{"id":80307,"date":"2025-02-10T18:01:59","date_gmt":"2025-02-10T18:01:59","guid":{"rendered":"https:\/\/peraltafinancing.com\/accounting\/will-cams-get-the-shaft-from-the-new-pcaob\/"},"modified":"2025-02-10T18:01:59","modified_gmt":"2025-02-10T18:01:59","slug":"will-cams-get-the-shaft-from-the-new-pcaob","status":"publish","type":"post","link":"https:\/\/fivemor.com\/?p=80307","title":{"rendered":"Will CAMs Get the Shaft from the \u2018New\u2019 PCAOB?"},"content":{"rendered":"


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In recent years I have presented an update on the activities of the PCAOB at the annual meeting of the Association of Audit Committee Members<\/a>.\u00a0 From that experience \u2014 particularly this past year \u2014 I can tell you that audit committees are not happy with PCAOB rulemaking.\u00a0 Much of it feels to them kind of like we all feel when taking off our shoes for the TSA: because of one misguided and inept soul (pun intended), everyone pays a price.\u00a0 To add insult to injury, we have absolutely no idea whether our collective acts of compliance do anything to make us safer.<\/p>\n

The most recent source of audit committee resentment of the PCAOB is the overhaul and expansion of the standard auditor\u2019s report<\/a> \u2014 most especially the requirement that the auditors communicate information about \u201ccritical audit matters,\u201d or CAMs.<\/p>\n

Two exposure drafts plus an extended period of deliberations by the SEC generated lots of comments, clearly divided along battle lines of the Accounting Establishment<\/a> versus investor interests.\u00a0 The former argued that CAM disclosures will rapidly devolve to boilerplate.\u00a0 Nowithstanding, they would not materially add to the information already available to investors. CAM disclosures, the Accounting Establishment argued, might even diminish audit quality because auditors would respond by limiting communications with a client\u2019s audit committee in reaction to a perception of a new source of liability exposure. \u00a0Finally, and as an aside and for reasons that totally escape me, it argues that management should be the sole source of information in SEC filings.<\/p>\n

Investors on the other side of the argument say that CAM disclosures would in fact provide useful information. \u00a0They base their comments in part on similar rules already in effect in Europe (more on that later) and numerous interesting audit reports that have been produced as a result. \u00a0Moreover, some commenters believe that better information from auditors about CAMs could have more clearly signaled the deteriorations in bank balance sheets that precipitated the 2008 Financial Crisis.\u00a0 As to consideration of the effect on audit quality, even if CAM disclosures devolved to boilerplate, disclosure per se<\/em> could positively affect how CAMs will actually be audited.<\/p>\n

I won\u2019t bore you with the official definition of a CAM.\u00a0 For the purpose of this post, we need only agree that they are basically about the parts of the audit that keeps the auditor awake at night.\u00a0 As an example of what is not a CAM, the Parmalat<\/a> financial fraud is instructive.\u00a0 One aspect of that fraud was falsifying cash balances.\u00a0 Although the auditor may have missed something they should have caught, auditing cash would not have risen to the level of a CAM.<\/p>\n

The Boilerplate Question<\/strong><\/p>\n

In October 2017, I wrote a post<\/a> celebrating the long-awaited SEC approval of the PCAOB\u2019s required CAM communications. \u00a0But, I didn\u2019t at that time adequately consider the possibility that the disclosures would devolve into boilerplate; hence, the motivation for this post.<\/p>\n

For each CAM communicated in the auditor\u2019s report, the auditor will be required to identify the CAM, describe the principal considerations that led the auditor to determine that the matter is a CAM, describe how the CAM was addressed in the audit, and refer to the relevant financial statement accounts and disclosures to which it relates. \u00a0Unfortunately, I now think that this is a recipe for boilerplate \u2014 because the required communications don\u2019t go far enough.<\/p>\n

During the PCAOB\u2019s deliberations, some investors suggested further enhancements to the auditor\u2019s report such as including an assessment of the significant accounting judgments and management estimates and requiring auditors to describe specific insights and findings related to each CAM.\u00a0 These are similar to the requirements that are already in place in Europe, and the fact that the PCAOB acceded to the Accounting Establishment on this point essentially dooms their efforts.\u00a0 \u00a0<\/em><\/p>\n

To see why, we need not look beyond the PCAOB\u2019s 2016 re-proposal, which, unlike the final release<\/em>, provides a couple of illustrative examples of CAM communications. In the final rule making release, the Board reasoned that examples would be inconsistent with the principles-based nature of the rules, which should lead to communications tailored to each engagement. \u00a0Nonetheless, the PCAOB failed to hold the high ground. \u00a0I would expect that auditors will carefully study these examples and squeeze every ounce of boilerplate that they can from them.<\/p>\n

Which should not be too difficult to do.\u00a0 Each illustration is cleanly divided into three parts that map directly onto the letter of the rules:\u00a0 (1) Identifying the CAM; (2) Setting forth the principle considerations in determining the CAM; and (3) Describing how the CAM was addressed in the audit.<\/p>\n

One example involved a hypothetical regional bank that in the most recent period added a new loan product \u2013 a 9-year auto loan in addition to their 3 and 5-year products.\u00a0 The principal considerations identified by the auditor (i.e., #2, above) were that it was a new product, the historical data on defaults of existing products would be of limited use, and that loan impairment on these products \u201cinvolved complex and subjective judgment\u201d (language straight out of the standard no less!).<\/p>\n

Regarding #3, how the audit of the loan loss reserve was addressed, the first thing the example states is that the auditor tested controls and the historical data that was used by management as inputs.\u00a0 For every CAM communication I have seen (which admittedly is limited at this point), they all start that way. \u00a0But after that, things get to a point where we can understand why the Accounting Establishment is squirming. The auditor reports that it evaluated the qualitative<\/em> adjustment to the historical loss rate, including the basis and significant assumptions.\u00a0 No matter who is doing that \u2014 management, the auditor, or a \u201cspecialist\u201d \u2014 this is a highly speculative exercise.\u00a0 It could well be that the auditor\u2019s best protection here is to communicate as little as possible beyond tried and tested boilerplate.<\/p>\n

Loan loss reserves should be a fairly common CAM disclosure, but there is no way to put a good face on them.\u00a0 The subjectivity of the accruals raise questions like whether audits of loan loss reserves based on current GAAP can provide reasonable assurance under any circumstances beyond plain vanilla. \u00a0It would seem that the PCAOB sensed this, because the example communication mentioned that a \u201cspecialist\u201d was involved in the estimate of the loan loss reserve. But, I wonder what kind of specialist they were envisioning?\u00a0 If the standard called for measurement of the loan portfolio at fair value, then I could imagine a specialist contributing in a substantive way, but for me, I don\u2019t know whether a specialist\u2019s crystal ball is any better for predicting future default rates than anyone else\u2019s, without actually trying to value<\/em> the portfolio, which is not required by GAAP.<\/p>\n

My Take<\/strong><\/p>\n

I would not be surprised if the Accounting Establishment has a number of concerns that they were not willing to express publicly during the PCAOB and SEC deliberation phases.\u00a0 For example, there is the high likelihood that readers will take CAMs to be signals about the reasonableness of management estimates and audit quality before the ink is even dry on the auditor\u2019s report.\u00a0 In this loan loss reserve example, an analyst might claim that based on a review of market prices for similar assets, the current value of the audited loans could well be much lower than indicated by management\u2019s estimate of the allowance; and<\/em><\/strong> that the auditors might not have weighted this information properly before concluding that the bad debt allowance is reasonable.<\/p>\n

That kind of threat to the auditors, leads me to predict that \u00a0CAM communications will be boilerplate right out of the box.\u00a0 The PCAOB will have egg on their face, and they will deserve it.\u00a0 The real, boilerplate-defeating information about CAMs is the auditor\u2019s own assessment of management\u2019s estimates.\u00a0 Because the Board acceded to the Accounting Establishment on this point, U.S. financial reporting will look tarnished as compared to the European approach to CAM communications.<\/p>\n

If I were on the Board that approved this rule, I would not have supported caving on the communications of the auditor\u2019s assessments.\u00a0 But, if I were on the current Board, I would not give CAMs the shaft, even if I became convinced that they are a recipe for pure boilerplate.\u00a0 Even though the optics would be very embarrassing, communication of CAMs really should<\/em> deter superficial audits. \u00a0Like taking our shoes off at the airport, we will have no way of knowing for sure whether CAM communications will reduce the incidence of auditor failures, but that is a fact of life regulators must accept when promulgating in good faith securities laws for the protection of investors.<\/p>\n

* * * * * * * *<\/p>\n

I would also like to believe that once auditing of the management estimates required under current GAAP is exposed as the dicey proposition that it is, maybe we will see improvements to GAAP: like more current value and less crystal ball.<\/p>\n<\/div>\n\n","protected":false},"excerpt":{"rendered":"

In recent years I have presented an update on the activities of the PCAOB at the annual meeting of the Association of Audit Committee Members.\u00a0 From that experience \u2014 particularly this past year \u2014 I can tell you that audit committees are not happy with PCAOB rulemaking.\u00a0 Much of it feels to them kind of […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[11759],"tags":[40336,17582,40337],"dealstore":[],"offerexpiration":[],"class_list":["post-80307","post","type-post","status-publish","format-standard","hentry","category-accounting","tag-cams","tag-pcaob","tag-shaft"],"yoast_head":"\nWill CAMs Get the Shaft from the \u2018New\u2019 PCAOB? - Som2ny Network<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/fivemor.com\/?p=80307\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Will CAMs Get the Shaft from the \u2018New\u2019 PCAOB? 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