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PCAOB Proposes New Standards for Auditor Reporting

August 26, 2013

On August 13, 2013, the Public Company Accounting Oversight Board (“PCAOB”) proposed two new auditing standards to significantly increase the amount of information auditors are required to include in audit reports. The PCAOB is currently seeking comment on the proposed standards, which, if adopted, would be applicable to audits of reporting companies, broker-dealers, investment companies, and employee stock purchase, savings and similar plans, and would be effective for audits of financial statements for fiscal years beginning on or after December 15, 2015.

The first proposed standard, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinions (“Proposed Auditor Reporting Standard”), would retain the pass/fail model of audit reports, but would require the auditor to report on “critical audit matters” — areas which involved the most difficult, subjective, or complex auditor judgments, or which posed the most difficulty to the auditor in forming the opinion on the financial statements. In addition to identifying the critical audit matters, the audit report would be required to describe the considerations that caused the auditor to determine that the matter was a critical audit matter and to refer to the financial statement accounts and disclosures to which the critical audit matter relates.

If the auditor determined there were no critical audit matters, the audit report would state that there were no such matters to communicate. The Proposed Auditor Reporting Standard would require new elements related to auditor independence, auditor tenure, and the auditor’s responsibility for, and evaluation of, other information in annual reports and would enhance certain standardized language in the auditor report.

The PCAOB noted that it proposed the communication of “critical audit matters” in response to requests from many investors that the audit report provide more insight about the most significant matters that the auditor addressed. The auditor would determine which matters to communicate, and that communication would be based on information already learned and procedures already performed as part of the audit. The PCAOB noted that these would ordinarily be matters that were required to be (1) documented in the engagement completion documentation; (2) reviewed by the engagement quality reviewer; (3) communicated to the audit committee; or (4) any combination of the three.

The second proposed standard, The Auditor’s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and Related Auditor’s Report (“Proposed Other Information Standard”), would require the auditor to evaluate other information in a company’s annual report filed with the SEC under the Exchange Act that also contains that company’s audited financial statements and the related audit report for a material misstatement of fact or a material inconsistency with amounts or information, or the manner of their presentation, in the audited financial statements, based on relevant audit evidence obtained and conclusions reached during the audit. “Other information” would include items such as Risk Factors, Selected Financial Data, Management’s Discussion & Analysis, exhibits and certain information incorporated by reference. The audit report would be required to include a statement of the auditor’s responsibility for the evaluation and the results of the evaluation.

The PCAOB noted that though there is no existing requirement for “other information” beyond the obligation to “read and consider,” some auditors already currently perform procedures related to “other information,” and that the PCAOB sought in the proposed standard to strike a cost-sensitive balance.

In developing the proposed standards, the PCAOB considered: (1) the information communicated in the current form of auditor’s report; (2) the potential benefits that may result from auditors providing additional communications; (3) the potential costs related to the proposed standards; (4) alternative approaches; (5) current developments in similar projects by other standard setters; (6) relevant academic research; and (7) significant comments received by the PCAOB from its outreach efforts.

The proposed standards have significant cost implications for auditors, the companies they audit, and audit committees, related to additional time incurred to prepare and review audit reports as well as additional litigation risk for the auditors. The PCAOB has requested comments regarding the nature and extent of the expected cost implications, and noted that the proposed standards are intended to respond to the needs of investors by making the audit report more informative, while avoiding unnecessary burden to the financial reporting process.

The full report, PCAOB Release No. 2013-005, is available here.

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This article was originally published by Bingham McCutchen LLP.