Reporting of Critical Matters

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PCAOB proposed inclusion of the critical matters in auditors report in 2013 (Public Company Oversight Board 116). This proposal was intended to balance the practical concern of what constitute auditors useful and relevant information to investors, with the investors need for more information that is specific to the audit of their company’s financial statements. However, the implementation of the proposal has a potential of leading to both positive and negative outcomes, inherent in this audit-reporting model, at varying measures.

Potential Positive Outcome

Reporting of critical matter would meet the need of investors for more information about the company. In the “pass/fail”audit-reporting model, auditors issue either qualified or unqualified opinion. The investors rely on this opinion to make their ensuing decisions. Inclusion of the critical matters about the company’s financial status or its disclosure will provide guidance in their investment decision. Usually, the investors are not sufficiently familiar with principles, techniques, and procedures of auditing. This means that they rely on the auditor’s opinion without sufficiently considering how the auditor has arrived at such opinion.

Revealing critical matter, which might be relevant for investors to know and might affect their investment, will make the auditor’s report more relevant and useful to the investor. It will go beyond giving good or not-good opinion. The reporting of the critical matter would allow the management of the company to give more attention to the identified areas. The audit committee and the management will seek to improve the financial statement disclosures that relate to the area that has given rise to the critical audit matters. This will make the company to give the disclosure of all the revenant information to the benefit of the investors.

Unintended Consequences

Requiring the auditor to give the critical matters would broaden their critical audit areas. This is because they judgement on the critical matters will be communicated publicly. Broadening audit of the critical areas will help to mitigate the questioning of their judgment. This could substantially increase the time required to carry out a comprehensive audit. Consequently, it would lead to an increment in the auditing fee in order to offset the increased auditor’s liability stemming from possible litigations. This would make the cost of auditing to costly which would in turn translate into low returns on the investors’ equity.

On addition to this, reporting on the critical matters will poses a risk that investors will give total focus to the areas identified as critical. They may overlook the other given financial information, which may be instrumental in making informed investment decision. Given that investors are not familiar enough with technical financial matters, and auditing procedures, they can rely on the critical audit matter without having the benefit of understanding how the auditors addressed themselves to the matter.

On top of this, the investors may not have the benefit of getting the evidence, which the auditors obtained, and how persuasive this evidence was in their reporting. The reporting will depend on the auditors’ judgment of what constitute a critical matter and thus its reporting will not seek to address a specific need of an individual investor. As such, it might appear to the investor that the financial statements of the company, which have several critical audit matter according to the report of the auditor, is riskier when in the real sense this might not be the case.

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