Microsoft Discloses ‘Critical Audit Matters’

By David McCann for CFO.com

The first group of large accelerated filers to disclose critical audit matters, required under PCAOB Auditing Standard 3101, includes one of the world’s most high-profile companies: Microsoft.

CAMs must be reported for fiscal years ending on or after June 30, 2019. That date marked the end of Microsoft’s latest fiscal year.

A CAM is any matter communicated or required to be communicated to the audit committee that satisfies two conditions: (1) it relates to material accounts or disclosures that are material to the financial statements; and (2) it involves “especially challenging, subjective, or complex auditor judgment.”

As noted in an Audit Analytics blog post, CAMs should not be confused with “critical accounting policies,” which must be disclosed under Securities and Exchange Commission rules.

Critical accounting policies (CAPs), as per SEC Financial Release No. 72, are related to items that have a material impact on financial statements and require “significant estimates, judgments or assumptions.”

Most CAMs (which are determined by auditors) will also be CAPs (determined by management), but not vice versa, as CAMs address how estimates made by management affect the audit process. In its 10-K report for its 2019 fiscal year, Microsoft reported seven CAPs and two CAMs, both of which were also CAPs.

The software giant’s auditor, Deloitte, identified two critical audit matters, pertaining to revenue recognition and uncertain income tax provisions.

With respect to income tax, Microsoft reported the following in a CAP: “Judgment is required in assessing the future tax consequences of events that have been recognized on our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements.”

Deloitte, in its audit opinion, expanded on that disclosure.

Microsoft remains under IRS audit, or subject to IRS audit, related to complex and subjective transfer pricing issues for multiple years following 2003, the auditor noted.

For that reason, “evaluating management’s estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment.”

Deloitte similarly described the difficulty of evaluating Microsoft’s judgments in determining revenue recognition for customer agreements.

That challenge underscores how some software companies have struggled to apply the new revenue recognition standard, ASC 606. The rule requires companies to account for each “performance obligation” under a customer contract to be accounted for separately.

When contracts call for a company to deliver multiple products and/or services to a customer, determining which promises should be considered distinct performance obligations “may require significant judgment,” Microsoft acknowledged in a CAP.

Deloitte, of course, had to evaluate those judgments. In its description of the revenue recognition CAM, the firm noted that it also had to review Microsoft’s judgments related to:

“Given these factors, the related audit effort in evaluating management’s judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment,” Deloitte reported.