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The PCAOB has issued two new proposed auditing standards addressing the auditor’s opinion and information included in annual reports.  To me the proposals seem to provide redundant information, are highly problematic, address matters that have better alternative solutions and don’t make sense.

Take the auditor’s report for example.  The PCAOB proposes that the auditor communicate “critical audit matters.” “Critical audit matters” include those matters addressed during the audit that, among other things, involved the most difficult, subjective, or complex auditor judgments.

In 2003 the SEC issued interpretive guidance on MD&As.  It stated in part:

“When preparing disclosure under the current requirements, companies should consider whether they have made accounting estimates or assumptions where:

  • the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change; and
  • the impact of the estimates and assumptions on financial condition or operating performance is material.

If so, companies should provide disclosure about those critical accounting estimates or assumptions in their MD&A.

Such disclosure should supplement, not duplicate, the description of accounting policies that are already disclosed in the notes to the financial statements. The disclosure should provide greater insight into the quality and variability of information regarding financial condition and operating performance.”

It’s hard for me, at least, to imagine how this portion of the PCAOB proposal differs significantly from current MD&A requirements.

“Critical accounting matters” also include those matters that posed the most difficulty to the auditor in obtaining sufficient appropriate evidence; or posed the most difficulty to the auditor in forming the opinion on the financial statements.  If there is a critical accounting matter, the auditor’s report would:

  • Identify the critical audit matter;
  • Describe the considerations that led the auditor to determine that the matter is a critical audit matter; and
  • Refer to the relevant financial statement accounts and disclosures that relate to the critical audit matter, when applicable.

So how would this work in practice?  A discussion to the effect that “The Company has a lot of Level 3 assets and we spent a lot of time trying to understand the valuations and after numerous discussions with management we found the Company’s practices acceptable”?  If the support isn’t adequate, it would be addressed I imagine through reporting a material weakness in internal control or an adverse opinion.  If the support is adequate, the discussion can only be a hook for litigation that is sure to follow or needless tension between auditors and management and audit committees.

The PCAOB proposes the audit report will include “A statement containing the year the auditor began serving consecutively as the company’s auditor.”  Yes, investors need some information to judge the relation of the auditor with the issuer.  And that information is already included in the proxy statement.  If this information is so important, it should go with the already required disclosures to prevent sprinkling it throughout the documents.

And then we get to the second proposal, which is referred to as the “proposed other information standard.”   The proposed standard would establish requirements regarding the auditor’s responsibilities with respect to “other information.”  “Other information” is information, other than the audited financial statements and the related auditor’s report, included in a company’s annual report that is filed with the SEC under the Exchange Act and contains that company’s audited financial statements and the related auditor’s report. For example, other information in an annual report filed by a company on Form 10-K would include, among other items, selected financial data, MD&A, exhibits, and certain information incorporated by reference.

What do current standards require?  Under existing PCAOB standards, the auditor has a responsibility to “read and consider” other information in certain documents that also contain the audited financial statements and the related auditor’s report; however, there is no related reporting requirement to describe the auditor’s responsibility with respect to other information.  Under the existing other information standard, the auditor considers whether the other information is materially inconsistent with information in the financial statements. If the auditor concludes there is a material inconsistency between the other information and the financial statements, the existing standard provides the auditor with certain procedures to respond to the material inconsistency. Additionally, the existing standard provides that, if while reading the other information for a material inconsistency, the auditor becomes aware of a material misstatement of fact in the other information, the auditor would discuss this with management and perform other procedures based on the auditor’s judgment.

Comparing the new standard to the old standard, it’s hard to find material, tangible improvements:

New Standard Old Standard
Apply the auditor’s responsibility for other information specifically to a company’s annual reports filed with the SEC under the Exchange Act that contain that company’s audited financial statements and the related auditor’s report. Nothing new here.  If the old standard didn’t apply to 10-Ks, what did it apply to?
Enhance the auditor’s responsibility with respect to other information by adding procedures for the auditor to perform in evaluating the other information based on relevant audit evidence obtained and conclusions reached during the audit. Seems as if this was implied by “read and consider,” although perhaps the new standard is a little more explicit about recalculating things that can be recalculated.
Require the auditor to evaluate the other information for a material misstatement of fact as well as for a material inconsistency with amounts or information, or the manner of their presentation, in the audited financial statements. Nothing new here.
Require communication in the auditor’s report regarding the auditor’s responsibilities for, and the results of, the auditor’s evaluation of the other information. No such requirement, but there are lots of things that auditors do that are perhaps more important that aren’t called out in an auditor’s report.
Auditor finds something wrong, and after discussion with management and the audit committee the matter is not corrected: 

  • Must determine the auditor’s responsibilities under Section 10A of the Exchange Act, 15 U.S.C. § 78j-1; AU sec. 316, Consideration of Fraud in a Financial Statement Audit; and AU sec. 317, Illegal Acts by Clients; and


  • Should determine whether to:
    • Issue an auditor’s report that states that the auditor has identified in the other information a material inconsistency, a material misstatement of fact, or both that has not been appropriately revised and describes the material inconsistency, the material misstatement of fact, or both; or
    • Withdraw from the engagement.


Seems to add nothing new unless you make the intellectual leap that an auditor would issue his or her opinion when the 10-K included material errors.

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