The Public Company Accounting Oversight Board just published three reports on the implementation of critical audit matters, all suggesting that the inclusion of “CAMs” in an audit report simply isn’t that big a deal.
The research, published with little fanfare last week, found no strong evidence that CAMs drive up audit fees or delay the completion of an external auditor’s report. At the same time, the research also found scant evidence that most investors respond to the information, and most corporate audit committee members say CAMs haven’t changed the conversations they have with their companies’ audit firms either.
That’s a rather anticlimactic update to something that had roiled corporate audit circles so much while regulators debated CAMs in the 2010s.
CAMs, you might recall, are disclosures that audit firms started making last year — and then in much greater numbers earlier this year. A critical audit matter is any issue that is material to financial statements and involves “especially challenging, subjective, or complex auditor judgment,” according to the language of the PCAOB standard. Audit firms are supposed to include a list of CAMs in the annual reports they publish about their clients, and discuss those issues with the audit committee.
What’s wrong with that? In theory, CAMs could result in the audit firm disclosing an issue to investors that the corporation has not disclosed in its quarterly filings; that rubbed some corporate voices the wrong way.
CAMs also tend to arise from significant deficiencies in internal controls. So again, in theory, an auditor could say, “That control you have there — I don’t like it. Fix it or I declare it a CAM and bring it to your audit committee.”
Those were the theoretical fears, at least. Now that we’ve had a year of CAMs disclosure, all the fears about audit fees, new disclosure, and pushy auditors may have been much ado about nothing.
Which brings us back to the PCAOB research.
What CAMs Data Is Saying
The PCAOB examined CAMs disclosed in 2,220 audit reports, and found an average of 1.7 matters per company. Half of all companies had only one CAM; another 34 percent had two. That’s in line with what the PCAOB had been forecasting all along: that just about all companies would have at least one critical audit matter in their report, but most companies would only have one or two in any given year. See Figure 1, below.
Which financial reporting subjects were cited as CAMs most often? All the line items that would typically be material to financial statements and loaded with complex, subjective judgment. See Figure 2, below.
That said, trends also tended to vary by industry. For example, financial services firms were more likely to have allowances for loan losses as a CAM, while the energy industry was more likely to cite property, plant & equipment.
It’s also possible that your critical audit matters might change over time. For example, if your company starts to pursue a more acquisitive growth strategy, goodwill might become a more significant part of your balance sheet, and hence CAM-worthy. Conversely, some audit matters might always be critical, no matter how you might modify your internal controls. An example of that might be a financial firm that carries lots of exotic derivatives on the balance sheet, where pricing information is always going to rely on complex judgment.
PCAOB staffers also did sophisticated analyses of both audit fees and audit hours at companies implementing CAMs. They found no statistically significant change in audit fees that could be tied to CAMs — meaning audit fees did increase, but so did fees for a comparison group of companies that hadn’t yet implemented CAMs. Moreover, audit hours actually increased less for CAMs companies compared to the control group, by roughly 5.5 percent.
So implementing critical audit matters hasn’t led to logistical or financial calamity like naysayers had predicted. In that case, the question is whether CAMs are helpful to investors in the first place, regardless of the labor that is (or isn’t) involved in preparing them.
What CAMs Consumers Are Saying
The PCAOB also interviewed the stakeholder groups most involved with CAMs: the audit firms compiling them, the audit committees discussing them, and the investors reading them. What did those groups have to say?
Audit firms. The audit firms said they invested considerable time preparing for CAMs, and the PCAOB calculated that among the Big 4, each firm spent about $6.5 million on new procedures and training to implement CAMs. Considering that the firms generated anywhere from $29 billion to $46 billion in revenue in 2019, that’s an insignificant expense.
Meanwhile, at the engagement level, audit partners said they devoted only about 1 percent of total audit hours on CAMs; and only 3 percent of audit partners said they made significant changes to the procedures of their audits to accommodate CAMs.
Audit committees. Audit committee chairmen interviewed by the PCAOB largely said the arrival of CAMs didn’t change the nature of conversations they tended to have with their audit firms about financial reporting. Some said CAMs helped to sharpen the focus of conversations, or shifted around the priority of which issues were discussed first — but that’s about as far as improvement went. As one audit committee member told the PCAOB: “To the extent there are issues that are raised in CAMs, it elevates dialogue. So if that’s useful to audit quality, on the margin it’s probably positive.”
That’s in step with what I’ve heard from audit committee chairs and chief audit executives myself: if CAMs cause some great change in the relationship between audit committee and audit firm, you were doing it wrong in the first place.
Investors. Investors were a mixed bad. Most who responded to the PCAOB said they had heard of CAMs but not examined many that closely; those who had read them closely said they generally found CAMs easy to understand. Most also said they planned to use CAMs in the future to help them identify and understand significant financial reporting risks. That was the original point of critical audit matters, so to that extent it’s good news.
So What Happens Next?
That’s an interesting question. Clearly investors and audit committees like CAMs, and the costs of preparing them aren’t onerous. But I’m not sure from these reports that people love CAMs, where they’d raise hell if the PCAOB or Securities & Exchange Commission decided to make CAM disclosure optional.
Under a Biden Administration, I’m sure critical audit matters would stay. Under a second Trump Administration, happy to give corporate cronies whatever they want — who knows? Even a regulation without significant cost burden might go under the ax.