Critical Audit Matters (CAM)
Critical Audit Matters (CAMs) defined as topics that arise during the audit process of the financial statements that have been discussed, or should have been discussed, with the Audit Committee, in addition meets the following two requirements:
- Relates to accounts or disclosures that are material to the financial statements; and
- Involved especially challenging, subjective, or complex auditor judgment.
According to the PCAOB’s AS 3101 when CAMs arise during the audit process of the financial statements, it should be reflected in the auditor’s report to the company’s financial statements.
In recent years, more and more items in the reports are based on the assessment and judgment of the company and its auditors. The PCAOB realized that there was a gap between the information that the auditor had (information that is relevant to the readers of the reports) and the information that was actually published and wanted to reduce that gap.
This gap is reduced by providing more significant information in the auditors’ reports, in respect to CAM events. What information appears in the report?
- Identification of the CAM.
- A description of the main considerations that led the auditor to determine that the matter is a CAM.
- Description of how the issue was addressed during the audit of the financial statements.
- Reference to either the relevant accounts or the notes of the financial statements.
To illustrate, at the end of the article, the text written in Microsoft’s auditor report for the year ended June 30, 2020.
The new information gives a comprehensive explanation, which was not before, to the readers of the financial statements. The information can give an indication of how to understand the data and how much weight to give to each component in the reports, according to the accountant’s explanations. In addition, the reader of the reports will be able to exercise his judgement as to the reasonableness and correctness of those topics, more than he could before.
CAMs involve “especially challenging, subjective, or complex auditor judgment.” In determining whether those criteria apply, the auditor should take into account, alone or in combination, the following nonexclusive list of factors:
- 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
As far as auditors are concerned, the standard requires them to learn and understand how to express and describe issues that were previously only reflected in the working papers. The auditors’ reports have not changed since the 1940s, and any change requires re-learning. This is especially true in such a subject, that there is no fixed wording and for every situation the appropriate wording must be found.
On the other hand, the change in reports requires companies to understand some important facts. First, each report looks different and there is no longer a uniform report, and therefore, the fact that the auditor added text does not harm the company. Second, the company needs to make sure they can support the assessments and judgments they make. Although officially, nothing has been changed in the process and manner of the audit, naturally when a particular issue is addressed in the auditor’s report more attention will be given to the issue.
When no CAM arise, the following text should be added:
Critical Audit Matters
Critical audit matters are matters arising from the current period audit of the financial statements that were 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 our especially challenging, subjective, or complex judgments. We determined that there are no critical audit matters.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were 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 our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate
Revenue Recognition – Refer to Note 1 to the financial statements
Critical Audit Matter Description
The Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.
Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following:
- Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services.
- The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation.
- Identification and treatment of contract terms that may impact the timing and amount of revenue recognized (e.g., variable consideration, optional purchases, and free services).
- Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately.
Given these factors and due to the volume of transactions, the related audit effort in evaluating management’s judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.
How the Critical Audit Matter Was Addressed in the Audit
Our principal audit procedures related to the Company’s revenue recognition for these customer agreements included the following:
- We tested the effectiveness of controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration.
- We evaluated management’s significant accounting policies related to these customer agreements for reasonableness.
- We selected a sample of customer agreements and performed the following procedures:
– Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement.
– Tested management’s identification and treatment of contract terms.
– Assessed the terms in the customer agreement and evaluated the appropriateness of management’s application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions.
- We evaluated the reasonableness of management’s estimate of stand-alone selling prices for products and services that are not sold separately.
- We tested the mathematical accuracy of management’s calculations of revenue and the associated timing of revenue recognized in the financial statements.