What Qualifies as a Critical Audit Matter?

A Critical Audit Matter (CAM) is a specific issue from the audit of a public company’s financial statements that required significant auditor attention. These disclosures are a requirement established by the Public Company Accounting Oversight Board (PCAOB) under Auditing Standard (AS) 3101. The purpose of including CAMs in the auditor’s report is to provide investors with more insight into the audit process, making the report more informative than a traditional pass/fail opinion.

Criteria for Identifying a Critical Audit Matter

For an issue to be classified as a CAM, it must meet a three-part definition from the PCAOB. The first condition is that the matter must have been communicated, or was required to be communicated, to the company’s audit committee. These required communications are detailed in standards like AS 1301, Communications with Audit Committees.

The second criterion is that the matter must relate to accounts or disclosures that are material to the financial statements. Materiality is an accounting concept that refers to the significance of an amount or transaction. If information is material, its omission or misstatement could influence the economic decisions of someone relying on those financial statements.

The final element is that the matter involved “especially challenging, subjective, or complex auditor judgment.” This is a principles-based assessment by the auditor. Factors contributing to this judgment include the company’s use of significant estimates with high measurement uncertainty, such as the valuation of goodwill or the liability for a major lawsuit. It could also involve areas with a high risk of material misstatement or significant unusual transactions.

The Auditor’s Determination Process

The process of determining a CAM is an exercise in professional judgment. Auditors begin with the matters that were communicated to the audit committee as the initial pool of potential CAMs. From this starting point, the auditor applies the subsequent filters of the CAM definition.

The engagement team then evaluates each of these matters against the remaining criteria. They assess whether the issue relates to accounts or disclosures that are material to the financial statements. Following this, they apply the filter of whether the matter involved especially challenging, subjective, or complex judgment from their perspective.

This determination involves extensive discussion among the senior members of the audit engagement team, including the lead partner. These internal deliberations help ensure consistency in applying the criteria. The conclusions are often discussed with the company’s audit committee, providing transparency into which matters are being considered for CAM disclosure.

Communication in the Audit Report

When a CAM is identified, its disclosure in the auditor’s report must follow a specific structure to ensure clarity for investors. For each CAM, the report must present four distinct pieces of information. This structured approach allows users of the financial statements to understand the issue and how the auditor handled it. The communication begins with the explicit identification of the CAM.

Following the identification, the auditor must describe the principal considerations that led them to classify the matter as a CAM. This explanation provides context, detailing why the issue was particularly challenging, subjective, or complex. It might reference the high degree of estimation required by management or the subjectivity involved in evaluating the evidence obtained by the audit team.

The third required component is a description of how the auditor addressed the CAM. This section details the audit procedures performed in response to the identified risks and complexities. For instance, if the CAM was the valuation of intangible assets, the auditor might describe their use of a valuation specialist and their testing of management’s assumptions like revenue growth rates against market data.

Finally, the communication must include a reference to the relevant financial statement accounts or disclosures that the CAM relates to. This links the audit issue back to the numbers and notes in the financial statements. Using the intangible asset example, the report would point the reader to the specific notes on business combinations and the goodwill and intangible assets line items on the balance sheet.