On October 23, 2017, the Securities and Exchange Commission approved the Public Company Accounting Oversight Board’s (“PCAOB”) proposal to adopt a new auditing standard, AS 3101. AS 3101 will require auditors to disclose more detailed information about what they learn during the course of an audit. This new auditing standard requires a major revision in how auditors think about what and how they communicate to boards and investors. It requires increased transparency on the part of auditors.

AS 3101 will require the audit report to include a discussion regarding the communication of critical audit matters (“CAMs”), which are defined as matters communicated or required to be communicated to the audit committee and that: (a) relate to accounts or disclosures that are material to the financial statements; and (b) involved especially challenging, subjective, or complex auditor judgment.

In determining whether a matter involved especially challenging, subjective, or complex auditor judgment, the PCAOB outlined the following (non-exhaustive) list of factors to be considered: (1) the auditor’s assessment of the risks of a material misstatement; (2) the degree of auditor judgment related to the areas in the financial statements that involved the application of significant judgment or estimation by management; (3) the nature and timing of significant unusual transactions and the extent of audit effort and judgment related to these transactions; (4) the degree of auditor subjectivity in applying audit procedures to address the matter or in evaluating the results of those procedures; (5) the nature and extent of the audit effort required to address the matter, including the nature of consultations outside the engagement team regarding the matter; and (6) the nature of audit evidence obtained regarding the matter.

If the auditor determines that a CAM arose out of the current period’s audit, auditors will be required to: (1) identify the CAM, (2) describe the principal considerations that led to the determination that the matter is a CAM, (3) describe how the CAM was addressed in the audit, and (4) provide a cross-reference to the relevant financial statement or disclosures. For large accelerated filers, the CAM disclosure requirements will take effect for audits of fiscal years ending on or after June 30, 2019. For all other filers, the CAM disclosure requirements will take effect for audits of fiscal years ending on or after December 15, 2020. Companies (and their audit committees) should begin to have discussions with their auditors as to how AS 3101 will impact their future audits, and as to whether there are any currently existing CAMs that can be remedied prior to the AS 3101 implementation periods. 

For any questions or more information on these or any related matters, please contact any attorney in the firm’s Corporate Practice Group.

Disclaimer

This update has been prepared by Sheppard, Mullin, Richter & Hampton LLP for informational purposes only and does not constitute advertising, a solicitation, or legal advice, is not promised or guaranteed to be correct or complete and may or may not reflect the most current legal developments. Sheppard, Mullin, Richter & Hampton LLP expressly disclaims all liability in respect to actions taken or not taken based on the contents of this update.