FOCUS on self-study CPE Tere are innumerable ways internal
control deficiencies may occur. When there is a deficiency, the auditor adjusts the audit plan to determine the impact of such deficiency on the financial statements of the company. Te severity and frequency of a deficiency determines if a significant deficiency or a material weakness exists, but they are not, in and of themselves, considered CAMs. However, a significant deficiency or material weakness could be among the principal considerations that potentially impel the auditor to determine that a matter is a CAM. Tus, the evaluation and determination
process for SOX 404 control deficiencies (AS 2201 and AS 1305) do not necessarily prompt any CAM disclosures, but if the audit response involves especially challenging, subjective or complex judgment, the auditor may decide on CAM disclosures. Nevertheless, for the purposes of evaluating whether a matter falls within the scope of CAM disclosures, the auditors assess the risks of material misstatement, including significant risks, to determine whether a matter requires especially challenging, subjective or complex auditor judgment for a CAM disclosure. If CAM disclosure was due to significant
deficiency, the auditor may disclose the control issue in the broader context of CAM without referencing the “significant deficiency” terminology. However, in case of material weakness, since the company has already reported it in its filings, the auditor can use the term “material weakness” in its CAM disclosures. For example, if the auditor has detected a significant deficiency in calculation of deferred tax assets, the auditor describes the relevant control-related issues over calculation of deferred tax assets in the broader context of the CAM without using the term “significant deficiency.” However, if the control deficiency was a material weakness, the auditor can describe the deficiency as a CAM and reference the term
“material weakness” since the company should have already disclosed the material weakness in its filings.
As the auditor determines how best to comply with the disclosure requirements of CAM, it must decide on how to discuss and treat sensitive information with the audit committee. CAM disclosures bring increased user attention and can potentially trigger litigations. Such increased attention may eventually exert an incremental focus on some aspects of management’s inadequate or faulty disclosures. Tis requires an early dialogue between and among management, legal counsel, audit committee and the auditor on how CAMs should be disclosed and presented in an audit report. CAMs’ proposed disclosures have an impact on CAEs and significant accounting policies (SAPs) disclosures in Form 10-Ks. Terefore, the legal counsel and management must ensure CAM disclosures do not conflict with their CAE and SAP disclosures in their Form 10-Ks. On the other hand, if CAMs are simply duplication of CAEs and SAPs, then the usefulness and applicability of CAM disclosures becomes questionable. Clearly, from the investor's perspective, there is a benefit in receiving information about the audit directly from the auditor's point of view, but, at the same time, management needs to establish a workable nexus to avoid any conflict between management’s and auditor’s disclosures. Any conflicts or surprises in CAE and SAP disclosures can potentially initiate concerns and possibly evoke litigations.
Summary Te requirement for communication and disclosure of CAMs is a significant shift in audit reports. Te objective is to make the auditor’s report more informative and relevant to investors and third-party users. A company’s management has the ultimate
responsibility for financial disclosures, but that does not necessarily prohibit the auditors from disclosing the CAMs from their own perspectives in their audit reports. Tis is not to say CAM disclosures give the audit report an unflinching consideration that safeguards users of financial statements for any possible irregularity, but, nevertheless, it is a step in the right direction, and time will tell how effective they can be. Management’s CAEs and SAPs have some
overlap with CAM disclosures, but they are not necessarily the same thing. While some CAEs and SAPs may be subject to CAMs, CAMs generally have a broader scope and are independent of CAEs and SAPs. However, management must ensure their CAE and SAP disclosures do not conflict with their auditors’ CAM disclosures. Even though an internal control deficiency per se does not trigger CAM disclosures, it could be among the principal considerations that potentially lead the auditor to determine a matter should be considered a CAM. Auditors assess the risks of material misstatement, including significant risks, to determine whether a matter requires especially challenging, subjective or complex auditor judgment for CAM disclosures. Finally, the sensitivity of CAM disclosures
requires an early dialogue and interaction among management, legal counsel, audit committee and the auditor on how CAMs should be described and presented in the audit report. Tus, management must ensure that CAE and SAP disclosures in their Form 10-Ks underpin CAM disclosures and do not conflict with them.
Reprint with the permission of Today’s CPA, a publication of the Texas Society of Certified Public Accountants. Tis article represents the opinions of the author and are not necessarily those of the Texas Society of Certified Public Accountants.
14 CPAFOCUS
July/August 2020
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