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MAYER HOFFMAN MCCANN P.C. – AN INDEPENDENT CPA FIRM

A publication of the Professional Standards Group

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The continuing focus on lessons learned from the global financial crisis has prompted the Public Company Accounting Oversight Board (PCAOB) to release two landmark proposals designed to address longstanding criticisms of auditor reporting. As critics grew more vocal in the aftershocks of the severe economic upheaval and unexpected business failures of 2008 and 2009, the PCAOB responded with a multi-year study of the pros and cons of various potential changes. Today’s proposals have been years in the making, and they pave the way for the first major changes in decades in the content of the audit reports issued by independent auditors of public companies.

This Messenger summarizes the proposals, expected benefits, and open questions. The appendix shows an example of how audit reports might look in the future.

Overview of proposals

The PCAOB has combined its proposed changes to auditor reporting into a single release known as PCAOB Release No. 2013-05 dated August 13, 2013 (the Release). This nearly 300-page release weaves together two sets of proposed audit standards and related amendments. One set of proposals aims to provide more useful information for investors by prescribing specific kinds of additional information

September 2013

Audit Reports for Public Companies: PCAOB Proposes First Major Changes in Decades

that auditors would be required to include in their reports about audits of financial statements. The other set seeks to broaden the auditor’s involvement with supplemental or “other” information that is provided in annual reports that include the audited financial statements. Additional details are provided below.

A. Expanded reports on audits of financialstatements

The first of the two proposed audit standards is entitled, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion. This standard would retain the generic characteristics of what is commonly known as a pass/fail type of audit opinion in which a pass indicates the financial statements are fairly presented, while a fail indicates they are not. But the proposed standard would go beyond the generic opinion by imposing a new requirement that auditors provide more information specific to the audit, including the following.

1. Descriptions of “critical audit matters.” This item would generally require a discussion of some of the more challenging issues that were addressed by the auditor during the audit of the financial statements. Specifically, the discussion would focus on issues that either: (a) involved the most difficult, subjective, or complex auditor judgments, (b) posed the most difficulty in obtaining sufficient appropriate audit evidence or (c) posed the most difficulty to the auditor in forming an opinion on the financial statements.

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Examples: valuations of assets that have no readily ascertainable market value, the timing and amount of impairments, contingencies such as possible exposures in lawsuits or regulatory investigations, exposure to loan losses, and conclusions regarding going concern issues. If no matters are communicated as critical audit matters, the auditor’s report would be required to state that no such matters were identified by the auditor and the work papers would need to document the reasons for not doing so. If one or more matters are communicated as critical audit matters, the information in the auditor’s report would include:

• Identification of the critical audit matter,

• The considerations that led the auditor to determine that the matter is a critical audit matter, and

• The relevant financial statement accounts and disclosures, when applicable.

Expected benefits: The intent is to help fill a gap that evolved as global business operations and financial reporting requirements grew more complex over the years, resulting in the need to use more judgments and estimates in areas such as fair value measurements where small differences in assumptions can have very material consequences.

2. Additional information about the audit and auditor. The proposal would require that the audit report contain statements about each of the following areas:

• The auditor’s independence. This item would include a statement about the auditor’s existing requirements to be independent of the company.

• The auditor’s tenure. This item would include the year the auditor began serving as the company’s auditor.

• The auditor’s evaluation of supplemental or “other” information. This item would include a statement describing the auditor’s responsibility for evaluating other information in annual reports filed with the SEC containing the financial statements and the related auditor’s report, along with the results of that evaluation.

The proposal would also require clearly-worded statements of some existing responsibilities, such as the auditor’s responsibility with regard to the notes to the financial statements.

Expected benefits: The general intent is to enhance investors’ and other financial statement users’ understanding about these matters and to serve as a reminder to auditors of their obligations in these areas. However, the statement about supplemental information would also provide the results of the auditor’s evaluation of this information, if the second proposed audit standard is finalized.

B. Auditor’s involvement with “other” information

The second of the two proposed new audit standards is entitled, The Auditor’s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor’s Report. This proposed standard would require that auditors perform certain procedures designed to evaluate supplemental or “other” information as a basis for reporting some of the additional information described in the preceding section.

1. Scope of “other” information. For purposes of this standard, other information would be defined as information (other than the audited financial

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statements and related auditor’s report) that is included in the annual report that is filed by a company with the SEC under the Exchange Act and that contains the company’s audited financial statements and the related auditor’s report. Examples: Risk Factors, Selected Financial data, Management’s Discussion and Analysis (MD&A), exhibits, and certain information incorporated by reference. Exclusions: The proposed other information standard would not apply to information formatted in eXtensible Business Reporting Language (XBRL) that is furnished with the SEC as an exhibit or otherwise.

2. Procedures to be performed. The auditor’s evaluation of the supplemental information would be based on relevant audit evidence obtained and conclusions reached during the audit. The auditor would be required to evaluate the information for a material misstatement of fact, as well as for a material inconsistency with the audited financial statements in the amounts, information, or manner of presentation.

Comparison with current standards. The current audit standards require the auditor to read the supplemental or other information and consider whether the information is materially inconsistent with information in the financial statements, then follow certain procedures to respond to any material inconsistency. If, while reading the other information for a material inconsistency, the auditor becomes aware of a material misstatement of fact in the other information, the auditor would discuss this with management and perform other procedures based on the auditor’s judgment. In contrast, the proposed other information standard includes procedures that auditors consistently would perform in evaluating the other information. This evaluation would represent a broadening of the auditor’s responsibility.

Expected benefits. The proposed procedures would enable the auditor to identify potential inconsistencies between the other information and the company’s financial statements that would otherwise be difficult for investors and other financial statement users to identify when analyzing the company’s financial performance. The PCAOB believes these added insights would promote consistency between the other information and the audited financial statements, which in turn could improve the quality of the information available to investors and thereby lower the cost of capital. The Board believes that, in practice, some auditors currently perform procedures related to other information similar to the procedures in the proposed other information standard. Other auditors may incur additional costs. On balance, the Board believes the proposed approach represents a cost-sensitive approach that would be scalable to less complex companies based on the nature and extent of the information outside their financial statements compared to companies with more extensive operations.

Open questions

The comment period for the Release ends on December 11, 2013. Although comments are requested on all aspects of the proposed standards and amendments, the PCAOB is requesting comments on a number of specific open questions. The questions raised by the proposal and by the PCAOB members include the following:

• What are some additional examples of critical audit matters that could be communicated in the auditor’s report under the proposed auditor reporting standard?

• What are the costs and benefits associated with the proposals?

• How valuable is the information on critical audit matters and audit tenure to investors?

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The information in this MHM Messenger is a brief summary and may not include all the details relevant to your situation. Please contact your MHM auditor to further discuss the impact on your audit or audit report.

• To what extent would the proposed standard on other information increase the quality of information available to investors?

• Are the current proposals strong enough to meet the needs of investors? Could they be enforced effectively?

• Are some accounting firms already performing the proposed procedures related to other information, and, if so, would the cost of implementing the new standards fall disproportionately on small- to mid-sized firms?

• How, if at all, should the scope of the other information standard be broadened? For example, should it apply to registration statements filed under the Securities Act of 1933 or glossy annual reports that are distributed by companies but not filed with the SEC?

• Should the proposed standards and amendments apply to audits of brokers and dealers?

• Should the proposed standards and amendments apply to audits of companies that qualify as emerging growth companies under the JOBS Act?

• How would the proposals affect broad economic and market considerations, such as efficiency, competition and capital formation?

• Would any of the proposals have unintended consequences? Examples: Would they lead to disclosures of borderline going concern issues that do not involve “substantial doubt?” Would investors misunderstand the scope of the other information standard and/or the relationship between auditor tenure and audit quality?

Additional questions may arise as the pros and cons of the PCOAB’s proposals are compared with those of international standard setters and regulators. The International Auditing and Assurance Standards Board recently issued its proposal on auditor reporting, and the European Commission has also been working on a project to change the auditor’s report.

There may also be some overlap with suggested audit quality reporting guidelines published in a “Resource on Audit Quality Reporting” by the Center for Audit Quality around the same time as the PCAOB’s Release. The CAQ’s Resource is designed to help accounting firms report publicly and voluntarily on their commitment to audit quality. The information to be reported includes auditor independence, audit process and methodology, and firm organization and structure.

Tentative effective date

Because there are so many open questions, it is possible that the proposed standard may be refined and re-proposed at a later time. Any standards or amendments would need to be approved by the SEC before they become effective. As the proposals stand now, the tentative effective date, subject to SEC approval is for fiscal years beginning on or after December 15, 2015.

For more information

If you would like more information about the topics discussed in this Messenger, please contact Rich Howard of MHM’s Professional Standards Group or your MHM service professional. You can reach Rich directly at rhoward@cbiz.com or 949.450.4402.

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MHM Messenger 17-13 Appendix: Audit Reports for Public Companies: PCAOB Proposes First Major Changes in Decades

An Illustrative Auditor’s Unqualified Report

The following illustrative report is adapted from the PCAOB’s Release 2013-05, p 46 and 47. Changes from the illustrative report under the current standard are underlined.

Report of Independent Registered Public Accounting FirmTo the shareholders and board of directors of X Company[Introduction] To the shareholders and board of directors of X Company

We have audited the accompanying balance sheets of X Company (the “Company”) as of December 31, 20X2 and 20X1, the related statements of operations, stockholders’ equity, and cash flows, for each of the three years in the period ended December 31, 20X2, and the related notes (collectively referred to as the “financial statements”). These financial statements are the responsibility of the Company’s management.

We are a public accounting firm registered with the Public Company Accounting Oversight Board (“PCAOB”) (United States) and are required to be independent with respect to the Company in accordance with the United States federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission (“SEC”) and the PCAOB. We or our predecessor firms have served as the Company’s auditor consecutively since [year].

[Basis of Opinion]

Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, appropriate evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

[Opinion on the Financial Statements]

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of [at] December 31, 20X2 and 20X1, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 20X2, in conformity with [the applicable financial reporting framework].

Critical Audit Matters

The standards of the PCAOB require that we communicate in our report critical audit matters relating to the audit of the current period’s financial statements or state that we determined that there are no critical audit matters. Critical audit matters are those matters addressed during the audit that (1) involved our most difficult, subjective, or complex judgments; (2) posed the most difficulty to us in obtaining sufficient appropriate evidence; or (3) posed the most difficulty to us in forming our opinion on the financial statements. The critical audit matters communicated below do not alter in any way our opinion on the financial statements, taken as a whole.

[Include critical audit matters]

The Auditor’s Responsibilities Regarding Other Information

In addition to auditing the Company’s financial statements in accordance with the standards of the PCAOB, we evaluated whether the other information, included in the annual report on [SEC Exchange Act form type] filed with the SEC that contains both the December 31, 20X2 financial statements and our audit report on those financial statements, contains a material inconsistency with the financial statements, a material misstatement of fact, or both. Our evaluation was based on relevant audit evidence obtained and conclusions reached during the audit. We did not audit the other information and do not express an opinion on the other information. Based on our evaluation, we have not identified a material inconsistency or a material misstatement of fact in the other information.

[Signature] [City and State or Country] [Date]