The Public Company Accounting Oversight Board (PCAOB) has proposed two new auditing standards that would expand the content of audit reports as well as the auditor’s responsibility regarding information outside the financial statements. PCAOB Release No. 2013-005 (August 13, 2013) is available at: http://pcaobus.org/Rules/Rulemaking/Docket034/Release_2013-005_ARM.pdf. The proposals are designed to retain the current “pass/fail” audit report model while increasing the informational value and relevance of the report. In his remarks about the proposals, PCAOB board member Steven Harris articulated the challenge of this project to be finding “a way to balance the need for a different, more useful and communicative model of the auditor’s report with the need not to change what auditors do, but how they report on what they do.”

Audit Report

The proposed standards would keep the basic elements of the current auditor’s report, including the current “pass/fail” model, but would require the auditor to include additional information specific to the audit. Auditors would be required to communicate “critical audit matters” as determined by the auditor. Critical audit matters are generally defined to be those addressed during the current-period financial statements audit that (1) involved the most difficult, subjective or complex auditor judgments, (2) posed the most difficulty to the auditor in obtaining sufficient appropriate evidence, or (3) posed the most difficulty in forming the opinion on the financial statements.

Described informally as the types of matters that kept the auditor up at night, critical audit matters are generally of such importance that they are included in the audit completion documents that summarize the significant issues and findings, reviewed by the audit engagement quality reviewer, and communicated to the company’s audit committee. The audit report would identify critical audit matters, describe the considerations that led the auditor to determine that each matter is a critical audit matter, and refer to relevant related financial statement accounts and disclosures. In the alternative, if the auditor determines that no critical audit matters exist, the auditor would include a statement to that effect in the report.

The proposed changes to the audit report would also add a requirement to include information in the report related to auditor tenure and independence.

Other Information

The proposed standards would also expand the auditor’s responsibilities for information included in the company’s annual report other than the audited financial statements. This “Other Information” would include management’s discussion and analysis, selected financial data, exhibits, and certain information incorporated by reference. The auditor’s current requirement is to “read and consider” information, but there is no related reporting requirement. The proposed standards would instead require the auditor to “read and evaluate” the other information for a material misstatement of fact or material inconsistency with the financial statements. The auditor would not opine on this other information, but would be required to disclose in its report its responsibility for other information and the results of its evaluation. Specifically, the auditor would state either that it did not identify a material inconsistency or material misstatement of fact in the other information, or, if it had, would state that it had identified something that had not been revised and would describe that material inconsistency, material misstatement of fact, or both, found in the other information.

Reactions and Next Steps

Response to the proposals has been mixed, with some investors and audit firms expressing receptiveness to enhancing auditor reporting to be more useful to financial statement users. Other parties, however, have raised concerns not only about the increased cost and complexity of the financial reporting process, but also about auditors directly communicating with shareholders regarding a company’s accounting judgments, including the potential chilling effect on communications between the company and the auditor and additional litigation risk for both the company and the auditor.

The public comment period on these proposals ends on December 11, 2013. In the proposing release, the PCAOB also noted that it is considering holding a public roundtable in 2014 to discuss the proposed standards and comments received.