A survey of 100 institutional investors conducted by KRC Research for the Center for Audit Quality finds that 92 percent of respondents use critical audit matters (CAMs) when making investment decisions. KRC conducts quarterly research on topics related to the views of institutional investors on the financial statement audit process, assurance on other corporate reporting, and other audit firm-related matters. The results of KRC’s third quarter survey research, conducted online from July 9-22, 2024, are reported in The Center for Audit Quality Critical Audit Matters Survey Research Findings--Q3 Survey. In a blog post on the survey results, Dennis McGowan, CAQ’s Vice President for Professional Practice and Anti-Fraud Initiatives, said “[I]t is gratifying to see evidence that the efforts of standard setters and auditors to increase transparency around the audit process with the communication of CAMs is benefiting the capital markets.”
Under the PCAOB’s auditing standards, a CAM is 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. The audit report must include a description of any CAMs and how the auditor addressed them in the audit.
KRC’s Q3 research assessed four issues: (1) The use of CAMs in the investment decision-making process; (2) Level of training or information investors received related to CAMs; (3) Satisfaction with CAMs; and (4) How CAMs could be improved. Respondents were professional investors employed at companies with a minimum of $500 million in assets under management who serve at the director level or higher and had at least 5 years of experience.
Key survey findings include:
Ninety-two percent of respondents use CAMs when making investment decisions. Specific examples of CAM topics that impact decision-making were valuation of assets/goodwill appraisal/intangible assets evaluation (22 percent), financial statement/occurrence of financial misstatements (21 percent), revenue recognition (18 percent), compliance issues/fraud (14 percent), and management estimates/management judgment (12 percent).
Eighty-eight percent of respondents reported having received either “significant” or “some” training and/or a written explanation on the value and utilization of CAMs. Sources of CAM training included Seminar/Webinar/Conference (27 percent), University Courses/Online Courses (25 percent), Financial Experts/AICPA/Auditing Experts (24 percent), At Work/Company-Provided/In-House (24 percent), and Written Material/Reports/Journals (22 percent).
Seventy-eight percent of respondents said that they “always” or “often” read the CAMs section of the auditor’s report on companies they invest in or are researching. On the other hand, five percent said that they never read CAMs, while two percent do so rarely.
Ninety-three percent of respondents said that CAMs play a “very important” or “somewhat important” role in their decision-making analysis of a potential investment. The remaining seven percent cited several reasons why CAMs were not significant, including “the information is overly standardized,” CAMs are “relevant only to a subset of financial statement accounts/areas,” and “portfolio I manage does not have an investment policy on utilizing CAMs.”
Ninety percent of respondents are either “satisfied” or “very satisfied” with the quality and clarity of CAMs.
As to ways in which CAM reporting could be improved, survey respondents had a variety of suggestions:
Fifty-eight percent of respondents would prefer more CAMs in the auditor’s report. On the other hand, 21 percent would prefer fewer CAMs, and 19 percent had no preference as to the number of CAMs. Half of respondents (51 percent) expect the number of CAMs in the auditor’s report to be either two or three. Twenty-one percent of respondents thought the expected number of CAMs varies by industry.
Fifty-one percent of respondents would like more detail in the auditor’s discussion of CAMs. A quarter of respondents recommended that CAMs be required in certain audit areas, including Revenue Recognition/Revenue Audit, Asset Valuation/Value Estimates, Management Estimates, and Complex Transactions.
Respondents cited several types of additional information related to CAMs they would find important to their investment decisions. Some frequently requested types of additional information included Financial Impact/Effect on Future Earnings/Reliability of Reports, Risk Profile/ Understanding & Pinpointing Risks, Origins of CAMs/What Qualifies as a CAM/How Auditor Identified CAMs, and Management Response & Reactions.
Audit Committee Takeaways
1. The high level of institutional investor usage of CAMs is a bit surprising and seems to suggest a sea-change in investor attitudes toward CAMs. In 2020, the PCAOB released an assessment of the initial impact of auditor CAM reporting. It found that only 31 percent of the 97 investor respondents had seen a CAM in an audit report. Those who had seen a CAM were asked about their future use of CAMs. Of the 21 who responded, eight said they would use CAMs, four said they might, and nine said they would not because “CAMs are not specific enough to provide useful information or do not provide additional value above and beyond what is already included in financial statements.” See PCAOB Interim Analysis Finds that Investor Interest in CAMs is Still Evolving, October-November 2020 Update. During the past four years, investors, at least those at large institutions, have apparently rethought the utility of CAMs.
2. If institutional investors are in fact taking CAMs as seriously in their decision-making as the CAQ-KRC survey indicates, audit committees should also pay close attention to their company’s CAMs. In particular, audit committees should consider whether any CAMs in their company’s audit report suggest weaknesses in the company’s financial reporting processes that could be remediated.
3. The PCAOB is also conducting a study of CAMs. The Board’s research agenda includes a project that will explore why the average number of CAMs has decreased and whether there is a need for guidance or PCAOB standards changes to improve the information provided in CAMs. See PCAOB Updates its Agendas and Adds a CAMs Review, November-December 2023 Update. If the PCAOB’s findings are consistent with those reported in the CAQ-KRC survey, it is possible that the Board will consider incorporating some of the institutional investor suggestions into the CAM standard.
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