[Federal Register Volume 82, Number 144 (Friday, July 28, 2017)]
[Notices]
[Pages 35396-35433]
[FR Doc No: 2017-15718]

Vol. 82

Friday,

No. 144

July 28, 2017

Part III

 Securities and Exchange Commission

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Public Company Accounting Oversight Board; Notice of Filing of Proposed
Rules on the Auditor's Report on an Audit of Financial Statements When
the Auditor Expresses an Unqualified Opinion, and Departures From
Unqualified Opinions and Other Reporting Circumstances, and Related
Amendments to Auditing Standards; Notice

Federal Register / Vol. 82 , No. 144 / Friday, July 28, 2017 /
Notices

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-81187; File No. PCAOB-2017-01]

Public Company Accounting Oversight Board; Notice of Filing of
Proposed Rules on the Auditor's Report on an Audit of Financial
Statements When the Auditor Expresses an Unqualified Opinion, and
Departures From Unqualified Opinions and Other Reporting Circumstances,
and Related Amendments to Auditing Standards

July 21, 2017.
    Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 (the
``Act'' or ``Sarbanes-Oxley Act''), notice is hereby given that on July
19, 2017, the Public Company Accounting Oversight Board (the ``Board''
or ``PCAOB'') filed with the Securities and Exchange Commission (the
``Commission'' or ``SEC'') the proposed rules described in Items I and
II below, which items have been prepared by the Board. The Commission
is publishing this notice to solicit comments on the proposed rules
from interested persons.

I. Board's Statement of the Terms of Substance of the Proposed Rules

    On June 1, 2017, the Board adopted new rules and amendments to
auditing standards (collectively, the ``proposed rules'') to make the
auditor's report more informative and relevant to investors and other
financial statement users. The text of the proposed rules appears in
Exhibit A to the SEC Filing Form 19b-4 and is available on the Board's
Web site at https://pcaobus.org/Rulemaking/Pages/Docket034.aspx and at
the Commission's Public Reference Room.

II. Board's Statement of the Purpose of, and Statutory Basis for, the
Proposed Rules

    In its filing with the Commission, the Board included statements
concerning the purpose of, and basis for, the proposed rules and
discussed any comments it received on the proposed rules. The text of
these statements may be examined at the places specified in Item IV
below. The Board has prepared summaries, set forth in sections A, B,
and C below, of the most significant aspects of such statements. In
addition, the Board is requesting that the Commission approve the
proposed rules and related amendments, with the exception of the
requirements related to critical audit matters, pursuant to Section
103(a)(3)(C) of the Sarbanes-Oxley Act, for application to audits of
emerging growth companies (``EGCs''), as that term is defined in
Section 3(a)(80) of the Securities Exchange Act of 1934 (``Exchange
Act''). The Board's request is set forth in section D.

A. Board's Statement of the Purpose of, and Statutory Basis for, the
Proposed Rules

(a) Purpose
Summary
    The Board has adopted a new auditor reporting standard, AS 3101,
The Auditor's Report on an Audit of Financial Statements When the
Auditor Expresses an Unqualified Opinion (the ``final standard'' or
``AS 3101'') and related amendments to its auditing standards that will
require the auditor to provide new information about the audit and make
the auditor's report more informative and relevant to investors and
other financial statement users. The final standard retains the pass/
fail opinion of the existing auditor's report but makes significant
changes to the existing auditor's report, including the following:
     Communication of critical audit matters--matters
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 especially challenging,
subjective, or complex auditor judgment;
     Disclosure of auditor tenure--the year in which the
auditor began serving consecutively as the company's auditor; and
     Other improvements to the auditor's report--a number of
other improvements to the auditor's report to clarify the auditor's
role and responsibilities, and make the auditor's report easier to
read.
    The Board believes that adopting these requirements responds to the
strong interest of investors for enhanced communication about the audit
and is consistent with its mandate to ``protect the interests of
investors and further the public interest in the preparation of
informative, accurate and independent audit reports.'' \1\
    The Board has adopted the final standard after more than six years
of outreach and public comment, including comments from members of the
Board's Standing Advisory Group (``SAG'') and Investor Advisory Group
(``IAG''). The Board has taken into consideration all comments and
believes its approach responds to investor requests for additional
information about the financial statement audit without imposing
requirements beyond the auditor's expertise or mandate.
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    \1\ Section 101(a) of the Sarbanes-Oxley Act of 2002
(``Sarbanes-Oxley''), 15 U.S.C. 7211(a).
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    Investors are the beneficiaries of the audit and the auditor's
report is the primary means by which the auditor communicates with
them. Currently, however, the auditor's report conveys little of the
information obtained and evaluated by the auditor as part of the audit.
And while the auditor's report has generally remained unchanged since
the 1940s, companies' operations have become more complex and global,
and the financial reporting frameworks have evolved toward an
increasing use of estimates, including fair value measurements. As part
of the audit, auditors often perform procedures involving challenging,
subjective, or complex judgments, but the auditor's report does not
communicate this information to investors. Stated differently, the
auditor's report does little to address the information asymmetry
between investors and auditors,\2\ even though investors have
consistently asked to hear more from the auditor, an independent third-
party expert whose work is undertaken for their benefit.\3\ The Board
believes that reducing the information asymmetry between investors and
auditors should, in turn, reduce the information asymmetry between
investors and management. Outside the United States, other regulators
and standard setters have already adopted expanded auditor reporting.
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    \2\ Economists often describe this imbalance, where one party
has more or better information than another party, as ``information
asymmetry.'' As part of the system of financial reporting, the audit
of the financial statements helps reduce the information asymmetry
investors face by providing an independent opinion about whether the
financial statements are presented fairly in all material respects.
    \3\ See PCAOB IAG survey, Improving the Auditor's Report (Mar.
16, 2011) (``IAG 2011 survey''). See also CFA Institute's Usefulness
of the Independent Auditor's Report Survey Results (May 4, 2011),
Independent Auditor's Report Survey Results (Mar. 31, 2010), and
Independent Auditor's Report Monthly Poll Results (Mar. 12, 2008)
(``CFA survey and poll results''). See also Board public meeting
transcripts and participant statements (Apr. 2-3, 2014), available
on the Board's Web site in Rulemaking Docket Matter No. 034,
Proposed Auditing Standards on the Auditor's Report and the
Auditor's Responsibilities Regarding Other Information and Related
Amendments (``Docket 034'').
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    The communication of critical audit matters will inform investors
and other financial statement users of matters arising from the audit
that involved especially challenging, subjective, or complex auditor
judgment, and how the auditor addressed these matters. The Board
believes that these matters will

likely be identified in areas that investors have indicated would be of
particular interest to them, such as significant management estimates
and judgments made in preparing the financial statements; areas of high
financial statement and audit risk; significant unusual transactions;
and other significant changes in the financial statements. The final
standard is designed to elicit more information about the audit
directly from the auditor. The Board believes that the critical audit
matter requirements will respond to requests from investors for more
information from the auditor while appropriately addressing concerns
raised by other commenters.
    Investors and investor advocates have suggested a variety of ways
in which investors can use the information provided in critical audit
matters. In the view of some investors, critical audit matters will add
to the total mix of information, providing insights relevant in
analyzing and pricing risks in capital valuation and allocation, and
contributing to their ability to make investment decisions. Investors
also stated that critical audit matters will focus their attention on
key financial reporting areas and identify areas that deserve more
attention, enhancing the efficiency of investors and others in the
consumption of financial information. Some investors believe that
critical audit matters will highlight areas that they may wish to
emphasize in their engagement with the company and provide important
information that they can use in making proxy voting decisions,
including ratification of the appointment of auditors.
    The final standard also includes a new required statement in the
auditor's report disclosing the year in which the auditor began serving
consecutively as the company's auditor, as well as a number of other
improvements to the auditor's report, such as a statement regarding the
requirement for the auditor to be independent. Requiring disclosure of
auditor tenure in the auditor's report will make this information
readily accessible in a timely way for investors who find it useful.
The other improvements to the auditor's report are intended to enhance
the user's understanding of the auditor's role and responsibilities
related to the audit of the financial statements, make the auditor's
report easier to read, and provide a consistent format.
    The final standard will generally apply to audits conducted under
PCAOB standards. However, communication of critical audit matters is
not required for audits of brokers and dealers reporting under the
Securities Exchange Act of 1934 (the ``Exchange Act'') Rule 17a-5;
investment companies other than business development companies;
employee stock purchase, savings, and similar plans (``benefit
plans''); and emerging growth companies (``EGCs''), as defined in
Section 3(a)(80) of the Exchange Act. Auditors of these entities may
choose to include critical audit matters in the auditor's report
voluntarily. The other requirements of the final standard will apply to
these audits.
    Critical audit matters are determined using a principles-based
framework and the Board anticipates that the level of auditor effort
will depend on the nature and complexity of the audit.
    The Board has adopted a phased approach to the effective dates for
the new requirements to provide accounting firms, companies, and audit
committees more time to prepare for implementation of the critical
audit matter requirements, which are expected to require more effort to
implement than the additional improvements to the auditor's report.
Subject to approval by the Securities and Exchange Commission
(``SEC''), the final standard and amendments will take effect as
follows:
     All provisions other than those related to critical audit
matters will take effect for audits of fiscal years ending on or after
December 15, 2017; and
     Provisions related to critical audit matters will take
effect for audits of fiscal years ending on or after June 30, 2019, for
large accelerated filers; and for fiscal years ending on or after
December 15, 2020, for all other companies to which the requirements
apply.
    Auditors may elect to comply before the effective date, at any
point after SEC approval of the final standard.
(b) Statutory Basis
    The statutory basis for the proposed rules is Title I of the Act.

B. Board's Statement on Burden on Competition

    Not applicable.

C. Board's Statement on Comments on the Proposed Rules Received From
Members, Participants or Others

    The Board released the proposed rule amendment for public comment
in Concept Release on Possible Revisions to PCAOB Standards Related to
Reports on Audited Financial Statements; and Related Amendments to
PCAOB Standards, PCAOB Release No. 2011-003 (June 21, 2011) (``concept
release''), Proposed Auditing Standards--The Auditor's Report on an
Audit of Financial Statements When the Auditor Expresses an Unqualified
Opinion; The Auditor's Responsibilities Regarding Other Information in
Certain Documents Containing Audited Financial Statements and the
Related Auditor's Report; and Related Amendments to PCAOB Standards,
PCAOB Release No. 2013-005 (Aug. 13, 2013) (``proposal''), Proposed
Auditing Standard--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. 2016-003 (May
11, 2016) (``reproposal''). See Exhibit 2(a)(A). A copy of Release Nos.
2011-003, 2013-005, 2016-003 and the comment letters received in
response to the PCAOB's requests for comment are available on the
PCAOB's Web site at https://pcaobus.org/Rulemaking/Pages/Docket034.aspx. The Board received 491 written comment letters. The
Board's response to the comments it received and the changes made to
the rules in response to the comments received are discussed below.
Discussion of the Final Standard
Critical Audit Matters
    Under the final standard, the auditor will be required to
communicate critical audit matters in the auditor's report in order to
provide more information about the audit and make the auditor's report
more informative and relevant to investors and other financial
statement users.
    Investor, investor advocate, and analyst commenters generally
supported the reproposed requirement to communicate critical audit
matters. Some of them stated that the communication of critical audit
matters would be relevant to investors and other financial statement
users by informing them of issues identified in the audit that were
significant to the auditor, focusing attention on issues that would be
pertinent to understanding the financial statements, and enhancing
investor confidence in the financial statements.
    The larger and some smaller accounting firms generally supported
including critical audit matters in the auditor's report with some
modification of the reproposed requirements. Other commenters,
including other smaller accounting firms, companies, and audit
committee members, did not support the requirements. Some of these
commenters asserted that critical audit matters would not provide
relevant information to investors, may be duplicative of the company's
disclosure, may result in disclosing information not otherwise required
to be disclosed,

could increase cost, or could delay completion of the audit.
    Other commenters suggested that the Board align the definition of
critical audit matters with the International Auditing and Assurance
Standards Board's (``IAASB'') definition of key audit matters to
enhance overall consistency.
    Consistent with the Board's statutory mandate under Section 101(a)
of Sarbanes-Oxley and in response to the 2008 U.S. Department of the
Treasury Advisory Committee on the Auditing Profession (``ACAP'')
recommendation and continued investor support for expanded auditor
reporting, the final standard includes the requirement to communicate
critical audit matters substantially as reproposed. The Board has taken
into consideration all comments, including concerns raised by some
commenters, which are described in more detail below, and believes its
approach responds to investor requests for additional information about
the financial statement audit without imposing requirements beyond the
auditor's expertise or mandate. The communication of critical audit
matters will inform investors and other financial statement users of
matters arising from the audit that involved especially challenging,
subjective, or complex auditor judgment, and how the auditor addressed
those matters.
    Critical audit matters are determined using a principles-based
framework and the Board anticipates that the level of auditor effort
will depend on the nature and complexity of the audit. This would in
turn depend on the complexity of the operations and accounting and
control systems of the company.
Determination of Critical Audit Matters
Definition of Critical Audit Matter
    The reproposed standard defined a critical audit matter as any
matter arising from the audit of the financial statements that was
communicated or required to be communicated to the audit committee and
that relates to accounts or disclosures that are material to the
financial statements and involved especially challenging, subjective,
or complex auditor judgment. For the reasons explained below, the Board
is adopting the definition as reproposed.
Communicated or Required To Be Communicated to the Audit Committee
    Most commenters agreed that matters communicated or required to be
communicated to the audit committee would be the appropriate source for
critical audit matters. These commenters stated that matters
communicated to the audit committee are the most meaningful to users of
the financial statements and using them as the source of critical audit
matters would assist the auditor in determining critical audit matters
in the most efficient and effective manner.
    PCAOB standards require the auditor to communicate to the audit
committee, among other things:
     Significant risks identified by the auditor;
     Certain matters regarding the company's accounting
policies, practices, and estimates;
     Significant unusual transactions;
     Certain matters regarding the auditor's evaluation of the
company's relationships and transactions with related parties; and
     Other matters arising from the audit that are significant
to the oversight of the company's financial reporting process.
    Several commenters suggested revising the source of critical audit
matters. Some suggested narrowing the source of critical audit matters
only to matters required to be communicated to the audit committee, on
the basis that this would avoid chilling communications regarding non-
required matters and reduce the burden of documentation. Other
commenters suggested that the Board consider, as an alternative,
selecting critical audit matters only from critical accounting policies
and estimates disclosed by management, which some said would eliminate
the potential for the auditor to become the original source of
information, as well as the potential for conflicting disclosures
between the auditor and management. Some commenters also recommended
not specifying the source for critical audit matters and leaving it up
to auditor judgment. Other commenters suggested broadening the source
of critical audit matters to include matters documented in the
engagement completion document, reviewed by the engagement quality
reviewer, or communicated with management and other members of the
board of directors, as the Board had originally proposed in 2013.
    The final standard retains the source of critical audit matters as
reproposed. Critical audit matters will be drawn from matters required
to be communicated to the audit committee (even if not actually
communicated) and matters actually communicated (even if not required).
The source will include auditor communication requirements under AS
1301, Communications with Audit Committees, other PCAOB rules and
standards,\4\ and applicable law,\5\ as well as communications made to
the audit committee that were not required. This approach scopes in the
broadest population of audit committee communications and will not
require the auditor to determine whether matters communicated to the
audit committee were required to be communicated. However, it seems
likely that matters that meet the definition of a critical audit matter
will usually relate to areas that are required to be communicated to
the audit committee, either under a specific communication requirement
or the broad provisions of paragraph .24 of AS 1301, which requires
communication of matters arising from the audit that are significant to
audit committee oversight of the financial reporting process.
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    \4\ See Appendix B of AS 1301, which identifies other PCAOB
rules and standards that require audit committee communication, such
as AS 2410, Related Parties, and AS 2502, Auditing Fair Value
Measurements and Disclosures.
    \5\ See, e.g., Section 10A(k) of the Exchange Act, 15 U.S.C.
78j-1(k); Rule 2-07 of Regulation S-X, 17 CFR 210.2-07; and Exchange
Act Rule 10A-3, 17 CFR 240.10A-3.
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    Required communications to the audit committee generally include
the areas in which investors have expressed particular interest in
obtaining information in the auditor's report, such as significant
management estimates and judgments made in preparing the financial
statements; areas of high financial statement and audit risk;
significant unusual transactions; and other significant changes in the
financial statements.
    The final standard does not limit the source of critical audit
matters to critical accounting policies and estimates because the Board
does not believe this would be an appropriate starting point in light
of investor interest in a broader range of topics related to the audit.
Additionally, the final standard does not broaden the source, as
proposed in 2013, to also include matters documented in the engagement
completion document and reviewed by the engagement quality reviewer
because it is unlikely that a matter that is determined to be a
critical audit matter would not have already been communicated to the
audit committee.
    Some commenters suggested that using audit committee communications
as the source for critical audit matters could impair the relationship
between auditor, management, and the audit committee (e.g., chill
communications, give rise to conflict, or cause auditors to communicate
more than they otherwise would). However, other commenters argued that
critical audit matters would

enhance, not impair, communications between auditors, investors, and
those charged with governance (including audit committees). For matters
required to be communicated to the audit committee, the Board believes
there should not be a chilling effect or reduced communications to the
audit committee because the requirements for such communications are
not changing. It would seem that any chilling effect would more likely
relate to matters that are not explicitly required to be communicated
to the audit committee, although given the broad requirements of AS
1301 (particularly paragraph .24), the Board believes that there may be
few, if any, relevant communications affected by that possibility.
    Some commenters suggested excluding certain required audit
committee communications from the source of critical audit matters,
generally because these communications relate to sensitive areas and
may result in the auditor communicating information not disclosed by
management. Suggestions included: Corrected and uncorrected
misstatements, qualitative aspects of significant accounting policies
and practices, alternative treatments within generally accepted
accounting principles (``GAAP'') for policies and practices related to
material accounts, violations or possible violations of law or
regulation, independence considerations, disagreements with management,
other material written communications between the auditor and
management, overall planned audit strategy, delays encountered in the
audit, and competency issues of management. Other commenters argued
that no audit committee communications should be specifically excluded
from consideration as a source of potential critical audit matters.
    The final standard does not exclude any required audit committee
communications from the source of critical audit matters. To the extent
that any such communication met the critical audit matter definition
(including that it (1) relates to accounts or disclosures that are
material to the financial statements and (2) involved especially
challenging, subjective, or complex auditor judgment), the Board
believes it will be an appropriate subject for an auditor to
communicate as a critical audit matter.
Relates to Accounts or Disclosures That Are Material to the Financial
Statements
    The materiality component of the reproposed definition of critical
audit matters--that the matter ``relates to accounts or disclosures
that are material \6\ to the financial statements''--was intended to
respond to investor requests for informative and relevant auditor's
reports while, at the same time, addressing other commenters' concerns
regarding auditor communication of immaterial information that
management is not required to disclose under the applicable financial
reporting framework and SEC reporting requirements.
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    \6\ The definition of materiality is established under the U.S.
federal securities laws. In interpreting those laws, the U.S.
Supreme Court has held that a fact is material if there is ``a
substantial likelihood that the . . . fact would have been viewed by
the reasonable investor as having significantly altered the `total
mix' of information made available.'' See TSC Industries v.
Northway, Inc., 426 U.S. 438, 449 (1976). See also Basic, Inc. v.
Levinson, 485 U.S. 224, 231-32 (1988). As the Supreme Court has
further explained, determinations of materiality require ``delicate
assessments of the inferences a `reasonable shareholder' would draw
from a given set of facts and the significance of those inferences
to him . . .'' TSC Industries, 426 U.S. at 450.
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    Some investor commenters suggested removing the materiality
component of the reproposed definition of critical audit matters,
arguing that it made the definition too narrow and would unnecessarily
exclude relevant information. Some of these commenters observed that
many cases of material accounting problems or fraud started as
``immaterial'' to the financial statements and built over time, and
that such matters may not meet the reproposed definition of a critical
audit matter because of the materiality component.
    Other commenters, primarily companies and accounting firms, argued
that the reproposed definition was too broad and suggested modifying
the materiality component such that a critical audit matter would
itself have to be material to the financial statements as a whole,
rather than relating to accounts or disclosures that are material to
the financial statements. These commenters expressed concern that the
phrase ``relates to accounts or disclosures that are material to the
financial statements'' could apply to too many matters, resulting in
the auditor disclosing immaterial matters that would not otherwise be
disclosed by management, or give the impression of a piecemeal opinion.
    After consideration of comments, the Board has determined to adopt
the materiality component in the final definition of critical audit
matter as reproposed. In the Board's view, the purpose of the
standard--making the auditor's report more useful and informative to
investors--is better served by auditor communication of matters related
to accounts or disclosures that are material to the financial
statements. As one commenter noted, limiting the source of critical
audit matters and adding a materiality component that directly relates
to accounts and disclosures ``would allow the auditor to emphasize the
most important matters to users of the financial statements, and limit
the inclusion of an overabundance of [critical audit matters] within
the auditor's report that could deemphasize their importance.'' \7\
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    \7\ See letter from Dixon Hughes Goodman, LLP (Aug. 15, 2016) at
2, available on the Board's Web site in Docket 034 (also noting that
there is a continuing risk that the auditor could disclose
information about the company that was not previously disclosed by
the company).
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    At the same time, in the Board's view, limiting critical audit
matters to those that are, in and of themselves, material to the
financial statements as a whole would not serve the intended purpose of
the standard. If the auditor were required to determine that a critical
audit matter itself is material, rather than related to an account or
disclosure that is material, it is likely that fewer matters would meet
the definition of a critical audit matter and, thus, investors would
likely receive less, and less audit-specific, information than under
the standard as adopted.
    Accordingly, as in the reproposal, the final standard provides that
each critical audit matter relates to accounts or disclosures that are
material to the financial statements. Consistent with the reproposal,
``relates to'' clarifies that the critical audit matter could be a
component of a material account or disclosure and does not necessarily
need to correspond to the entire account or disclosure in the financial
statements. For example, the auditor's evaluation of the company's
goodwill impairment assessment could be a critical audit matter if
goodwill was material to the financial statements, even if there was no
impairment; it would relate to goodwill recorded on the balance sheet
and the disclosure in the notes to the financial statements about the
company's impairment policy and goodwill. In addition, a critical audit
matter may not necessarily relate to a single account or disclosure but
could have a pervasive effect on the financial statements if it relates
to many accounts or disclosures. For example, the auditor's evaluation
of the company's ability to continue as a going concern could also
represent a critical audit matter depending on the circumstances of a
particular audit.
    On the other hand, a matter that does not relate to accounts or
disclosures that are material to the financial statements

cannot be a critical audit matter. For example, a potential loss
contingency that was communicated to the audit committee, but that was
determined to be remote and was not recorded in the financial
statements or otherwise disclosed under the applicable financial
reporting framework, would not meet the definition of a critical audit
matter; it does not relate to an account or disclosure in the financial
statements, even if it involved especially challenging auditor
judgment. The same rationale would apply to a potential illegal act if
an appropriate determination had been made that no disclosure of it was
required in the financial statements; the matter would not relate to an
account or disclosure that is material to the financial statements.
    For the same reason, the determination that there is a significant
deficiency in internal control over financial reporting, in and of
itself, cannot be a critical audit matter; such determination, in and
of itself, does not relate to an account or disclosure that is material
to the financial statements as no disclosure of the determination is
required. A significant deficiency could, however, be among the
principal considerations that led the auditor to determine that a
matter is a critical audit matter.\8\
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    \8\ See below for additional considerations related to auditor
disclosure of original information.
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Involved Especially Challenging, Subjective, or Complex Auditor
Judgment
    Many commenters supported including ``matters that involved
especially challenging, subjective, or complex auditor judgment'' in
the reproposed definition of a critical audit matter. Other commenters
argued that the phrase ``especially challenging, subjective, or complex
auditor judgment'' is broad and subjective and would lead to
inconsistent application of the reproposed definition. For example,
some commenters said that critical audit matters would vary based on
the experience and competence of the auditor, even if the underlying
facts and circumstances were the same. One commenter urged disclosure
of the auditor's perspective on material related party transactions.
Another commenter suggested that the standard include a note stating
that it is expected that in most audits, financial statement matters
involving the application of significant judgment or estimation by
management would involve especially challenging, subjective, or complex
auditor judgment.
    Several commenters suggested using the IAASB's definition of key
audit matters, which includes those matters that were of most
significance in the audit of the financial statements and that required
significant auditor attention. One commenter argued that this would
avoid reliance on the auditor's determination of whether a matter
involved especially challenging, subjective, or complex auditor
judgment, which the commenter said would give auditors too much
discretion.
    After consideration of comments, the Board is adopting this
component of the definition of critical audit matter as reproposed,
namely ``matters that involved especially challenging, subjective, or
complex auditor judgment.'' This grounds the definition in the
auditor's expertise and judgment, which is directly responsive to
investor requests for information from the auditor's point of view.
Thus, the Board believes that this definition will focus critical audit
matters in areas where investors will particularly benefit from
expanded reporting by the auditor.
    The determination of critical audit matters is principles-based and
the final standard does not specify any items that would always
constitute critical audit matters. For example, the standard does not
provide that all matters determined to be ``significant risks'' under
PCAOB standards would be critical audit matters.\9\ Some significant
risks may be determined to be critical audit matters, but not every
significant risk would involve especially challenging, subjective, or
complex auditor judgment. To illustrate, improper revenue recognition
is a presumed fraud risk and all fraud risks are significant risks;
\10\ however, if a matter related to revenue recognition does not
involve especially challenging, subjective, or complex auditor
judgment, it will not be a critical audit matter. Similarly, the final
standard does not provide, as some commenters suggested, that material
related party transactions or matters involving the application of
significant judgment or estimation by management always constitute
critical audit matters. The auditor must determine, in the context of
the specific audit, that a matter involved especially challenging,
subjective, or complex auditor judgment. In addition, focusing on
auditor judgment should limit the extent to which expanded auditor
reporting could become duplicative of management's reporting. To the
extent that critical audit matters reflect differences in auditors'
experience and competence, this in itself should also be informative.
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    \9\ A significant risk is a ``risk of material misstatement that
requires special audit consideration.'' Paragraph .A5 of AS 2110,
Identifying and Assessing Risks of Material Misstatement.
    \10\ See AS 2110.71.
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Factors
    The reproposal included the following nonexclusive list of factors
for the auditor to take into account, together with audit-specific
factors, when determining whether a matter involved especially
challenging, subjective, or complex auditor judgment:
    a. The auditor's assessment of the risks of material misstatement,
including significant risks;
    b. The degree of auditor subjectivity in determining or applying
audit procedures to address the matter or in evaluating the results of
those procedures;
    c. 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;
    d. 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;
    e. The nature and timing of significant unusual transactions and
the extent of audit effort and judgment related to these transactions;
and
    f. The nature of audit evidence obtained regarding the matter.
    Commenters in general agreed that including such factors would
assist the auditor in determining critical audit matters.
    Some commenters suggested changes to better align the factors with
areas of complex management judgment, to reduce the risk that the
auditor would be the source of original information, to clarify the
linkage of procedures performed by the auditor and sufficient
appropriate audit evidence obtained in performing those procedures, and
to focus the auditor on the audit procedures executed to obtain
sufficient and appropriate audit evidence rather than audit strategy
decisions. Some commenters suggested harmonizing the factors with the
IAASB's factors for determining key audit matters.
    After considering the comments received, the Board has modified the
factors by reordering them and revising the factor relating to the
degree of auditor subjectivity (factor b above) to refer to the
application (rather than determination) of audit procedures, which
focuses it more clearly on the

performance of the audit rather than audit strategy.
    Some commenters suggested that the factor pertaining to the nature
and extent of the audit effort (factor c) be revised to relate to the
nature and extent of audit effort required to obtain sufficient
appropriate audit evidence to address a matter and the factor
pertaining to the nature of audit evidence (factor f) be deleted to
clarify that obtaining audit evidence is a component of audit effort.
The final standard does not change factor c as suggested because it
would inappropriately narrow the factor exclusively to considerations
related to obtaining audit evidence rather than the nature of the
overall audit effort. Additionally, the Board determined to retain
factor f as a stand-alone factor because, as stated in the reproposal,
in the limited implementation trial conducted by several accounting
firms, this factor appeared to be one of the most useful in determining
critical audit matters.\11\
---------------------------------------------------------------------------

    \11\ See letter from the Center for Audit Quality (June 19,
2014) at 5, available on the Board's Web site in Docket 034.
---------------------------------------------------------------------------

    A commenter recommended including a factor based on the extent of
interaction with the audit committee. The final standard does not
include this factor because the extent of interaction might not be a
meaningful indicator of the complexity or subjectivity of the matter
and it could create incentives to limit communication between the
auditor and the audit committee.
    One commenter did not agree with elimination of two proposed
factors that related to the severity of control deficiencies and
corrected and uncorrected misstatements. These factors were eliminated
from the reproposal in response to comments that the factors would lead
the auditor to determine matters as critical audit matters in areas
where the company has no existing reporting obligation, or where the
company has determined that the matters are not material and therefore
do not require disclosure under the financial reporting framework. For
these reasons, the final standard does not include these factors.
    Under the final standard, once the auditor identifies a matter
communicated or required to be communicated to the audit committee that
relates to accounts or disclosures that are material to the company's
financial statements, the auditor should take into account the
following nonexclusive list of factors, as well as other audit-specific
factors, when determining whether a matter involved especially
challenging, subjective, or complex auditor judgment:
    a. The auditor's assessment of the risks of material misstatement,
including significant risks;
    b. 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;
    c. The nature and timing of significant unusual transactions and
the extent of audit effort and judgment related to these transactions;
    d. The degree of auditor subjectivity in applying audit procedures
to address the matter or in evaluating the results of those procedures;
    e. 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
    f. The nature of audit evidence obtained regarding the matter.
    The determination should be made in the context of the particular
audit, with the aim of providing audit-specific information rather than
a discussion of generic risks. The factors provide a principles-based
framework for the auditor to use in assessing whether a matter involved
especially challenging, subjective, or complex auditor judgment.
Depending on the matter, the auditor's determination that a matter is a
critical audit matter might be based on one or more of these factors,
other factors specific to the audit, or a combination.
Audit Period Covered by Critical Audit Matters
    The reproposal would have required the auditor to communicate
critical audit matters for the audit of the current period's financial
statements. Because the communication of critical audit matters for
prior periods might also be useful to investors and other financial
statement users in certain situations, the reproposed standard provided
that the auditor may communicate critical audit matters relating to a
prior period when: (1) The prior period's financial statements are made
public for the first time, such as in an initial public offering, or
(2) issuing an auditor's report on the prior period's financial
statements because the previously issued auditor's report could no
longer be relied upon.
    Some commenters generally supported communicating critical audit
matters for only the current period's financial statements or for all
periods if audited financial statements have not been made public
previously. Other commenters supported communication of critical audit
matters for all periods presented along with an explanation if prior
year critical audit matters are not repeated in the current year. Yet
another commenter stated that the auditor should be encouraged to use
judgment as to whether to include critical audit matters for prior
periods and not limit the consideration only to the circumstances
described in the reproposal.
    The final standard retains the requirement to communicate critical
audit matters only for the current audit period. While most companies'
financial statements are presented on a comparative basis, and thus
most auditor's reports cover a similar period, requiring auditors to
communicate critical audit matters for the current period, rather than
for all periods presented, will provide relevant information about the
most recent audit and is intended to reflect a cost-sensitive approach
to auditor reporting. In addition, investors and other financial
statement users will be able to look at prior years' filings to analyze
critical audit matters over time. However, the auditor could choose to
include critical audit matters for prior periods. The final standard
clarifies that the two situations relating to a prior period are
examples rather than the only situations in which a critical audit
matter for a prior period may be communicated.
    As noted in the reproposal, if the auditor's report is dual-dated,
the auditor will determine whether the new information for which the
auditor's report is dual-dated gives rise to any additional critical
audit matters.
    In situations in which a predecessor auditor has been asked to
reissue its auditor's report, the communication of critical audit
matters for the prior period need not be repeated because it is only
required for the current year. However, the predecessor auditor could
choose to include prior year critical audit matters in the reissued
auditor's report.
Requirements of Other Regulators and Standard Setters
    IAASB. Under the IAASB's standard, ``key audit matters'' are
defined as those matters that, in the auditor's professional judgment,
were of most significance in the audit of the financial statements of
the current period. Key audit matters are determined using a two-step
process. First, the auditor identifies the matters communicated

with those charged with governance \12\ that required significant
auditor attention in performing the audit, taking into account:
---------------------------------------------------------------------------

    \12\ See paragraph 8 of ISA 701. See also ISA 260, Communication
with Those Charged with Governance, which provides requirements for
auditor communications with those charged with governance.
---------------------------------------------------------------------------

     Areas of higher assessed risks of material misstatement,
or significant risks;
     Significant auditor judgments relating to areas in the
financial statements that involved significant management judgment,
including accounting estimates that have been identified as having high
estimation uncertainty; and
     The effect on the audit of significant events or
transactions that occurred during the period.\13\
---------------------------------------------------------------------------

    \13\ See paragraph 9 of ISA 701.
---------------------------------------------------------------------------

    Second, of the matters that required significant auditor attention,
the auditor identifies those of most significance in the audit as the
key audit matters.\14\ The IAASB requires the communication of key
audit matters for the current period only.\15\
---------------------------------------------------------------------------

    \14\ See paragraph 10 of ISA 701.
    \15\ See paragraphs 8 and 10 of ISA 701.
---------------------------------------------------------------------------

    European Union (``EU''). The EU requires the auditor to describe
the most significant assessed risks of material misstatement, including
assessed risks of material misstatement due to fraud.\16\ The EU does
not specify the period for which these need to be described.
---------------------------------------------------------------------------

    \16\ See requirements in 2(c) of Article 10, Audit Report, of
Regulation (EU) No. 537/2014.
---------------------------------------------------------------------------

    Financial Reporting Council in the United Kingdom (``FRC''). The
FRC requires the auditor to describe the risks of material misstatement
that had the greatest effect on: (1) The overall audit strategy; (2)
the allocation of resources in the audit; and (3) directing the efforts
of the engagement team.\17\ The FRC does not specify the period for
which these need to be described.
---------------------------------------------------------------------------

    \17\ See paragraph 19A of UK ISA 700 (2013).
---------------------------------------------------------------------------

Communication of Critical Audit Matters
    Under the reproposal, the auditor would have been required to
include introductory language in the auditor's report preceding the
communication of critical audit matters and to communicate critical
audit matters by identifying each matter, describing the auditor's
principal considerations for determining that the matter was a critical
audit matter, describing how the critical audit matter was addressed in
the audit, and referring to the relevant financial statement accounts
and disclosures.
    Comments varied on the reproposed requirements for communication of
critical audit matters and the level of detail the auditor should
provide, including whether the auditor should be permitted to provide
information about the company that has not been previously disclosed by
the company (which commenters referred to as ``original information'').
Commenters generally agreed with identifying each critical audit matter
and referring to the relevant financial statement accounts and
disclosures. One commenter suggested removing the requirements to
describe the considerations for determining that a matter was a
critical audit matter and how the critical audit matter was addressed
in the audit. While some commenters stated that the proposed
requirements regarding auditor's communication of critical audit
matters are sufficiently clear, many suggested improvements to some of
the components of the communication requirements. After consideration
of comments, the Board has made some enhancements to the communication
requirements, as described below.
Introductory Language
    The reproposed standard provided introductory language to be
included in the ``Critical Audit Matters'' section of the auditor's
report indicating that critical audit matters did not alter the opinion
on the financial statements and that the auditor was not providing a
separate opinion on the critical audit matters. Some commenters
supported the introductory language on the basis that it could minimize
users' potential misunderstanding of the critical audit matters.
    Some commenters suggested additions to the introductory language to
emphasize that critical audit matters are subjective and may not
represent the most important aspects of the financial statements, to
clarify that the description of procedures should not be taken as
indicative of results of any individual procedure, or to limit reliance
on critical audit matters by adding language similar to that used in a
report on an audit of internal control over financial reporting
(``ICFR'').\18\ The introductory language in the final standard does
not include the suggested additions because such language could be
interpreted as disclaiming or inappropriately minimizing the
communication of critical audit matters.
---------------------------------------------------------------------------

    \18\ The auditor's report on the audit of internal control over
financial reporting requires a paragraph stating that, ``because of
inherent limitations, internal control over financial reporting may
not prevent or detect misstatements and that projections of any
evaluation of effectiveness to future periods are subject to the
risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or
procedures may deteriorate.'' See paragraph .85j of AS 2201, An
Audit of Internal Control Over Financial Reporting That Is
Integrated with An Audit of Financial Statements.
---------------------------------------------------------------------------

    Other commenters suggested minor revisions in the introductory
language to refer to the ``communication of critical audit matters''
rather than the critical audit matters themselves. In response to this
comment, the required introductory language in the final standard has
been revised as follows (additions are in italic and deletions are in
{brackets{time} ):

    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
{C{time} critical audit matters does not alter in any way our
opinion on the financial statements, taken as a whole, and we
{do{time}  are not, by communicating the critical audit matters
below, {provide{time}  providing separate opinions on the critical
audit matters or on the accounts or disclosures to which they
relate.
Communication Requirements
    The reproposal required that, for each critical audit matter, the
auditor would:
     Identify the critical audit matter;
     Describe the principal considerations that led the auditor
to determine that the matter is a critical audit matter;
     Describe how the critical audit matter was addressed in
the audit; and
     Refer to the relevant financial statement accounts and
disclosures that relate to the critical audit matter.
    As discussed in more detail below, these requirements have been
adopted substantially as reproposed.\19\
---------------------------------------------------------------------------

    \19\ The reproposing release included two illustrative examples
of the communication of critical audit matters. See PCAOB Release
No. 2016-003, Section IV.A.2.b. Given the principles-based nature of
the requirements for critical audit matters and the objective of
providing tailored, audit-specific information, the examples were
intended to function as illustrations of how critical audit matters
could be communicated, and not as templates for how critical audit
matters should be communicated. Comments received on these examples
were taken into account in the Board's consideration of the final
standard. Illustrative examples do not appear in the adopting
release because the Board believes auditors should provide tailored,
audit-specific information when communicating critical audit matters
in the auditor's report.

---------------------------------------------------------------------------

Identify the Critical Audit Matter and Describe the Principal
Considerations That Led the Auditor To Determine That the Matter Is a
Critical Audit Matter
    Many commenters who addressed this topic supported the
identification of the critical audit matter and limiting the
description to ``the principal considerations'' that led the auditor to
determine that the matter is a critical audit matter, and those aspects
of the communication requirements are adopted as reproposed. The
auditor's description of the principal considerations should be
specific to the circumstances and provide a clear, concise, and
understandable discussion of why the matter involved especially
challenging, subjective, or complex auditor judgment. It is expected
that the communication will be tailored to the audit to avoid
standardized language and to reflect the specific circumstances of the
matter.
Describe How the Critical Audit Matter Was Addressed in the Audit
    The reproposed standard included a new requirement for the auditor
to describe how the critical audit matter was addressed in the audit.
While the standard did not specify how this should be done, the
reproposing release provided four examples of potential approaches to
such descriptions: (1) The auditor's response or approach that was most
relevant to the matter; (2) a brief overview of the procedures
performed; (3) an indication of the outcome of the auditor's
procedures; and (4) key observations with respect to the matter, or
some combination of these elements.\20\
---------------------------------------------------------------------------

    \20\ These elements are similar to the IAASB's elements
described in paragraph A46 of ISA 701. The EU also requires that the
auditor describe key observations with respect to the most
significant assessed risks of material misstatement.
---------------------------------------------------------------------------

    Many commenters were supportive of a requirement to describe how
each critical audit matter was addressed in the audit. Some commenters
asserted that a description of how a critical audit matter was
addressed would benefit investors by providing insights on how and on
what basis the auditor developed the opinion or the rigor that
underlies the audit procedures performed. For example, one investor
commenter stated that including audit procedures in the description of
a critical audit matter would make the auditor's report more
informative and useful. Several investors suggested that the auditor
should be required or encouraged to provide informative, company-
specific findings when describing how the critical audit matter was
addressed in the audit, such as whether management's significant
accounting estimates and judgments were balanced, mildly optimistic, or
mildly pessimistic.
    One commenter suggested that the description of how the critical
audit matter was addressed in the audit should be optional. Several
commenters objected to the auditor including audit procedures in the
description of critical audit matters because it would not provide any
incremental value or actionable information to investors, investors may
not have the expertise or context to understand audit procedures, or
the description of audit procedures would become boilerplate. One
commenter suggested adding a note to clarify that the purpose of
describing audit procedures is to provide information about the audit
but not specific details that would compromise the effectiveness of
audit procedures. Other commenters suggested that only the principal
audit procedures should be provided.
    The final standard includes the requirement for the auditor to
describe how the critical audit matter was addressed in the audit
because it is consistent with the Board's objective of providing more
information about the audit and, if developed with an appropriate focus
on the intended audience, should be of interest to users. Similar to
the reproposal, the final standard does not prescribe a specific way to
meet this requirement. Several commenters suggested that the four
examples provided in the reproposing release be included in the
standard because they provide helpful guidance on how the requirement
could be met. The final standard includes a note incorporating these
examples, which should clarify the Board's expectations while providing
flexibility in describing how a critical audit matter was addressed in
the audit.
    While the description of how the critical audit matter was
addressed in the audit will require judgment, the auditor should bear
in mind that the intent of communicating critical audit matters is to
provide information about the audit of the company's financial
statements that will be useful to investors. A brief overview of the
audit procedures performed is one of the alternatives for describing
how the critical audit matter was addressed. If the auditor chooses to
describe audit procedures, the descriptions are expected to be at a
level that investors and other financial statement users would
understand. In addition, as the four examples should make clear, the
objective is to provide a useful summary, not to detail every aspect of
how the matter was addressed in the audit. Limiting the use of highly
technical accounting and auditing terms in the description of critical
audit matters, particularly if the auditor chooses to describe audit
procedures, may help financial statement users better understand these
matters in relation to the audit of the financial statements.
    In its comment letter, a working group of the IAG stressed the
importance to investors of auditor findings, which they described as
``the one item that [they] believe would provide the greatest value to
investors.'' \21\ Acknowledging the difficulty of mandating reporting
of findings, the working group recommended that the Board encourage
auditors to include them voluntarily. Under the final standard,
communication of the auditor's findings is not required; however, in
describing the audit response, the auditor may choose to include
findings as an indication of the outcome of audit procedures or key
observations about a matter. The Board shares the working group's view
that the inclusion of informative, company-specific audit findings
related to critical audit matters may, in appropriate circumstances, be
valuable to investors and encourages auditors to consider including
such findings in their auditor's reports. However, in describing
findings, the language used should not imply that the auditor is
providing a separate opinion on the critical audit matter or on the
accounts or disclosures to which they relate.
---------------------------------------------------------------------------

    \21\ Letter from the IAG's auditor's report working group (Aug.
15, 2016) at 1, available on the Board's Web site in Docket 034. The
working group made a presentation regarding its comment letter at
the IAG meeting in October 2016, available on the Board's Web site.
---------------------------------------------------------------------------

Refer to the Relevant Financial Statement Accounts or Disclosures That
Relate to the Critical Audit Matter
    The reproposed standard would have required the auditor to refer to
the relevant financial statement accounts and disclosures that relate
to the critical audit matter. There were few comments on this
requirement. One commenter suggested that, to avoid duplication,
reference should be made only to the disclosures and not the financial
statement accounts. In response to this suggestion, the final standard
clarifies that the auditor could refer to either the relevant account
or disclosure, rather than both, to avoid potential duplication.
    The reproposal also solicited comment on whether, in addition to
referring to the relevant financial

statement accounts and disclosures, the auditor should refer to
relevant disclosures outside the financial statements. Commenters that
addressed this question generally opposed the auditor referencing
disclosures outside the financial statements when describing a critical
audit matter because it may incorrectly suggest that such information
is audited or cause readers to misinterpret the auditor's role in
relation to such information. The final standard only requires the
auditor to refer to the relevant financial statement accounts or
disclosures.
Additional Considerations Related to the Communication Requirements
Auditor Disclosure of ``Original Information'' About the Company
    The reproposed standard included a note to indicate that, when
describing critical audit matters in the auditor's report, the auditor
is not expected to provide original information unless it is necessary
to describe the principal considerations that led the auditor to
determine that a matter is a critical audit matter or how the matter
was addressed in the audit.
    Investor commenters, including the auditor's report working group
of the IAG, argued that there should not be any limitation on the
auditor providing original information and that the reproposal went too
far in constraining the auditor from providing original information in
response to concerns expressed by other commenters (which were
primarily companies and accounting firms).
    Other commenters expressed the view that auditors should not
provide original information about the company or should be limited to
providing information about the audit and not the company. These
commenters stated that the auditor providing original information about
the company would be inconsistent with the traditional U.S. regulatory
framework, whereby management provides information about the company
and the auditor attests to compliance with the applicable financial
reporting framework. However, one investor commenter noted that auditor
reporting should not be limited by ``original information,'' a term
that is undefined in auditing literature.
    No PCAOB standard, SEC rule, or other financial reporting
requirement prohibits auditor reporting of information that management
has not previously disclosed. Rather, there are areas under current law
and auditing standards that require auditor reporting that goes beyond
attesting to the compliance of management disclosures (e.g.,
substantial doubt about a company's ability to continue as a going
concern \22\ or illegal acts \23\). As discussed in more detail below,
auditors may have professional or state law obligations to maintain
client confidentiality, but these obligations should not apply to, or
should be preempted by, reporting obligations arising under federal law
and regulations, including under PCAOB standards. Accordingly, the
requirement to communicate critical audit matters is not, as some
commenters have suggested, inconsistent with the existing U.S.
financial reporting framework and auditors' other obligations.
---------------------------------------------------------------------------

    \22\ See AS 2415, Consideration of an Entity's Ability to
Continue as a Going Concern. The auditor is required to include a
going concern explanatory paragraph if the auditor concludes that
substantial doubt exists about the entity's ability to continue as a
going concern for a reasonable period of time (see AS 2415.12). If
management's disclosure with respect to the company's ability to
continue as a going concern is inadequate, the auditor's reporting
responsibility regarding going concern remains and the report
includes either a qualified or an adverse opinion (see AS 2415.14).
    \23\ Auditors may be required, under certain circumstances,
pursuant to the Private Securities Litigation Reform Act of 1995
(codified in Section 10A(b)1 of the Exchange Act), to make a report
to the SEC relating to an illegal act that has a material effect on
the financial statements.
---------------------------------------------------------------------------

    Commenters also said that the role of the audit committee or
management would be undermined by requiring the auditor to disclose
information about the company's financial statements, since in their
view it is solely management's responsibility to determine what
disclosure is appropriate. Several commenters stated that the
communication of critical audit matters would give auditors leverage to
encourage disclosure of information by management, and that management
would likely modify its disclosure in response to the communication of
critical audit matters in the auditor's report so the auditor would not
be a source of original information. While some commenters said that
this would improve management disclosures, others said it would be an
inappropriate expansion of the auditor's role or would add significant
costs. Other commenters stated that companies could be harmed by the
disclosure of confidential or competitively sensitive information.
Another commenter expressed concern that investors could be confused or
misled if auditor reporting lacked context or appeared to conflict with
management disclosures. One commenter suggested that the auditor should
disclose original information only if a disclosure matter continues to
be unresolved after discussion with management and the audit committee.
    The Board acknowledges these concerns and, in developing the
auditor's communication requirements, has sought to strike an
appropriate balance between investor demands for expanded auditor
reporting and the costs and potential unintended consequences
associated with providing it. While auditor reporting of original
information is not prohibited, it is limited to areas uniquely within
the perspective of the auditor: Describing the principal considerations
that led the auditor to determine that the matter is a critical audit
matter and how the matter was addressed in the audit. The objective of
critical audit matters--helping investors to focus on identified areas
of the audit and understand how the auditor addressed them--may not be
accomplished if the auditor is prohibited from providing such
information. Moreover, prohibiting the auditor from providing such
information could make critical audit matter communications incomplete
in a way that could be confusing to or misunderstood by investors.
    It seems likely, as one commenter observed, that auditors will
generally not have incentives to provide information about the company
that the company has not already made public. Another commenter noted
that, in current practice, disclosure is already guided by an iterative
process between management and the auditor, and expected that a similar
process would occur for critical audit matters, reducing the likelihood
that the auditor would be a source of original information since
critical audit matters would likely overlap with increased management
disclosure.\24\ To the extent that an auditor's decision to communicate
a critical audit matter incents the company to expand or supplement its
own disclosure, the Board believes this may improve the quality of
public disclosures, which would be an indirect benefit of the standard.
However, if the company does not provide additional disclosure, and the
information is necessary to describe the principal considerations that
led the auditor to determine that the matter is a critical audit matter
or how it was addressed in the audit, the Board believes it is in the
public interest for the auditor to include that information in the
auditor's report. The final standard therefore retains the note from
the reproposal explaining that

the auditor is not expected to provide information about the company
that has not been made publicly available by the company unless such
information is necessary to describe the principal considerations that
led the auditor to determine that a matter is a critical audit matter
or how the matter was addressed in the audit.
---------------------------------------------------------------------------

    \24\ It should be noted, however, that critical audit matters
are not a substitute for disclosures required of the company under
the applicable financial reporting framework.
---------------------------------------------------------------------------

    Of course, any matter that will be communicated as a critical audit
matter will already have been discussed with the audit committee, and
the auditor will be required to provide a draft of the auditor's report
to the audit committee and discuss the draft with them.\25\ In
addition, as the auditor determines how best to comply with the
communication requirements, the auditor could discuss with management
and the audit committee the treatment of any sensitive information.
---------------------------------------------------------------------------

    \25\ See AS 1301.21, as amended.
---------------------------------------------------------------------------

    Some commenters also stated that, in areas where there are specific
reporting obligations under the applicable financial reporting
framework or SEC reporting requirements but the matter falls below the
disclosure threshold (for example, a significant deficiency), auditor
communication could, in effect, impose a lower disclosure threshold.
With regard to such areas, it is likely that the nature of a critical
audit matter and its description would be broader than, for instance,
focusing on a significant deficiency. In addition, while the auditor is
required to describe the principal considerations that led the auditor
to determine that the matter is a critical audit matter, (which may
include, if relevant, information about the company's processes and
controls) and how the overall matter was addressed, it is not necessary
for the auditor's description to use the terminology of the other
auditing standard, such as ``significant deficiency'' within the
broader context of a critical audit matter. For example, if a
significant deficiency was among the principal considerations in
determining that revenue recognition was a critical audit matter, the
auditor would describe the relevant control-related issues over revenue
recognition in the broader context of the critical audit matter without
using the term ``significant deficiency.'' \26\
---------------------------------------------------------------------------

    \26\ It should be noted that the determination that a matter was
a significant deficiency in internal control over financial
reporting, on its own, could not be a critical audit matter.
---------------------------------------------------------------------------

    Some commenters suggested that any expanded disclosure requirements
should come from the SEC and the Financial Accounting Standards Board
(``FASB''), in the form of additional management disclosures, rather
than from the Board expanding requirements for auditor reporting.
However, investors have consistently asked to hear more from the
auditor, an independent third-party expert whose work is undertaken for
the investor's benefit. As one commenter noted, the auditor is best
suited to provide insights on how and on what basis the auditor
developed its opinion. The final standard is designed to elicit
information about the audit directly from the auditor's perspective.
    If auditors can adequately convey to investors the principal
considerations and how the auditor addressed the matter without
including previously undisclosed information, it is expected that they
will. However, the standard provides that even when management has not
disclosed information, the auditor is not constrained from providing
such information if it is necessary to describe the principal
considerations that led the auditor to determine that a matter is a
critical audit matter or how the matter was addressed in the audit.
    The Board intends to monitor implementation of the critical audit
matter requirements to determine if additional guidance is needed in
this area.
Potential Compliance Issues Related to Critical Audit Matters
    Some commenters suggested that the reporting of critical audit
matters could create compliance challenges for companies.
    Two commenters expressed concern that companies' SEC filings may
have to be amended because of changes in the description or reporting
of critical audit matters. In principle, auditors should approach
errors and misstatements in the communication of critical audit matters
in the same way they would approach any other error or misstatement in
the auditor's report that does not affect the auditor's opinion or the
ability of market participants to rely on the opinion.\27\ It appears
that under current practice, SEC filings have been amended solely to
correct errors in auditor's reports, such as incorrect auditor's report
dates or missing explanatory paragraphs.
---------------------------------------------------------------------------

    \27\ The final standard indicates that the auditor's
communication of critical audit matters does not alter in any way
the auditor's opinion on the financial statements, taken as a whole.
---------------------------------------------------------------------------

    Another commenter expressed concern that management may be asked to
respond to investor questions regarding issues described in critical
audit matters and may not be in a position to do so, particularly in
light of their responsibilities under Regulation FD. Given the
auditor's responsibility to communicate with the audit committee, and
the likelihood of extensive discussions between auditors and management
regarding critical audit matters, it seems likely that management will
be prepared to respond appropriately and in compliance with their legal
obligations (including Regulation FD), as they would with regard to any
other question about information included in an SEC filing.
Ability To Communicate No Critical Audit Matters
    The reproposal provided that the auditor could determine there were
no critical audit matters and provide a statement to that effect in the
auditor's report. Commenters generally supported the auditor's ability
to determine that there are no critical audit matters. Two commenters
suggested that the auditor should not have to make a statement in the
auditor's report that there were no critical audit matters because the
absence of a critical audit matter should be sufficient without the
definitive statement, similar to an emphasis paragraph. The final
standard includes the possibility that the auditor could determine, and
state in the auditor's report, that there are no critical audit
matters.\28\ The statement that there are no critical audit matters is
required because unlike an emphasis paragraph, critical audit matters
are a required element of the auditor's report.
---------------------------------------------------------------------------

    \28\ Since communication of critical audit matters will not be
required for the audits of EGCs, brokers and dealers reporting under
Exchange Act Rule 17a-5, 17 CFR 240.17a-5, investment companies
other than business development companies, and benefit plans, the
auditor's report for the audits of these entities will not be
required to include the statement that there are no critical audit
matters.
---------------------------------------------------------------------------

    The determination of critical audit matters is based on the facts
and circumstances of each audit. The Board expects that, in most audits
to which the requirement to communicate critical audit matters applies,
the auditor will determine that at least one matter involved especially
challenging, subjective, or complex auditor judgment. There may be
critical audit matters even in an audit of a company with limited
operations or activities. However, there may be circumstances in which
the auditor determines there are no matters that meet the definition of
a critical audit matter and, in those circumstances, the auditor will
communicate that there were no critical audit matters.

Requirements of Other Regulators and Standard Setters
    IAASB. For each key audit matter, the IAASB requires the auditor to
reference the related disclosures, if any, in the financial statements
and address: (1) Why the matter was considered to be one of most
significance in the audit and therefore determined to be a key audit
matter and (2) how the matter was addressed in the audit.\29\ The IAASB
allows the auditor to determine that there are no key audit matters to
communicate in the auditor's report and, if so, requires a statement to
this effect.\30\
---------------------------------------------------------------------------

    \29\ See paragraph 13 of ISA 701.
    \30\ See paragraphs 14 and 16 of ISA 701.
---------------------------------------------------------------------------

    EU. The EU requires the auditor to include in the auditor's report:
(1) A description of the most significant assessed risks of material
misstatement, including assessed risks of material misstatement due to
fraud; (2) a summary of the auditor's response to the risks; and (3)
where relevant, key observations arising with respect to the risks.\31\
---------------------------------------------------------------------------

    \31\ See requirements in 2(c) of Article 10, Audit Report, of
Regulation (EU) No. 537/2014.
---------------------------------------------------------------------------

    FRC. The FRC requires the auditor, among other things, to: (1)
Describe those assessed risks of material misstatement that were
identified by the auditor and (2) provide an overview of the scope of
the audit, including an explanation of how the scope addressed the
assessed risks of material misstatement.\32\ The explanations of the
matters set out in the auditor's report should be described in a way
that: (1) Enables a user to understand their significance in the
context of the audit of the financial statements as a whole and not as
discrete opinions on separate elements of the financial statements; (2)
enables the matters to be related directly to the specific
circumstances of the audited entity and are not therefore generic or
abstract matters expressed in standardized language; and (3)
complements the description of significant issues required to be made
by the audit committee.\33\
---------------------------------------------------------------------------

    \32\ See paragraph 19A of UK ISA 700 (2013).
    \33\ See paragraph 19B of UK ISA 700 (2013).
---------------------------------------------------------------------------

Documentation of Critical Audit Matters
    The reproposed standard required documentation of the basis for the
auditor's determination whether each matter that both: (1) Was
communicated or required to be communicated to the audit committee and
(2) relates to accounts or disclosures that are material to the
financial statements, involved or did not involve especially
challenging, subjective, or complex auditor judgment. Some commenters
supported a documentation requirement only for matters that were
determined to be critical audit matters. Some of these commenters
asserted that documentation about matters determined not to be critical
audit matters would add costs and primarily benefit PCAOB inspections
rather than audit quality. Others stated that the requirement is not
aligned with the IAASB's documentation requirement, which, in their
view, focuses on rationale for inclusion as a key audit matter rather
than exclusion. However, another commenter argued that the
determination that a matter was not a critical audit matter would seem
to be an important audit judgment that ought to be documented for
review by the engagement quality reviewer. This commenter suggested
that documentation be required only for matters required to be
communicated to the audit committee (which would already have been
documented) and not for those that are communicated otherwise. One
auditor argued that the reproposed requirement would lead auditors to
document all audit committee communications even if not required, and
that this would disproportionately affect smaller companies whose audit
committees more commonly request information not required to be
communicated under PCAOB standards.
    The final standard substantially retains the approach from the
reproposal of requiring the auditor to document the basis for
determining critical audit matters.\34\ The objective of the
requirement is to document how the determination of critical audit
matters (or the determination that there are no critical audit matters)
was made from among the matters communicated or required to be
communicated to the audit committee that relate to accounts or
disclosures that are material to the financial statements. The
documentation requirement will also facilitate review by the engagement
quality reviewer.\35\
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    \34\ The language of the documentation requirements has been
redrafted to improve clarity, based on a commenter's suggestion.
    \35\ Under the existing audit documentation requirements, audit
documentation facilitates the planning, performance, and supervision
of the engagement, and is the basis for the review of the quality of
the work because it provides the reviewer with written documentation
of the evidence supporting the auditor's significant conclusions.
See paragraph .02 of AS 1215, Audit Documentation.
---------------------------------------------------------------------------

    The amount of documentation required could vary with the
circumstances. For example, the auditor's basis for the determination
may be so clear for some matters that a single sentence will be
sufficient. This situation may arise, for instance, when the auditor's
documentation prepared in the course of the audit includes sufficient
detail about whether or not the matter involved especially challenging,
subjective, or complex auditor judgment. Other matters may require more
extensive documentation.
    As noted in the reproposing release, for matters determined to be
critical audit matters, the description in the auditor's report (which,
among other things, must describe the principal considerations that led
the auditor to determine that it was a critical audit matter) will
generally suffice as documentation.
    The auditor could comply with the documentation requirement in a
variety of different ways. For example, the auditor could start with
the communications to the audit committee, which are already
documented, identify which of those matters relate to accounts or
disclosures that are material to the financial statements, and then
document the basis for the auditor's determination of whether or not
each matter involved especially challenging, subjective, or complex
auditor judgment. In documenting the basis for the determination, the
auditor may include the factors the auditor took into account. This
documentation may be prepared as an extension to the audit committee
documentation or the auditor may prepare separate documentation.
Requirements of Other Regulators and Standard Setters
    The IAASB requires the auditor to document the matters that
required significant auditor attention and the rationale for the
auditor's determination as to whether or not each of these matters is a
key audit matter.\36\ The EU does not include documentation
requirements for expanded auditor reporting. The FRC does not include
specific documentation requirements related to expanded auditor
reporting.\37\
---------------------------------------------------------------------------

    \36\ See paragraph 18(a) of ISA 701.
    \37\ General documentation requirements appear in ISA (UK and
Ireland) 230, Audit Documentation.
---------------------------------------------------------------------------

Liability Considerations Related to Critical Audit Matters
    In both the proposal and the reproposal, the Board acknowledged
that including critical audit matters would change the auditor's report
in ways that could affect auditors' potential liability. As discussed
in those releases, liability may be imposed on auditors under a number
of different legal theories depending on the specific

facts and circumstances of a particular case, including pursuant to
Section 11 of the Securities Act of 1933, Section 10(b) of the Exchange
Act, and various state law causes of action. The critical audit matters
would themselves be new statements that could be the basis for asserted
claims. In addition, information provided regarding critical audit
matters could affect other aspects of securities fraud claims against
either the issuer, the auditor, or both (for example, by being
described in pleadings in an effort to plead fraud with particularity
or as a basis to seek to undercut a claim of reliance). The Board
specifically sought comment on what effect the communication of
critical audit matters would have on private liability and whether
there were any steps the Board could or should take to address any
likelihood of an increase in potential liability in private litigation.
    A number of companies and accountants responded to this request for
comment. While several of these commenters noted that changes from the
proposal had addressed certain of their liability concerns, most
continued to express varying degrees of concern about the potential for
increased liability, either for auditors or for both auditors and
companies.
    In particular, commenters expressed concern that investors who
suffer a financial loss could assert legal claims against the auditor
based on statements made in identifying and describing critical audit
matters. As with the proposal, commenters expressed general concerns
that communication of critical audit matters would encourage baseless
litigation, would likely lead to increased audit fees, raise the
settlement value of spurious claims, or potentially undermine the
stringent pleading standards of the Private Securities Litigation
Reform Act of 1995, which were intended to curtail non-meritorious
claims against auditors and avoid the costs and burdens associated with
them. Some commenters argued that auditors, to avoid being second-
guessed, would have the incentive to communicate matters to the audit
committee that were not otherwise required or to identify too many
critical audit matters in an effort to protect themselves from
liability. Several commenters expressed concern that communicating
critical audit matters might compromise their ability to argue that the
statements in the audit report are opinions which, one commenter
argued, were ``less vulnerable to challenges that they are false or
misleading.'' \38\ However, at least one of these commenters noted that
the revised definition of a critical audit matter in the reproposal
mitigated their concern on that point. Other commenters argued that the
information communicated in describing critical audit matters could
potentially be used to attack the audit by challenging the procedures
performed or the adequacy of audit evidence obtained by the auditor. On
the other hand, one commenter noted that the communication of critical
audit matters is about disclosure of risks and challenges and expressed
the belief that non-communication of such matters would be more
problematic from a litigation point of view.
---------------------------------------------------------------------------

    \38\ Letter from PricewaterhouseCoopers LLP (Aug. 15, 2016) at
7, available on the Board's Web site in Docket 034.
---------------------------------------------------------------------------

    Some commenters argued that the risk of liability would be
heightened if the auditor were providing original information about the
company. In particular, several commenters contended that doing so
would conflict with accountants' professional obligation to maintain
client information in confidence, which could give rise to claims by
the company against the auditor under state law.
    Some commenters argued that critical audit matters could increase
litigation risk for companies as well as the auditor because the new
statements required of the auditor could form a basis for new legal
claims, could be misinterpreted as acts of negligence on the part of
the company, or could be used by plaintiffs as a ``road map'' for
litigation against the company. One commenter argued that, because the
underlying work papers are subject to discovery, critical audit matters
would be used as a source for potential litigation against both
auditors and companies.
    Some of the commenters that expressed concerns about the potential
for increased auditor liability also suggested changes to the
reproposal that they maintained would reduce the liability impact of
determining and communicating critical audit matters. For example, as
previously discussed, several commenters suggested substantially
similar changes to modify the materiality component of the definition
of critical audit matters and to prohibit or discourage auditor
communication of original information.
    The Board has carefully considered commenters' concerns about
potential liability throughout this standard-setting process, including
the comments received on the reproposal. While mandating disclosure of
critical audit matters will, by design, entail new statements in the
auditor's report, the Board notes that any claim based on these new
statements would have to establish all of the elements of the relevant
cause of action (for example, when applicable, loss causation and
reliance). Critical audit matters will not replace or alter the
fundamental requirement that the auditor's report include the auditor's
opinion that the financial statements are fairly presented in
accordance with the applicable financial reporting framework, which has
been, and the Board expects will continue to be, the primary statement
at issue in most private securities litigation under federal law
involving auditors.
    Throughout this standard-setting process, the Board has carefully
considered commenters' suggestions to alter the terms of its proposal
to mitigate their concerns about potential liability for omitting a
critical audit matter. As discussed in the reproposal, the Board
limited and clarified the process for determining critical audit
matters, including by narrowing the source of critical audit matters to
matters communicated or required to be communicated to the audit
committee, adding a materiality component to the critical audit matter
definition, and refining the factors used to determine critical audit
matters. Those changes, as well as the critical audit matter
definition's focus on the auditor's judgment, should mitigate concerns
about potential liability for omitting a critical audit matter. With
respect to suggestions to further narrow the definition of critical
audit matters and the related communication requirements, it is not
clear, and commenters did not explain, how those changes would mitigate
liability concerns other than by reducing the number and content of
required communications of critical audit matters. As described above,
the Board has determined not to incorporate those suggested changes
because they appear likely to significantly reduce the number of
potential critical audit matters and the informativeness of auditor
communication of critical audit matters.
    With respect to potential state law claims by companies against
their auditors for disclosing original information, the Board notes
that, as discussed above, it does not expect that, in general, critical
audit matters will provide sensitive information that has not been
disclosed by the company. With respect to the potential for a claim
based on a situation in which the auditor found such disclosure
necessary, the Board notes that auditors already have preexisting
duties to

disclose original information in certain circumstances.\39\ Commenters
did not cite any specific examples in which these requirements have
resulted in unwarranted claims against auditors for disclosing client
confidences. Because the auditor's obligations under PCAOB standards
arise under federal law and regulations, professional or state law
duties of client confidentiality should not apply to,\40\ or should be
preempted by,\41\ the obligation to communicate critical audit
matters.\42\
---------------------------------------------------------------------------

    \39\ For example, for at least the last 20 years, auditors have
had duties to disclose in their auditor's reports when they have
substantial doubt about the company's ability to continue as a going
concern. See Section 10A of the Exchange Act and AS 2415. In
addition, when in an audit of internal control over financial
reporting, the auditor identifies a material weakness that has not
been included in management's assessment, the auditor must modify
its report to, among other things, ``include a description of the
material weakness, which should provide the users of the audit
report with specific information about the nature of the material
weakness and its actual and potential effect on the presentation of
the company's financial statements . . .''. See Note to paragraph
.91 of AS 2201; cf. Statement of Gaylen R. Hansen, CPA, at the PCAOB
public meeting (Apr. 2, 2014) (``Client confidentiality has a long-
standing and important place in the accountancy profession. However,
it doesn't serve investors well when it is parlayed to obfuscate the
important obligation to call things as they are seen.'').
    \40\ For example, the relevant AICPA rule provides that auditors
``shall not disclose any confidential client information without the
specific consent of the client,'' but further provides that the
confidentiality obligation shall not be construed ``to prohibit . .
. compliance with applicable laws and government regulations.'' See
paragraphs .01 and .02 of 1.700.001 Confidential Client Information
Rule of the AICPA Code of Professional Conduct (as of Dec. 15,
2014).
    \41\ See Crosby v. Nat'l Foreign Trade Council, 530 U.S. 363,
372-73 (2000); New York v. FCC, 486 U.S. 57, 64 (1988).
    \42\ Some commenters suggested that safe harbor rules be created
to protect auditors and companies from liability for statements
about critical audit matters. While, as noted above, the Board will
monitor the effects of critical audit matters should the
requirements be approved by the SEC, the Board is not convinced at
this time that any such safe harbor is necessary and, in any event,
such a safe harbor is beyond the Board's authority.
---------------------------------------------------------------------------

    While the Board takes seriously the prospect of potential increases
in auditors' or companies' liability, the Board believes it has
appropriately addressed commenters' concerns regarding liability in a
manner compatible with the objectives of this rulemaking, and in view
of the rulemaking's anticipated benefits. Indeed, the Board notes that
at least one of the commenters that expressed concern about potential
liability, noted that those concerns ``should not stand in the way of
moving forward'' on the reproposed standard.\43\ At the same time, the
Board acknowledges that a variety of claims can be raised related to
the statements in the audit report and that litigation is inherently
uncertain. If the final standard is approved by the SEC, the Board will
monitor the standard after implementation for any unintended
consequences.
---------------------------------------------------------------------------

    \43\ See letter from Deloitte & Touche LLP (Aug. 12, 2016) at 5,
available on the Board's Web site in Docket 034.
---------------------------------------------------------------------------

Additional Improvements to the Auditor's Report
    The reproposal provided a list of basic elements to be included in
every auditor's report. Some of these basic elements, such as auditor
tenure, would be new elements in the auditor's report. Other basic
elements, such as the auditor's opinion, identification of the
financial statements audited, and management's and auditor's
responsibilities, were drawn from the existing auditor reporting
standard.\44\ Yet other basic elements, such as the name of the company
under audit and the date of the financial statements, were incorporated
from existing illustrative auditor's reports.
---------------------------------------------------------------------------

    \44\ See existing AS 3101.06-.08.
---------------------------------------------------------------------------

Auditor Tenure
    The reproposal included a required statement in the auditor's
report of the year the auditor began serving consecutively as the
company's auditor. The Board also sought comment on whether auditor
tenure should be disclosed in Form AP, Auditor Reporting of Certain
Audit Participants (``Form AP''), rather than in the auditor's
report.\45\
---------------------------------------------------------------------------

    \45\ In December 2015, the Board adopted Form AP, which provides
investors and other financial statement users with information about
engagement partners and other accounting firms that participate in
audits of issuers. See Improving the Transparency of Audits: Rules
to Require Disclosure of Certain Audit Participants on a New PCAOB
Form and Related Amendments to Auditing Standards, PCAOB Release No.
2015-008 (Dec. 15, 2015).
---------------------------------------------------------------------------

Disclosure of Tenure
    Investor commenters stated that information regarding auditor
tenure would be useful to financial statement users, for example, in
deciding whether to vote to ratify the appointment of the auditor.
Investors that expressed a preference supported tenure disclosure in
the auditor's report, some on the basis of reducing investor search
costs by ensuring a consistent location for the disclosure. One
commenter representing a group of investors asserted that since the
auditor's report is the primary means by which the auditor communicates
with investors, it is appropriate for auditor tenure to be included in
the auditor's report. This commenter further stated that disclosure of
auditor tenure on Form AP would be an acceptable alternative to
disclosure in the auditor's report only if the timeliness,
accessibility, searchability, and overall functionality of the
information disclosed on Form AP were at least equivalent to having the
information disclosed in the auditor's report. Another commenter
suggested that, if disclosure were required in the auditor's report, a
specific location should be designated.
    Currently, information about auditor tenure is not required to be
communicated to investors by the auditor, management, or the audit
committee.\46\ However, there is a growing trend toward voluntary
disclosure of auditor tenure. Recent analysis of corporate proxy
statements for annual meetings of shareholders has found that a growing
number of companies are disclosing auditor tenure,\47\ presumably due
to interest from investors. However, voluntary disclosure is not
provided for a significant number of audits subject to the Board's
jurisdiction. Additionally, if disclosed, such information may not be
provided in the same location in the proxy statement; for instance,
some disclosures are in the audit committee report while others are in
another section of the proxy.\48\ Further, the proxy rules do not apply
to all companies required to be audited under PCAOB standards; for
example, foreign private issuers, many companies whose

securities are not listed on a national securities exchange, and most
investment companies are not required to prepare proxy statements.
---------------------------------------------------------------------------

    \46\ In certain instances, investors may be able to manually
calculate tenure by reviewing company filings on the SEC's
Electronic Data Gathering, Analysis and Retrieval system (``EDGAR'')
to determine when a company changed auditors. However, the
information is not available prior to 1994 and may not be available
for certain entities, such as investment companies and brokers and
dealers, that are not required to file Form 8-K. See 17 CFR 249.308,
Item 4.01 Changes in Registrant's Certifying Accountant.
Accordingly, currently available information is neither complete nor
a readily accessible alternative to auditor tenure disclosure.
    \47\ The Center for Audit Quality, together with Audit
Analytics, reviewed corporate proxies filed through the end of June
2016, 2015, and 2014 of 1,500 Standard and Poor's (``S&P'')
Composite companies. Their analysis identified that in 2016, 2015,
and 2014 auditor tenure was disclosed in the annual proxy statements
of 59, 54, and 47 percent of the S&P 500 large-cap companies,
respectively, 45, 44, and 42 percent of the S&P MidCap 400
companies, respectively, and 48, 46, and 50 percent of the S&P
SmallCap 600 companies, respectively. See Center for Audit Quality
and Audit Analytics, 2016 Audit Committee Transparency Barometer
(Nov. 2016). Separately, during their review of proxy statements of
Fortune 100 companies, Ernst & Young identified that 63 percent of
the companies reviewed voluntarily disclosed auditor tenure in 2016
compared to 62 percent in 2015, 51 percent in 2014, 29 percent in
2013, and 24 percent in 2012. See Ernst & Young, Audit Committee
Reporting to Shareholders in 2016 (Sept. 2016).
    \48\ See Center for Audit Quality and Audit Analytics, 2016
Audit Committee Transparency Barometer (Nov. 2016).
---------------------------------------------------------------------------

    Some commenters, primarily companies, did not support disclosure of
auditor tenure in the auditor's report on the basis that such
disclosure would not provide value to investors. Other companies and
accounting firms raised a concern that tenure disclosure could result
in inferences that, in their view, would be inappropriate about
correlations between auditor tenure and audit quality, or between
auditor tenure and auditor independence. Some commenters also suggested
that auditor tenure is a corporate governance matter and that
disclosure should be provided by management or the audit committee
rather than the auditor. A few commenters suggested that tenure
disclosure should be addressed by SEC rulemaking or provided only
voluntarily. Some commenters, many of whom generally opposed auditor
tenure disclosure, suggested that Form AP would be a preferable
location for disclosing tenure if the Board proceeded with requiring
the disclosure.
    The SEC's Investor Advocate stated that he ``strongly support[s]
requirements for public disclosure of auditor tenure,'' recognizing
that there were different opinions about the best party and location to
make that disclosure.\49\ Noting that the SEC had issued a concept
release asking whether auditor tenure should be disclosed in the audit
committee report,\50\ the SEC's Investor Advocate stated that he
believed the SEC should ultimately decide these questions. In light of
these considerations, the SEC's Investor Advocate recommended that the
PCAOB act to require disclosure of auditor tenure (either in the
auditor's report or in Form AP), but also consider including a
contingent sunset clause such that the auditor disclosure requirement
would expire if and when the SEC imposed any form of a company
disclosure requirement.
---------------------------------------------------------------------------

    \49\ See letter from Rick A. Fleming, Investor Advocate, SEC
(Aug. 15, 2016) at 4, available on the Board's Web site in Docket
034. The letter noted that the views of the Investor Advocate do not
necessarily reflect the views of the SEC, the Commissioners, or
staff of the SEC, and the SEC disclaims responsibility for the
letter and all analyses, findings, and conclusions contained
therein. Additional information about the Office of the Investor
Advocate is available on the SEC's Web site.
    \50\ See SEC, Possible Revisions to Audit Committee Disclosures,
Exchange Act Release No. 75344 (July 1, 2015), 80 FR 38995 (July 8,
2015).
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    The Board believes that public disclosure of auditor tenure is
important and in the public interest, and that it is appropriate to
require disclosure in the auditor's report because it is the primary
means by which auditors communicate with investors. This will ensure
that the disclosure is in a readily accessible and consistent
location--the auditor's report--for all companies. It will make auditor
tenure information immediately available to investors upon filing with
the SEC of a document containing the auditor's report. Disclosure of
auditor tenure in the auditor's report will also reduce search costs
for investors who are interested in auditor tenure, relative to the
current environment of voluntary reporting. Disclosure of auditor
tenure in the auditor's report may also be more likely to encourage
further discussion of auditor tenure by management and the audit
committee and potential disclosure in company filings.
    The Board is not persuaded by commenters' concerns that disclosure
of auditor tenure in the auditor's report necessarily suggests a
specific correlation between auditor tenure and audit quality, or
between auditor tenure and auditor independence. In the Board's view,
auditor tenure is another data point about the auditor, in addition to
the firm name and the office issuing the auditor's report, for which
there is demonstrable investor demand.
    The standard does not specify a required location within the
auditor's report for the statement on auditor tenure; auditors that are
concerned about the inferences readers may draw based on the placement
of the disclosure in the auditor's report have discretion to present
auditor tenure in the part of the auditor's report they consider
appropriate. Consistent with the reproposal, the illustrative auditor's
report in the final standard includes the statement on auditor tenure
at the end of the report.
    The Board considered disclosure of auditor tenure in Form AP, which
requires disclosure of the name of the engagement partner and of the
names and percentage of participation of other accounting firms in the
audit for all issuer audits. Form AP was developed primarily to respond
to commenter concerns about the potential liability consequences of
naming persons in the auditor's report, the potential need to obtain
consents from those named persons in connection with registered
securities offerings, and the additional time needed to compile
information about the other accounting firms. The Board's determination
to require disclosure in Form AP, rather than in the auditor's report,
was a means to address these concerns. Disclosure of auditor tenure
does not have the same potential liability or other consequences as
disclosure of the name of the engagement partner or other accounting
firms, so such an approach is unnecessary in this case.
    The Board acknowledges that the SEC, given its broader authority
and responsibility for the financial reporting process, could in the
future determine that auditor tenure should be disclosed by some other
party or in some other location, in addition to or instead of in the
auditor's report. Accordingly, the Board is adopting its requirement
for tenure disclosure in the auditor's report today. The Board
anticipates that, if the SEC undertook rulemaking for disclosure of
auditor tenure, the Board would work with the SEC to ensure that PCAOB
standards coordinate appropriately with any new SEC requirements.\51\
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    \51\ Of course, the SEC also has authority to abrogate or modify
PCAOB rules at any time, to, among other things, further the
purposes of the securities laws. Section 107(b)(5) of Sarbanes-
Oxley, 15 U.S.C. 7217(b)(5).
---------------------------------------------------------------------------

Determination of Tenure
    The reproposal contemplated that tenure would be calculated taking
into account firm or company mergers, acquisitions, or changes in
ownership structure, and it included a note providing that if the
auditor is uncertain as to the year the auditor became the company's
auditor, the auditor should so state and provide the earliest year of
which the auditor has knowledge. Some commenters objected to this
approach, saying that it could confuse investors and its relevance is
unclear. The Board believes that the disclosure of tenure should
reflect the entire relationship between the company and the auditor,
including the tenure of predecessor accounting firms and engagement by
predecessors of the company under audit. No changes have been made to
the note in the final standard.
    Additionally, if a company went public and maintained the same
auditor, auditor tenure will include the years the auditor served as
the company's auditor both before and after the company became subject
to SEC reporting requirements.
    Because of the unique structure of investment companies, which
typically includes common accounting, internal control, and oversight
functions at the group level, the reproposed standard required that,
for an investment company that is part of a group of investment
companies,\52\ the auditor's

statement regarding tenure will contain the year the auditor began
serving consecutively as the auditor of any investment company in the
group of investment companies.\53\ For example, if Firm A has been
auditing investment companies in XYZ group of investment companies
since 1980, the current auditor's report for XYZ fixed income fund,
whose inception date was in 2010, will state that Firm A has served as
the auditor of one or more XYZ investment companies since 1980.
---------------------------------------------------------------------------

    \52\ A group of investment companies, as defined by Section
12(d)(1)(G)(ii) of the Investment Company Act of 1940 (``Investment
Company Act''), means any two or more registered investment
companies that hold themselves out to investors as related companies
for purposes of investment and investor services. For purposes of
determining auditor tenure, any tenure with other entities that may
be part of an investment company complex, such as investment
advisers or private investment companies, is not included.
    \53\ The following is an example of such statement: ``We have
served as the auditor of one or more [Group Name] investment
companies since [year].''
---------------------------------------------------------------------------

    A commenter asserted that measuring auditor tenure from the first
year of service to the group of investment companies might confuse or
even mislead the reader of the auditor's report for a new fund,
especially if the auditor has served the group for several years.
Another commenter supported the reproposed methodology for measuring
tenure for investment companies stating that it is appropriate given
the common accounting system, system of internal control over financial
reporting, and board oversight for a group of investment companies.
    After considering the comments received, the Board is adopting the
requirement regarding auditor tenure for an investment company that is
part of a group of investment companies as reproposed. The Board
believes that the length of an auditor's relationship with the group is
more relevant than the relationship with an individual fund, since
funds can be started and merged over time but the auditor's
relationship with the group continues.
Requirements of Other Regulators and Standard Setters
    The EU requires a statement in the auditor's report that indicates
the total uninterrupted engagement period, including previous renewals
and reappointments of the statutory auditors or the audit firms.\54\
The IAASB and the FRC do not include a similar requirement.
---------------------------------------------------------------------------

    \54\ See requirements in 2(b) of Article 10, Audit Report, of
Regulation (EU) No 537/2014.
---------------------------------------------------------------------------

Clarification of Existing Auditor's Responsibilities
    The reproposed standard included requirements that would enhance
standardized language of the auditor's report by clarifying the nature
and scope of the auditor's existing responsibilities, such as a new
statement regarding auditor independence and the addition of the phrase
``whether due to error or fraud,'' when describing the auditor's
responsibility under PCAOB standards to obtain reasonable assurance
about whether the financial statements are free of material
misstatements. In addition, the reproposed standard included a
requirement intended to promote uniformity with respect to the
addressee of the report.
Auditor Independence
    The reproposed standard included a required statement in the
auditor's report that the auditor is a public accounting firm
registered with the PCAOB and is required to be independent with
respect to the company in accordance with the U.S. federal securities
laws and the applicable rules and regulations of the SEC \55\ and the
PCAOB.\56\
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    \55\ See Regulation S-X Rule 2-01, 17 CFR 210.2-01.
    \56\ See PCAOB Rule 3520, et seq.
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    Commenters generally supported the required statement regarding
auditor independence. Some said that the statement would reinforce
financial statement users' understanding of the auditor's existing
obligations to be independent and serve as a reminder to auditors of
these obligations. Some commenters preferred a more definitive
statement, such as stating that the auditor is in fact independent and
in compliance with applicable independence rules. A few commenters
questioned whether the statement will improve an investors'
understanding of the auditor's independence responsibilities, yield any
incremental benefits or insight to investors, or have any impact on
auditor behavior. Some of these commenters pointed out that
independence is already included in the title of the auditor's report
and including an additional statement in the auditor's report is
redundant and unnecessary.
    After consideration of comments, the statement regarding auditor
independence is adopted as reproposed. The Board believes that the
independence statement in the auditor's report will both enhance
investors' and other financial statement users' understanding of the
auditor's existing obligations to be independent, and serve as a
reminder to auditors of these obligations. The statement regarding
auditor independence is not intended to, and will not, affect auditor
independence requirements under the securities laws, SEC rules, or
PCAOB rules.
Requirements of Other Regulators and Standard Setters
    The IAASB requires that the auditor's report include a statement
that the auditor is independent of the entity in accordance with the
relevant ethical requirements relating to the audit and has fulfilled
the auditor's other ethical responsibilities in accordance with these
requirements.\57\ The EU requires a statement in the auditor's report
that the auditor remained independent of the audited entity in
conducting the audit.\58\ The FRC requires the auditor to state that
the auditor is required to comply with the United Kingdom's ethical
standards for auditors, which include requirements regarding auditor
independence.\59\
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    \57\ See paragraph 28(c) of ISA 700.
    \58\ See requirements in 2(f) of Article 10, Audit Report, of
Regulation (EU) No 537/2014.
    \59\ See paragraph 15 of UK ISA 700 (2013).
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Addressee
    Under the existing standard, the auditor's report may be addressed
to the company whose financial statements are being audited, its board
of directors, or stockholders.\60\ Under current practice, the
auditor's report is generally addressed to one or more of the
following: (1) The board of directors and stockholders/shareholders, or
their equivalent for issuers that are not organized as corporations;
(2) the plan administrator or plan participants for benefit plans; and
(3) the directors or equity owners for brokers or dealers.\61\
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    \60\ See existing AS 3101.09.
    \61\ This information is based on a review by PCAOB staff of a
random sample of 2014 fiscal year-end auditor's reports for issuers
and brokers and dealers.
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    To promote consistency in addressing the auditor's report to the
company's investors, the reproposed standard included a requirement for
the auditor's report to be addressed to the shareholders and the board
of directors, or equivalents for companies not organized as
corporations. The reproposed standard stated that the auditor's report
may include additional addressees.
    Commenters generally supported the addressee requirement as
reproposed stating that it is appropriate and will create consistency
in practice. A commenter suggested limiting the required addressees to
the shareowners of corporations or equivalents for companies not
organized as corporations because investors are the key customers of
the auditor's report. A few commenters stated that the auditor's report
is intended for general use and the requirement for the auditor's
report to be addressed to a specific party is not

necessary. A commenter expressed concern that retaining the option for
the auditor's report to be addressed to third parties could
inadvertently result in increased auditor liability and cost.
    In response to comments, and to promote greater uniformity in the
addressees of the auditor's report, the Board is adopting the addressee
requirement as reproposed. Since inclusion of additional addressees is
voluntary, auditors could assess, based on the individual
circumstances, whether or not to include additional addressees in the
auditor's report. In addition, the Board believes that it is
appropriate for the auditor's report to be addressed to the board of
directors and not just to the shareholders, because of the role of the
board of directors in the governance of the company.
Requirements of Other Regulators and Standard Setters
    The IAASB requires that the auditor's report be addressed as
appropriate, based on the circumstances of the engagement.\62\ The EU
does not specify the addressee of the auditor's report. The FRC
requires that the auditor's report be addressed as required by the
circumstances of the engagement.\63\ UK auditor's reports are typically
addressed to either the members or the shareholders of the company.\64\
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    \62\ See paragraph 22 of ISA 700.
    \63\ See paragraph 13 of UK ISA 700 (2013).
    \64\ See paragraph A5 of UK ISA 700 (2013).
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Other Enhancements to the Basic Elements
    The reproposal would have changed the language for certain elements
in the existing auditor's report. These elements included:
     Financial statement notes--The identification of the
financial statements, including the related notes and, if applicable,
schedules, as part of the financial statements that were audited.\65\
Under the existing standard, the notes to the financial statements and
the related schedules are not identified as part of the financial
statements.
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    \65\ The final standard uses the term ``financial statements''
to include all notes to the statements and all related schedules, as
used under SEC rules that apply to issuers. See Regulation S-X
Section 1-01(b), 17 CFR 210.1-01(b), which states in part, ``the
term financial statements . . . shall be deemed to include all notes
to the statements and all related schedules.'' The final standard
will not apply to schedules included as supplemental information, as
defined in AS 2701, Auditing Supplemental Information Accompanying
Audited Financial Statements, because those schedules are not
considered part of the financial statements. The auditor should
continue to look to the requirements of AS 2701 for the auditor's
reporting responsibilities regarding supplemental information
accompanying audited financial statements.
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     Error or fraud--A description of the auditor's
responsibility to plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatements, whether caused by error or fraud.\66\ The existing
standard does not require the auditor's report to contain the phrase
whether due to error or fraud.
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    \66\ See paragraph .02 of AS 1001, Responsibilities and
Functions of the Independent Auditor.
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     Nature of the audit--The description of the nature of the
audit reflected the auditor's responsibilities in a risk-based audit
and aligned the description with the language in the Board's risk
assessment standards, including:
     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;
     Examining, on a test basis, appropriate evidence regarding
the amounts and disclosures in the financial statements;
     Evaluating the accounting principles used and significant
estimates made by management; and
     Evaluating the overall presentation of the financial
statements.
    Commenters generally supported the reproposed language for these
basic elements of the auditor's report. These elements are adopted as
reproposed.
Additional Basic Elements Suggested by Commenters
    In addition to the changes proposed by the Board, commenters on the
reproposal suggested additional elements to be included in the
auditor's report.
    Several commenters suggested that the PCAOB consider additional
standardized language in the auditor's report to describe the