’s responsibility for CAMs or the auditor’s opinion on the financial statements is not appropriate and may not be used. The language used to communicate a CAM should not imply that the auditor is providing a separate opinion on the CAM or on the accounts or disclosures to which they relate.
None of the auditor’s reports for companies in the S&P 100 population described how the matter was addressed in the audit by including an indication of the outcome of the audit procedures.
What were the most common CAMs?
Of the 198 CAMs identified within auditor’s reports in the S&P 100, there were four common categories of CAMs: taxes (32 CAMs), goodwill and/or intangibles (28 CAMs), contingent liabilities (23 CAMs), and revenue (18 CAMs).
It is not surprising that matters in these categories could meet the definition of a CAM. Accounts and disclosures in these four areas are typically material to the financial statements, are matters that would be communicated or required to be communicated to the audit committee, and are matters that often involve a high degree of management judgment, which could in turn involve especially challenging, subjective, or complex auditor judgment.
Fifty-one percent of the CAMs in the auditor’s reports for companies in the S&P 100 were in these four common categories of CAMs. The remaining 49 percent of the CAMs were spread across 23 different categories that were less prominent from a trend perspective. This demonstrates the uniqueness of CAMs to each individual audit. Business combinations, sales returns and allowances, pensions and other post-employment benefits, and asset retirement and environmental obligations were all topics that auditors of companies in the S&P 100 identified as CAMs.
Explore each CAMs topic:
A Closer Look at CAMs
In the CAQ’s December 2018 publication Critical Audit Matters: Lessons Learned, Questions to Consider, and an Illustrative Example, the CAQ provided questions that audit committee members could ask their auditors as the CAM requirements were being implemented. We will revisit some of those topics based on the CAMs we observed in the auditor’s reports for S&P 100 companies.
Has there been a CAM for every critical accounting policy or estimate disclosed by management?
Within the auditor’s reports for the S&P 100, the CAQ observed a single instance of an auditor’s report having a CAM for each critical accounting policy or estimate disclosed in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section of its Form 10-K. Many filings had two to three times the number of critical accounting policies in the MD&A section of their Form 10-K than CAMs communicated in the auditor’s report.
In their early analysis of CAMs, the SEC staff observed some connection between CAMs identified by the auditor and critical accounting estimates disclosed in the MD&A, but not a one-to-one relationship. The identified trend is consistent with the SEC staff’s expectations, as, despite some similarities between CAMs and critical accounting estimates, their objectives differ. CAMs tend to be a subset of critical accounting estimates, but not every critical accounting estimate necessarily involves especially challenging, subjective, or complex auditor judgment.
The source of CAMs also is broader than just critical accounting estimates; therefore, the auditor may identify CAMs in areas that are not disclosed by management as critical accounting estimates. For example, 12 CAMs in auditor’s reports for S&P 100 companies related to a business combination, and only one company also had a critical accounting policy related to business combinations.
Were there any CAMs that communicated a significant deficiency in internal control over financial reporting (ICFR)?
A significant deficiency, in and of itself, cannot be a CAM; such determination, in and of itself, does not relate to an account or disclosure that is material to the financial statements as no disclosure of the determination is required. A significant deficiency could, however, be among the principal considerations that led the auditor to determine that a matter is a CAM. As expected, we did not observe any CAM communications that mentioned a significant deficiency in ICFR.
The description of the principal considerations is meant to provide a clear, concise, and understandable discussion of why the matter is a CAM, including the especially challenging, subjective, or complex auditor judgments made in the context of the particular audit. The “why” is intended to provide information appropriately tailored to the audit and the matter that helps financial statement users understand the aspects of the audit that stood out from the auditor’s perspective.
We did observe two auditor’s reports in the population of S&P 100 companies with a CAM that mentioned a material weakness in ICFR as a principal consideration for the CAM. These also were the only two S&P 100 companies that disclosed a material weakness during the 2019 fiscal year.
A Closer Look at CAMs outside of the S&P 100
The S&P population of filers is made up of many highly capitalized and well-known companies, but it is limited to only 100 of the over 2,000 large accelerated filers for which the CAM requirements were implemented. The entire population provides some additional interesting data points.
Were there any auditor’s reports without any CAMs communicated?
There were no companies in the S&P 100 population without CAMs, but we did observe 16 auditor’s reports for large accelerated filers without a CAM in the broader population. The determination of CAMs is based on the facts and circumstances of each audit. It is expected that, in most audits to which the CAM requirements apply, the auditor will determine at least one CAM. However, there also may be audits in which the auditor determines there are no CAMs.
How comparable are CAMs and KAMs?
Both the PCAOB’s and the International Auditing and Assurance Standards Board’s (IAASB’s) auditor reporting standards were adopted with the overall intent of providing users of auditor’s reports with more audit-specific information. The IAASB standard requires auditors to first determine which matters require significant auditor attention, and then determine which of those matters are of most significance to the current period’s audit, and therefore constitute key audit matters (KAMs). KAMs, unlike CAMs, may include matters relevant to the audit that are not directly related to accounts and disclosures in the financial statements.
Prior to the implementation of CAMs, KAMs had already been implemented in many jurisdictions. Recognizing the potential similarities, the PCAOB has stated that, although the processes of identifying these matters vary across jurisdictions, there are commonalities in the underlying criteria regarding the matters to be communicated and the communication requirements, such that expanded auditor reporting could result in the communication of many of the same matters under the various approaches.
While no S&P 100 filings reported both CAMs and KAMs, within the broader population of large accelerated filers there were foreign private issuers that communicated both (CAMs in their PCAOB auditor’s report and KAMs in their statutory auditor’s report). The CAMs and KAMs included in several of the reports analyzed by the CAQ were as unique as the companies themselves. In some auditor’s reports, there were differences between the number of CAMs and KAMs that were communicated for the same entity. Given the broader definition of KAMs, this is not unexpected. Some KAMs do not directly relate to accounts or disclosures in the financial statements and thus cannot be CAMs under PCAOB standards. There were instances in which the filer’s reports included the same quantity and identical topics between CAMs and KAMs, but the description of the CAMs and KAMs varied based on the differing requirements of the standards.
The PCAOB’s phased implementation approach of CAMs based on filing status means that, a year from now, thousands more CAMs will be included in auditor’s reports. The early trends highlighted within this publication demonstrate the additional transparency provided by auditors within their reports. The addition of CAMs to the existing mix of publicly disclosed information provides users of auditor’s reports with a better understanding of the areas that involve especially challenging, subjective, or complex auditor judgment.