United States: Do Companies Disclose The Role Of Audit Committees In Connection With CAMs?

As you know, critical audit matters are defined for purposes of the auditor's report 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." The standard for CAMs became effective for audits of large accelerated filers (LAFs) for fiscal years ended on or after June 30, 2019, and will be required for companies other than LAFs (excluding emerging growth companies) for fiscal years ending on or after December 15, 2020. CAM disclosure is strictly the province of the auditors and included in the auditor's report. But what has been the role of audit committees? Audit Analytics has performed an analysis of companies in the S&P 1500 to see what, if anything, they have disclosed in their proxy statements about the part that audit committees have played in connection with CAM identification and disclosure.

As you know, critical audit matters are defined for purposes of the auditor's report 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." The standard for CAMs became effective for audits of large accelerated filers (LAFs) for fiscal years ended on or after June 30, 2019, and will be required for companies other than LAFs (excluding emerging growth companies) for fiscal years ending on or after December 15, 2020. CAM disclosure is strictly the province of the auditors and included in the auditor's report. But what has been the role of audit committees? Audit Analytics has performed an analysis of companies in the S&P 1500 to see what, if anything, they have disclosed in their proxy statements about the part that audit committees have played in connection with CAM identification and disclosure.

Under the requirement for CAM disclosure, the auditor is required to identify each 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 a PCAOB Resource for Audit Committees, 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 CAM rule, the SEC observed that the 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 PCAOB has also observed that the requirement for the auditor to communicate CAMs should not change required audit committee communications, other than the requirement for the auditor to provide and discuss with the audit committee a draft of the auditor's report. Moreover, the information should not be a surprise to the committee, the PCAOB advised, because matters that will be disclosed as CAMs should have already been discussed with the audit committee. However, the audit committee does not have a role in determining and approving CAM communications-no veto power. Rather, CAMs are "the sole responsibility of the auditor," and the purpose of the CAM requirement is "to elicit more information about the audit directly from the auditor." The auditor is, however, required to share with the audit committee the draft auditor's report, which includes any CAMs, and, if there is any sensitive information that might be included in the CAM communication, the auditor "could discuss with management and the audit committee the treatment of any sensitive information."

SideBar

In other PCAOB staff guidance, A Deeper Dive on the Determination of CAMs, the staff advised that events such as natural disasters, cybersecurity breaches, significant changes in regulations, standards, government policy or the economic or business environment could significantly impact the financial statements. For example, these types of events could affect key estimates, valuations, or the accounting for transactions and related disclosures and are sometimes the subject of communications between the auditor and the audit committee, leading auditors to consider the impact on the audit and the audit response. The example the staff provided is of a cybersecurity breach that targets the company's general ledger system, which could affect specific accounts or could be pervasive. Even more relevant today might be COVID-19, given the significant changes in the economic and business environment resulting from the impact of pandemic. For example, the SEC Chief Accountant has observed that the acute uncertainty resulting from COVID-19 has exacerbated the challenge of making significant judgments and estimates, including, among other topics, estimates and judgments related to fair value and impairment considerations, leases, debt modifications or restructurings and revenue recognition. (See this PubCo post.) Should we expect to see a flood of pandemic-related CAM disclosure? (See this PubCo post.)

Audit Analytics examined 770 proxy statements for companies in the S&P 1500 between July 1, 2019 and March 31, 2020, finding that only slightly over 6% included any disclosure regarding the audit committee's role related to CAMs. However, within that time period, the numbers and percentages increased after the first quarter. In the first quarter examined (Q3 2019) only 1.1% of proxy statements mentioned CAMs. However, that percentage increased substantially in Q4 of 2019 to 9.0%, declining somewhat to 6.7% in Q1 of 2020. Audit Analytics reports that, for the second half of 2019, companies in the S&P 1500 filed 187 proxy statements, of which eight mentioned CAMs in the audit committee report and three mentioned CAMs elsewhere in the proxy statement. By comparison, in Q1 of 2020, companies in the S&P 1500 filed 583 proxy statements, with 27 mentioning CAMs in the audit committee report and 11 mentioning CAMs elsewhere in the proxy statement (with one mentioning CAMs both in the report and elsewhere in the proxy statement).

Larger companies were more inclined to discuss the role of the audit committee in connection with CAMs. According to Audit Analytics, over the entire three-quarter period, almost 10.5% of companies (about 30 companies) in the S&P 500 discussed the role of the audit committee in connection with CAMs, compared with only about 4% of companies in the S&P 400 mid-cap and S&P 600 small-cap indices. The disclosures typically indicated the audit committee's role in reviewing or discussing the CAMs with the independent auditor. They might also indicate that the audit committee agreed with the auditor's identification of the particular CAMs.

SideBar

As discussed here, the PCAOB has provided some sample questions for audit committees to consider-in their discretion-asking their auditors about CAM implementation, copied below:

Questions Audit Committees Could Consider Asking their Auditors

(See this PubCo post.)