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Controversy Surrounding Audit Reports Continues

March 10, 2016

Traditionally, audit reports are issued in a pass-fail format, but that model could soon change.

Traditionally, audit reports are issued in a pass-fail format. That is, either your financial statements present information fairly and in conformity with U.S. Generally Accepted Accounting Principles (GAAP) — or they don’t. But that model could soon change.

Investors vs. Management

Many investors think the pass-fail model is insufficient, and they want more information about significant, subjective, complex issues that arise during the audit process. So, in August 2013, the Public Company Accounting Oversight Board (PCAOB) issued a proposal that would require public company auditors to identify so-called “critical audit matters” (CAMs) in the audit report.

However, it’s been met with significant opposition from public companies and their auditors, who argue that disclosing CAMs might cause confusion and prematurely reveal issues that management isn’t ready to disclose to the public. For example, critics worry that disclosing CAMs in the audit report — which appears as a cover letter for the financial statements — might give these issues undue weight and leave the impression that the audit process is flawed, internal controls are ineffective or management is unqualified.

Some investors also have criticized the proposal. They argue that disclosing CAMs in such a high-profile portion of the financial statements could lead to knee-jerk responses in the marketplace and reduced stock prices.

New Proposal in the Works

For two years, the PCAOB tabled its audit report project to work on more pressing (and less controversial) matters, such as identification of the lead partner in an audit, updates to the going concern guidance and the use of accounting estimates. But, in the second quarter of 2016, it plans to issue a revised proposal on audit reports that would require auditors to disclose only CAMs that are “material” to investors and previously disclosed to the company’s audit committee.

When this revised proposal is released for public comment, we’ll closely evaluate how likely it is to affect publicly traded companies and their stakeholders. History indicates that there tends to be a trickle-down effect of public company reporting to private companies over time. This continues to be a hot topic to follow.

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