Dive Brief:

• Auditors of large public companies disclosed fewer critical audit matters — a term for challenging or subjective material found in their client’s financial statements — in their audit reports after evidence emerged that investors interpreted increased CAM disclosures as an indication of business risk, according to a study completed this month by professors at the University of San Diego and Bucknell University.
• The new CAMs, or disclosures of key issues that surface during audits, were mandated by the Public Company Accounting Oversight Board for certain filers beginning in 2019.
• The “Disappearing Audit Disclosure Study” provides “empirical evidence that auditors significantly dialed back the extensiveness of CAM disclosures in the second year of reporting,” and suggests the PCAOB and audit firms may need to rethink the approach to making audit reports more informative, the report states.  

Dive Insight:

The study also underscores the long-standing conflict of interest in the process whereby auditors are paid by the clients or companies they audit, even as they are responsible for disclosing potentially sensitive or negative information about those clients, Kate Suslava, one of the study’s co-authors and an assistant professor of accounting at Bucknell, said in an interview.

“Auditors have incentives to minimize these disclosures and see what they can get away with,” Suslava wrote in an emailed response to questions. Suslava’s co-authors are Mary Durkin and Kristyn Calabrese of the University of San Diego.

The study, which analyzed 5,391 10-K filings with the CAM disclosures made between June 2019 to May 2021, showed that auditors disclosed both fewer CAMs and provided less information on audit procedures in their second year of reporting after the requirements went into effect. 

In the first year of the adoption, the report said academics found that companies with more CAMS evidenced more volatile stock around the filing date. “This could have alerted managers and auditors that more lengthy CAMs are harmful to the company stock price,” the report states, adding that managers and auditors may have pulled back on disclosures after having a chance to see how their peers handled the disclosures. 

The largest year-over-year declines in notations were related to tax positions (a 6% decline), intangibles (a 3% decline) and leases (a 2% drop). The details on audit procedures also fell, with the steepest declines seen in analytical procedures, which dropped 12%.