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21 October 2019
In this report, Critical Audit Matters: Public company adaptation to enhanced auditor reporting, Intelligize examines data from a survey, conducted by SourceMediaResearch/Accounting Today, of 171 compliance specialists at public companies to examine "how public company compliance officials are adapting their own corporate disclosure and processes to comply with this new regime." Among the issues considered were the impact of "dry runs," changes to company disclosures and changes in controls. The report includes a 25-page appendix with examples of CAMs, organized by subject matter, which should prove to be interesting reading for those about to embark on the project. Interestingly, the report stressed the importance of lining up the investor relations team to consider how best to communicate the company's message about CAMs.
As you may recall, under AS 3101, the new auditing standard for the auditor's report, CAMs are defined as "matters communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements; and (2) involved especially challenging, subjective, or complex auditor judgment." For each CAM, the auditor is required to identify the CAM, describe the principal considerations that led to the determination that the matter was a CAM, describe how the CAM was addressed in the audit, and refer to the relevant financial statement accounts or disclosures that relate to the CAM.
According to the PCAOB, CAM disclosure is designed to "make the auditor's report more informative and relevant to investors and other financial statement users. CAMs are intended to provide tailored information specific to the audit—from the auditor's point of view—on matters that require especially challenging, subjective, or complex auditor judgment." In approving the new CAM rule, the SEC observed that the new requirement "will add to the total mix of information available to investors by eliciting more information about the audit itself— information that is uniquely within the perspective of the auditor, and thus, not otherwise available to investors and other financial statement users." The new standard is effective for audits of large accelerated filers (LAFs) for fiscal years ending on or after June 30, 2019, and will be required for companies other than LAFs (excluding EGCs) for fiscal years ending on or after December 15, 2020.
The online survey received responses from 171 employees (mostly finance-related) and directors at 69 LAFs, 51 companies that will be required to report CAMs after 2020 and 51 EGCs. Companies ranged in size from under 2,500 employees (57%) to 100,00 or more employees (7%).
Many auditors have been working with audit committees to conduct CAM "dry runs" to get a better handle on how the new CAM disclosures will look and how the process will affect financial reporting. To perform these dry runs, some auditors are identifying CAMs using the prior year's audit, actually crafting the disclosures, engaging in discussions with audit committees about the disclosures and creating the supporting documentation. In addition, the practice session is helping to identify the types of controls that need to be developed.
Most survey respondents either conducted or plan to conduct dry runs with their auditors. In the survey, 54% of LAFs conducted dry runs; 51% of post-2020 companies have conducted or plant to conduct dry runs, but 31% are undecided; and 41% of EGCs intend to conduct them, with 45% undecided. For 68% of LAFs, management met with auditors during the dry runs; audit committee members met with the auditors for 65% of LAFs; 46% of LAFs had counsel meet with the auditors and 16% of LAFs arranged meetings between the IR team and the auditors.
Conducting dry runs turned out to be far from a trivial pursuit: 62% of LAFs held between three and six meetings with their auditors, and 14% had seven or eight meetings. Thirty-five percent of LAFs reported that the process lasted up to three months, 41% said four to six months, 14% said seven to nine months and, for 8% of LAFs, the dry-run process lasted for 10 to 12 months.
What did companies learn during the dry runs? First, auditors identified the following potential topics for CAMs: income tax (57%); revenue recognition (49%); lease accounting (38%); intangible assets (32%); goodwill impairment (30%); business combinations (30%); allowance for loan and lease losses (27%); and valuation of loss reserves (24%). For 11% of LAFs, no topics were identified.
One important lesson that many companies learned was the need to beef up their internal controls. During the dry runs, 43% of the audit committees of LAFs identified additional controls required to be implemented; 38% identified none and 19% remained undecided about the need for new controls.
Most respondents seem to expect CAM disclosures to have an impact on the companies' own disclosures, apparently having accepted the advice of experts that CAM disclosure will be most effective if it references disclosures in the company's financial statements: 52% of LAFs, 61% of post-2020 companies and 85% of EGCs stated that they will consider updates to their financial statement disclosure; 49% of LAFs are considering changes to MD&A as a consequence of CAM results, 49% of post-2020 respondents and 40% of EGCs are considering the same; 29% of LAFs are considering updates to proxy disclosures regarding their board committees, 31% of post-2020 respondents and 45% of EGCs are also considering committee updates. Among LAFs, only 20% said that their disclosure will not change and 12% of post-2020 companies agreed.
Why are audit committees looking at companies' own disclosures? As discussed in this article from Compliance Week, generally, audit committees much prefer that the company get a jump on the disclosure so that the auditors will not need to resort to the creation of original material and the company can best frame the discussion from its own perspective. After all, no audit committee would be enthusiastic about the prospect of the auditor's sharing with the investing public the concerns that arose in performing the audit or the struggles involved in reaching conclusions about the financials. Although the adopting release suggested that the process would be an iterative one between management and the auditors, time will tell how much input audit committees and managements will have in a crunch. To best position the company, a former Director of Corp Fin cited in the article advised, audit committee members should be revisiting the company's own disclosures now, as soon as they have an inkling of which CAMs the auditor plans to identify: the "best CAM disclosure…will be one that cross references a disclosure in the financial statements." One auditor observed in the article that enhancing corporate disclosure has now evolved into a regular part of the CAM discussion. Another auditor even ventured that improving the entirety of corporate disclosure—not just the auditor's report—"'was the objective of the entire standard.…It not only gets the view of the auditor's unique perspective on corporate reporting, but it could help the overall disclosure package in total.'" The ineluctable conclusion: start the process early and, as part of that process, revisit the company's own disclosures. (See this PubCo post.)
Although the article advocates that companies involve their IR teams in the CAM disclosure process, the survey indicates that only a small percentage of companies have taken any steps in the direction. Only about a third of LAFs IR teams have met with management, the auditors or the audit committee about the presentation of CAMs to the investing public. And even fewer (28%) have met with the financial reporting team or corporate counsel.
Surprisingly, a substantial number of non-LAF respondents plan to voluntarily or early adopt CAM disclosure requirements. Of companies that will be required to report post-2020, 55% said they plan to early adopt, 29% were undecided and 16% had decided against early adoption. Among EGCs, 39% responded that they plan to apply the CAM requirements voluntarily to audits that do not require CAM disclosure, 39% are undecided and 22% will definitely not apply them voluntarily.
For further information on this topic please contact Cydney Posner at Cooley LLP by telephone (+1 415 693 2000) or email (firstname.lastname@example.org). The Cooley LLP website can be accessed at www.cooley.com.
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