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PCAOB Adopts New Standards on Unqualified Audit Opinion Disclosures

Accounts Filing Forms-SF
August 28, 2017

Last week, we reported on some of the issues raised at the recently concluded National Association of Insurance Commissioners Summer 2017 National Meeting. In a future report, we will focus in greater detail on the corporate governance accreditation standards. But an article appearing August 18, 2017, in the Wall Street Journal caught our attention. The topic of the article, written by Jason Zweig and titled "How a New Audit Rule Could Bring Sunshine to U.S. Markets," does not immediately seem to have implications for captive insurers. However, in our opinion, new standards adopted by the Public Company Accounting Oversight Board (PCAOB) concerning audit opinion disclosures frequently morph into "best practices" that independent auditors require for all of their clients. In that vein, it is important for captive owners and board members to understand the new requirements and discuss the implications for their own organizations in case these standards become more widely adopted outside of public companies.

The new auditor reporting rule in question is called AS 3101, The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion. It was adopted June 1, 2017, and becomes effective in two parts: for audits of fiscal years ending on or after December 15, 2017, and for the critical audit matters (CAM) provisions, for audits of fiscal years ending on or after December 15, 2020. The United States is actually one of the last countries to adopt the new expanded disclosure requirements. As Mr. Zweig notes (citing Matt Waldron, International Auditing and Assurance Standards Board technical director), "Similar rules are already in force in the United Kingdom and Europe and other parts of the world; all told, 124 countries have adopted or are adopting these standards."

The adoption of this new disclosure requirement is part of a broader effort between the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). Since 2002, FASB and the IASB have been making an effort aimed at convergence of US generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS). FASB and IASB wanted to develop a single set of high-quality, compatible accounting standards that could be used for both domestic and international financial reporting.

The goal of both parties was removing individual differences between US GAAP and IFRS and improving the comparability and consistency of financial statements on a worldwide basis. Convergence has proven difficult, however. In September 2014, FASB announced plans to move away from the strict convergence model. Instead, FASB aligned behind an idea of improving financial reporting and decreasing differences in global accounting standards by creating an informal and collaborative network of accounting bodies in major capital markets. 

AS 3101 fits into to this new framework concept. Investors in public companies are the intended beneficiaries of the independent auditor's report. However, the way this information is communicated to the investing public has changed little since the 1940s. As the Wall Street Journal article cited above reports, "An independent accounting firm confidentially pores over a company's books and records and other aspects of the business, and then gives a terse thumbs-up or thumbs-down in the company's annual report…. That's it. These certifications—a handful of paragraphs typically indistinguishable from one company to another—offer no further information for investors."

The new standard is intended to add further clarification to this pass/fail opinion in the auditor's report. The most significant change is the addition of a discussion item on CAM. Beginning in 2020, public companies will be required to include CAM information in their audit reports, which are typically released as part of their annual report to investors. PCAOB describes CAM as follows.


Critical audit matters ... —requires the auditor to communicate in the auditor's report any critical audit matters arising from the current period's audit of the financial statements or state that the auditor determined that there were no critical audit matters:

  • A critical audit matter is defined as a matter that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex auditor judgment.

  • In determining whether a matter involved especially challenging, subjective, or complex auditor judgment, the auditor takes into account, alone or in combination, certain factors, including, but not limited to:

    • The auditor's assessment of the risks of material misstatement, including significant risks;

    • The degree of auditor judgment related to areas in the financial statements that involved the application of significant judgment or estimation by management, including estimates with significant measurement uncertainty;

    • The nature and timing of significant unusual transactions and the extent of audit effort and judgment related to these transactions;

    • The degree of auditor subjectivity in applying audit procedures to address the matter or in evaluating the results of those procedures;

    • The nature and extent of audit effort required to address the matter, including the extent of specialized skill or knowledge needed or the nature of consultations outside the engagement team regarding the matter; and

    • The nature of audit evidence obtained regarding the matter.

  • The communication of each critical audit matter includes:

    • Identifying the critical audit matter;

    • Describing the principal considerations that led the auditor to determine that the matter is a critical audit matter;

    • Describing how the critical audit matter was addressed in the audit; and

    • Referring to the relevant financial statement accounts or disclosures.

  • The documentation of critical audit matters requires that for each matter arising from the audit of the financial statements that (a) was communicated or required to be communicated to the audit committee, and (b) relates to accounts or disclosures that are material to the financial statements, the auditor documents whether or not the matter was determined to be a critical audit matter (i.e., involved especially challenging, subjective, or complex auditor judgment) and the basis for such determination.

Source: Public Company Accounting Oversight Board (PCAOB), The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion and Related Amendments to PCAOB Standards, PCAOB Release No. 2017-001, June 1, 2017, PCAOB Rulemaking Docket Matter No. 034, Section III, "Overview of the Final Standard."

Many captive insurers may view this new accounting standard as "much ado about nothing." First, the implementation period is still 3 years away. Second, most captives are not required to produce an annual report, and many do not even publish any of their audited financial information. In our opinion, however, this new rule continues the move toward greater financial transparency.

As we noted earlier, rules such as AS 3101—while not targeted at nonpublic companies— have a way of becoming best practices within audit firms. Partially, this helps to limit the professional liability exposure of the independent auditors since they only have to follow one set of procedures when conducting an audit. But the fact of the matter is it also forces the boards and management teams of individual companies to take a self-critical look at how they are arriving at the financial information they present to their stakeholders. Captive insurers, like most insurance companies, rely on some critical estimates in their accounting, such as pricing models, valuation of investments, and reserve estimates. From a corporate governance standpoint, we all have a vested interest in making sure these numbers are as accurate as we can make them.

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