Critical audit matters: a quick overview

It is hard to deny that the world of finance has changed significantly in recent decades. Corporations have evolved from domestic entities into global powerhouses, stretching far beyond borders of any one country.

For financial professionals inside growing companies, this creates a catch-22: the more companies grow, the more stakeholders and investors demand transparency into increasingly complex financial behaviors. Plus, they want that information more quickly than ever before.

Just as business and stakeholder demands have evolved, so must the auditor's report: the method auditors use to communicate vital information to the investing public.

According to the Public Company Accounting Oversight Board (PCAOB), the standard has remained largely untouched since its inception in the 1940s. In light of increasingly complex and global business operations, the reporting standard was overdue for a change.

The PCAOB unveiled the new standard in June, and in October the Securities and Exchange Commission (SEC) approved the changes, requiring companies to use the new standard.

This change does not simply reduce information asymmetries and make the auditor’s report more relevant and useful to the investing public. If handled correctly, it also provides the internal audit role an opportunity to step up and evolve into a value-added role in the organization.

Here is a quick look into one of the more important aspects of the new reporting standard—critical audit matters—and what it means for your organization.

Critical audit matters

A major change that auditors must master is the inclusion of critical audit matters (CAMs) in their reporting. These are matters arising from findings that:

• Have been or are required to be communicated to the audit committee
• Relate to accounts or disclosures that are material to financial statements
• Involve especially challenging, subjective, or complex auditor judgment

The sensitive and difficult nature of CAMs requires particular care. The inclusion of a CAM, while not required in any report, suggests high financial statement and audit risk, significant unusual transactions, or other significant changes in the financial statements where an additional degree of documentation would be beneficial.

For auditors, addressing a CAM must be approached in three phases:

1. Determine the critical audit matters.
   The auditor should investigate the factors that help determine whether a matter involves challenging, subjective, or complex judgment—such as the auditor’s assessment of the risks of material misstatement.
2. Communicate these matters in the auditor’s report.
   The auditor would first identify the CAM and then describe the principal considerations that led to its determination. Auditors must describe how it was addressed in the audit and refer to the relevant financial statement accounts or disclosures. If there are no CAMs, the auditor would state so in his or her report.
3. Document each matter.
   Finally, the auditor would document matters that were communicated or required to be communicated to the audit committee, whether or not the matter was determined to be a CAM and the basis for such determination.

The impact of the new standard

As the standard has only been active for a short time, its overall impact has yet to be realized. Still, different organizations have spoken up about its potential—both positive and negative.

The Center for Audit Quality applauds the new standard, saying it "provide(s) additional information to investors and other stakeholders in an increasingly complex and global business environment,” while the U.S. Chamber of Commerce feels that the new requirements “obfuscate disclosures for investors and make capital formation less efficient.”

Regardless, in years to come, the effects of the new standard will ripple through public companies of all sizes, stretching across the audit committee, management, and internal audit functions. The faster auditors feel comfortable with this change, the more effective and agile they will be in years to come.

For a broader understanding of the new audit reporting standard, what it means for your organization, and how you can adapt, download this white paper.