United States: What's Happening With Critical Audit Matters?

Ideagen AuditAnalytics has just released its 2024 Report on Critical Audit Matters, a 3-Year Review, covering the years 2020 to 2022. Under the auditing standard for the auditor's report (AS 3101), adopted in 2017, CAMs are defined as "matters communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements; and (2) involved especially challenging, subjective, or complex auditor judgment." Essentially, the concept is intended to capture the matters that kept the auditor up at night, so long as they meet the standard's criteria. AS 3101 was initially adopted in 2017 and phased in beginning in 2019 according to the status of the filer. (See this PubCo post.) The Report provides data on the prevalence of CAMs and the most common topics for CAMs, and takes a deeper dive on matters such as valuation of assets in the merger context and going concerns.

Identification of CAMs is intended to be a principles-based inquiry. Once the auditor identifies a matter communicated or required to be communicated to the audit committee that relates to material accounts or disclosures, the auditor, in determining whether a matter involved especially challenging, subjective or complex auditor judgment, will need to take into account a nonexclusive list of factors, including the following factors identified in the standard:

Depending on the matter, the auditor's determination might be based on only one factor or a combination of these or other factors.

According to IAA, for "each critical audit matter communicated in the auditor's report, the auditor must:

1. Identify the critical audit matter;
2. Describe the principal considerations that led the auditor to determine that the matter is a critical audit matter;
3. Describe how the critical audit matter was addressed in the audit; and
4. Refer to the relevant financial statement accounts or disclosures that relate to the critical audit matter."

IAA indicates that its database includes data for over 30,000 CAMs, from over 22,000 audit reports applicable to 6,097 SEC public registrants. The CAM data covers all SEC registrants that have disclosure relating to CAMs in their auditor's report in annual filings (10-K, 20-F, and 40-F).

Percentage of CAMs in audit reports. According to IAA, since FY2020, the percent of opinions disclosing CAMs has been increasing, from 62% in FY2020 to 65% in FY2022. However, the number of CAMs has decreased over the period, from 6,769 in FY2020 to 6,995 in FY2021 to 6,654 in FY2022.

By far, it was most common to disclose only a single CAM per opinion; the frequency was 61% in FY2020, increasing to 73% in FY2022. It was all downhill from there: the percentage of companies with two CAMs was 29% in FY2020, decreasing to 22% in FY2022. Opinions with more than two CAMs are all in the single digits or less. Similarly, the average number of CAMs per opinion has also been decreasing, with 1.34 CAMs disclosed per opinion in FY2022.

Topics. What was the most frequently cited topic? According to IAA, that was revenue recognition from customer contracts, at 13% of CAMs over the three-year period. You might remember ASC 606 on revenue recognition gave companies a fair amount of heartburn. (See this PubCo post.) IAA characterizes it as "one of the most significant changes in US GAAP. It requires a five-step approach to recognizing revenue and includes numerous aspects where significant judgments may apply." As a result, it's not terribly surprising that revenue recognition would be at the top of the heap. Next on the list were business combinations at 9% of CAMs and goodwill, also at 9%. Allowance for credit losses came in at 7%. The same top four were at the top of the list for FY 2022 alone.

But taking a deeper dive, IAA pooled the CAMs related to many business combinations—asset valuation, fair value and impairment—and the result was the most common CAM subject: according to IAA, 33% of all FY2022 opinions with CAMs included a CAM for fair value of assets, exceeding the single subject total percentage for revenue recognition in FY2022. IAA notes that fair-value-related CAMs hit their highest percentage in FY2020 at 30% of total CAMs, which IAA attributes to "the uncertain forecasts indicating potential impairment during the pandemic."

Among industries, IAA reports, CAMs regarding revenue from customer contracts were disclosed most frequently by "companies in the manufacturing industry, at 1,049 CAMs, and the services industry, at 1,045, each representing 39% of all CAMs with that topic." It was also the most common CAM topic for companies in the manufacturing, services and construction industries. IAA observes that different characteristics of each industry may lead auditors to focus on specific audit areas. For example, in the construction industry, customer contracts "often include longer duration revenue cycles with performance over time, creating areas of judgment for estimating costs and percentage completion." In the finance industry, the most common CAM topic was allowance for credit losses, a topic that was found in 40% of finance opinions with CAMs. In the retail industry, the most common CAM topic was long-lived assets.

IAA also reports that, 35% of all going-concern opinions contained at least one CAM, and, over the last three fiscal years, only 299 (18%) of the 1,649 going-concern opinions with CAMs also included a going-concern CAM. That means, IAA calculated, that only 6% of the total going-concern opinions included a going-concern CAM. The most common topic in going-concern opinions was "other debt." Interestingly, IAA points out that "there were 204 opinions over the three fiscal years of 2020-2022 with a going concern CAM that did not result in a going concern explanatory paragraph in the opinion."

Because SPACS are not operating companies, their opinions included very few CAMs, IAA reported. CAMs were included in only 3% of SPAC opinions in FY2022. What CAM was most common? Going concern, which IAA found was disclosed in 39% of all SPAC opinions with CAMs.

Filer status. Over the three-year period, IAA reports, 98% of audit opinions for large accelerated filer included CAMs, while 71% of opinions for accelerated and 43% of opinions for non-accelerated filers included CAMs. Opinions for large accelerated filers also contained 10% more CAMs per opinion than both accelerated and non-accelerated filers. IAA suggest that the differences are the result of the "relative complexities of their audits."

IAA reports that, for all filer statuses, the number of CAMs per opinion has been decreasing each fiscal year, with large accelerated filers declining 15% since FY 2020, the largest decrease in the average number of CAMs per opinion over the three years. For large accelerated filers, the percentage disclosing only one CAM increased year over year. In FY2022, the percentage of opinions for large accelerated opinions that included only one CAM increased to 70% from 54% in FY2020.

For foreign filers, 62% of total opinions issued since FY2020 have included CAMs, compared to 64% of US filers. However, IAA reports, foreign filers reported 28% more CAMs per opinion than US filers; in FY2022, foreign filers included more CAMs on average in each opinion (1.67 CAMs in FY 2022) than did domestic filers (1.29 CAMs in FY2022). IAA attributes the difference to "slightly different, broader definitions of key audit matters (KAMs) under International Accounting Standards," where KAMs are "defined as those matters that, in the auditor's professional judgment, were of most significance in the audit of the financial statements of the current period." In FY2022, the companies that disclosed the most CAMs in one opinion—six—were all foreign filers.

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