American Institute of CPAs chairman Richard Caturano told an audience of CPAs at the AICPA’s Conference on Current SEC and PCAOB Developments in Washington, D.C., that the Institute is committed to engaging with regulators.
The opening day of the conference Monday included speeches by SEC commissioner Luis Aguilar, Public Company Accounting Oversight Board chairman James Doty, SEC acting chief accountant Paul Beswick and other top officials and accounting industry leaders, such as Center for Audit Quality executive director Cindy Fornelli.
[IMGCAP(1)]“At the AICPA, we are committed to a constructive dialogue with the SEC, the PCAOB and others,” said Caturano, who is executive managing partner of the Boston office of McGladrey. “We share a common purpose, which includes maintaining regulatory consistency among the multiple layers of state and federal regulation. At the same time, the CPA profession will continue to take a position on the leading financial and regulatory issues of the day that could affect CPAs. Among those are rules to implement the Dodd-Frank Act that relate to accounting and auditing. We’ll continue to be a resource, advocate and defender of investor protections.”
Caturano noted that he is almost two months into his term as AICPA chairman. "More than ever, I’ve come to recognize that what’s key to the CPA profession moving forward is the ability to embrace change," he said. "We’re living in an era marked by complexity and flux—in our economy, in financial reporting and auditing, and in the regulatory environment. I know my own firm is focused on building a culture that embraces these changes and looks for the opportunities they present. I’ve always believed that’s what CPAs do. We must proceed with this mindset on behalf of the profession as a whole, so that it will continue to thrive in tomorrow’s business landscape."
He observed that just a few years ago, auditing was being called a commodity. "You don’t hear that anymore," said Caturano. "Auditors are being scrutinized more closely than ever, and are taking on more responsibility. That needs to be reflected in the value placed on audits, one of the most important services for businesses and the capital markets. Within this environment, a financial reporting model based on relevance, reliability and transparency is more critical than ever. The investor community is also demanding stronger internal control, assurance at all levels of a company’s business, and stronger risk oversight protocols."
Aguilar talked in his keynote speech about how investors feel uneasy with the capital markets in the aftermath of the financial crisis and how it is important for accountants to help restore that sense of trust. “Obviously we need to turn that trend around,” he said. “It is clear that if you want people to invest in the capital markets, you have to work to make the capital markets trustworthy.
"I know that the AICPA shares this perspective," he added. "As an organization responsible for setting professional and ethical standards for accountants, the AICPA is the public representative of a rigorous and noble profession. As financial statement preparers and auditors, I count it as a special responsibility to help make sure that the capital markets are trustworthy. You are important gatekeepers. Your professional training and experience prepares you for this role, and whether you work in industry or public accounting, your clients and colleagues look to you for guidance. Investors count on you as well. They look to make sure that they get the information they need to make good investment decisions. The work of the accounting profession is critically important to investors and absolutely central to capital formation.”
Aguilar talked about the importance of the audit profession as well, citing research from the SEC’s Office of the Chief Accountant that assessed the effectiveness of audits of internal controls. “The study concluded that financial reporting is more reliable when the auditor is involved with internal control assessments, and that investors generally view the auditor attestation as beneficial,” he said. “In particular, the study found evidence that auditor testing of internal controls has generally resulted in the disclosure of control deficiencies that were not previously disclosed by management. Auditor testing also appears to have had a positive effect on the quality of financial reporting generally.”
However, Aguilar acknowledged that recent legislation like the Dodd-Frank Act and the JOBS Act have exempted many smaller companies from the Sarbanes-Oxley requirements for audits of internal control.
“I am concerned that the rollback of Section 404(b) would be harmful for both investors and for capital formation,” he said. “Uncertainty regarding the accuracy of financial reporting is likely to damage investor confidence. This could actually reduce demand for the securities of those companies, raising their cost of capital, and harming, rather than helping, the market for IPOs.”
Aguilar noted that researchers had found that companies that voluntarily comply with Sarbanes-Oxley Section 404(b) experience a lower cost of capital, including a decline in the cost of equity and debt capital in the first year.
SEC acting chief accountant Paul Beswick followed Aguilar’s presentation and discussed topics such as the convergence efforts between the Financial Accounting Standards Board and the International Accounting Standards Board. “I will acknowledge that there is a certain amount of standard-setting fatigue,” he said. “On some level, that is quite understandable as the boards have been working on these projects for the better part of a decade. I am hopeful that the boards are in the final stage of completing these projects. As the boards work through the remaining issues on the convergence project, I am encouraged about the level of convergence in the revenue and leasing projects that the boards have been able to achieve to date. When thinking about the status of the financial instruments project, I think some perspective is important. As I’ve frequently mentioned, 18 to 24 months ago, it was called almost unthinkable by some that the boards would be able to reach substantial agreement in classification and measurement of financial instruments, yet today the boards are a lot closer than many of you would have guessed.
[IMGCAP(2)]"During that same period, however, the boards have diverged on the impairment aspect of this project," Beswick added. "Regarding the next steps and potential way forward, I think it is important for both boards to expose their models for public feedback to see if there is a way to reconcile the two views. It is also important that the exposure period for the documents be similar so that the interested parties can have the benefit of both boards’ thinking and provide feedback to both boards concurrently.”
Beswick noted that the feedback of the CPA profession would be particularly helpful in this area. However, he also cautioned against trade organizations developing their own implementation guidance ahead of the authoritative guidance from the two boards. He observed that keeping implementation consistent is of paramount importance and the SEC is already trying to coordinate with other securities regulators across the globe. “First to press isn’t always the best thing,” he said. “I’m getting the sense from some trade organizations and others that they are trying to be the first to press with their implementation guides to individual convergence projects. I would caution everyone to be thoughtful and deliberative in their approach to nonauthoritative implementation guides.”
He acknowledged that there also needs to be more coordination between FASB and the IASB and their task forces on issuing interpretive guidance.
Dangers of Expanding Consulting Practices
Beswick also warned against accounting firms expanding into other businesses, saying it could damage the image of auditor independence.
“As a profession, accountants have a duty to act with integrity, objectivity and high ethical standards,” he said. “This is the hallmark of our profession. Revenue and profit pressures at an accounting firm can give rise to conflicting incentives, but the accountant’s obligation to the public trust cannot change.
“Keeping that in mind, I continue to observe that some accounting firms are actively growing their consultancy practices,” said Beswick.
He noted that the SEC’s Office of the Chief Accountant is occasionally asked about transactions involving accountants who are expanding their non-attestation service practices. “Some of the expansion relates to businesses that are fairly removed from an accountant’s professional mandate to perform quality audits,” he added. “For instance, we are aware that accountants have been acquiring businesses that provide project management, system architecture and design, and other IT services. At a minimum, these transactions can raise transitional issues with respect to compliance with the auditor independence rules. However, in my mind, more important is how the accounting firm views its non-audit service practice and whether this results in the accounting firm devoting the appropriate resources to its audit practice.
“My interest goes beyond technical compliance with the rules, which is very important, of course,” Beswick added. “I also question whether the accountants’ expanding practices into areas unrelated to their primary competencies weakens the public trust. I am disheartened when I read an article in the press that raises questions about the propriety of non-audit services that accountants provide to their audit clients. It is firmly rooted in the independence principles that independence is needed in both fact and appearance. As you all know, perception is reality, and negative perceptions can undermine investor confidence in audits. I am also concerned that expanding into businesses that have little relevance to the accountant’s primary competencies probably does little to promote audit quality and has the potential to distract a firm’s leadership and other personnel from providing appropriate attention to their audit practice. Such expansion runs the risk of damaging the accountant’s reputation.”
Audit Independence Conflicts
PCAOB chairman James Doty discussed the tension between these roles in his speech as well. “As I have learned in this job, getting the accounting right is indeed not the same thing as getting the auditing right,” he said. “My sense from accountants I talk to is that auditing is receiving well-deserved attention in its own right. Our economic success depends on the confidence of the users of capital and the providers of capital alike. Corporate managers hire internal accountants — many of you here today—to ensure they have accurate and detailed information on which to base management decisions. Managers ignore opportunities to glean trends and insights from this data at their peril. Mistakes in this information can send a company into a business line or market that squanders resources. We now know that the true cost of financial misstatement is much greater than stock market fallout, concomitant lawsuits and insurance claims.”
[IMGCAP(3)]Doty noted that “fudging the financials” misleads investors and companies alike into inefficient allocation of capital. “Economists warn that this, in turn, leads workers to train up, and sometimes move families, for jobs in industries that don't need them,” he added. “Years later, when they lose those jobs, their potential productivity is yet again wasted in unemployment. These are social costs of financial misreporting in economic terms. When they occur, they imply a market failure: efficient market allocations have been diverted by bad numbers.”
Doty said it was time to focus on auditing as a discipline in its own right and improve the training of auditors, while teaching them about the history of fraud. “Many accounting firms devote inestimable time and attention to the study of the fine points of the applicable accounting regimes,” he said. “But with this history, it is high time that we focus on auditing as its own discipline, to be studied, nurtured and trained. All auditors should be versed in the case studies on fraud. It is simply not the case that frauds do not repeat; although there may be new twists, familiar elements reappear.”
Doty is concerned about the growing role of consulting revenue at auditing firms. “Large audit firms' revenues from consulting are growing rapidly, at some firms more than 15 percent a year,” he pointed out. “Audit fees have stagnated at, basically, the inflation rate. Thus audit practices have shrunk in comparison to audit firms' other client service lines—not all of which are schooled in, or depend upon, the fundamental exercise of skepticism. This threatens to weaken the strength of the audit practice in the firm overall.”
He noted that after nearly 10 years of inspecting the audits of issuers, the PCAOB has identified hundreds of engagements that did not meet PCAOB standards in significant respects. “These are serious audit deficiencies in procedures and actions that mean, essentially, that the audit opinions involved were not adequately supported,” said Doty. “Moreover, inspection findings have increased at many firms over the last several years. This is a hard message. It is to be expected that the inspection findings are a disappointment to a profession proud of its reputation for technical excellence. Some firms have seen even more findings this year.”
However, Doty acknowledged that the PCAOB has seen good news from its audit inspections too, especially when the firms use the inspection results to improve their practices. “Yet I say with confidence that I have seen dramatic improvements in audit quality in response to the findings,” he said. “When a firm accepts the findings, and undertakes a rigorous root cause analysis, it can design actions to reduce and eliminate recurrence. The audit firm takes a significant step on the road to excellence when it acknowledges that the number and vector of our findings indicate root cause, systemic issues, and not merely episodic failures in execution. That involves self-monitoring and testing—not just waiting to see if the PCAOB finds the problem in other audits.
“Inspectors have seen it done,” Doty added. “This requires, when a firm is grappling with evidence of a lack of skepticism in certain past audits, the firm demands—through its words, actions and subsequent testing—pervasive and explicit evidence of skepticism in the work papers. It means the firm issues meaningful, believable and consistent messages internally that quality is not one of many goals, but the firm's number one priority. It means these communications go to—and are honored by—all professionals, because the firm engages all professionals in the remediation efforts. I hope you are seeing these actions and improvements in your firm. Not all firms have gone to these lengths. But this is what quality means.”