Critical Audit Matters –What is Actually Being Communicated?

The Public Company Accounting Oversight Board (PCAOB) started requiring financial statement auditors of large accelerated public company filers to include “critical audit matters” in audit reports for fiscal years ending on or after June 30, 2019. All other nonexempt filers will begin including such information for fiscal years on or after December 15, 2020.

A critical audit matter is any matter that has been communicated or is required to be communicated to the audit committee. It must relate to material accounts or disclosures, and involve especially challenging, subjective, or complex auditor judgments. However, these matters do not change the audit opinion.

The auditor’s report must identify any critical audit matters (or a statement that none exists), why they are considered to be critical, the related accounts and disclosures, and how the matters were addressed on the audit. A cross-reference to the related notes may also be included for further information.

Many public company audit reports released in 2019 are including 1-2 critical audit matters, with the following being examples:

• Revenue recognition on customer agreements containing multiple products and services acquired through volume programs, making transaction price highly subjective.
• Material reserves for rights to return inventory and receive sales credits for price changes or allowances that rely heavily on management judgment.
• Unresolved open tax positions requiring significant estimates in determining deferred taxes, including the realizability of deferred tax assets.
• Valuation and impairment of goodwill and other indefinite-lived intangible assets.
• Identifying and disclosing related party transactions.
• Completeness of litigation and claims accruals.

Responses reported by the auditor often included a combination of the following:

• Evaluating the design and operating effectiveness of relevant internal controls.
• Assessing the reasonableness of management’s estimates and judgments, including the completeness and accuracy of data inputs.
• Using the work of specialists, including external legal counsel.
• Comparing reserves to actual outcomes.