The Public Company Accounting Oversight Board proposed for public comment a new auditing standard and related amendments to enhance the auditor's reporting model on Tuesday.

The proposed standard would retain the pass/fail model in the existing auditor’s report, but would provide additional information to investors and other financial statement users about the audit and the auditor. The PCAOB is also proposing a new related auditing standard on the auditor’s responsibilities for other information in an annual report.

“These proposed changes will make the auditor's report more relevant to investors,” said PCAOB chairman James R. Doty in a statement. “More robust audit reports that demonstrate the strength and value of the audit also should lead to better public awareness of, and appreciation for, auditors’ skill and insight.”

In 2010 and 2011, PCAOB staff conducted outreach to investors, auditors, preparers of financial statements, audit committee members, and other interested parties to seek their views on potential changes to the auditor's report. The staff presented its findings to the board at an open meeting in March 2011.

In June 2011, the PCAOB issued a concept release to seek public comment on potential changes to the auditor's reporting model.

In addition, in September 2011, the PCAOB held a public roundtable to obtain insight from a diverse group of investors and other financial statement users, preparers of financial statements, audit committee members, and auditors on the alternatives presented in the concept release.

The proposed auditor reporting standard would require:

•  the communication of critical audit matters as determined by the auditor;
•  the addition of new elements to the auditor's report related to auditor independence, auditor tenure, and the auditor's responsibilities for, and the results of, the auditor's evaluation of other information outside the financial statements; and,
•  enhancements to existing language in the auditor's report related to the auditor’s responsibilities for fraud and notes to the financial statements.

The proposed other information standard describes the scope of “other information” and  procedures the auditor is required to perform, including procedures when the auditor identifies a material inconsistency between the other information and the audited financial statements, a material misstatement of fact, or both.

The scope of “other information” in an annual report filed on Form 10-K would include, among other items, selected financial data and management’s discussion and analysis.

“The goal of these proposed standards and amendments is to significantly improve the current auditor reporting model by requiring the auditor to communicate specific information about each audit based on audit procedures performed,” said PCAOB chief auditor and director of professional standards Martin F. Baumann. “Communicating critical audit matters in the auditor's report will make the report more informative, thereby, increasing its relevance and usefulness to investors and other financial statement users.”

The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, the proposed auditor reporting standard, would supersede portions of AU sec. 508, Reports on Audited Financial Statements.

The Auditor's Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor's Report, the proposed other information standard, would supersede AU sec. 550, Other Information in Documents Containing Audited Financial Statements.

Watershed Moment
“This is a watershed moment, and it’s important to know how the water runs downhill after the watershed,” said Doty in a press conference Tuesday with reporters following the PCAOB meeting. “This is more than a promising start. This is a highly disciplined, highly rigorous, economically analyzed and justified proposal for a change that involves the most technical and the most focused aspects of audit conduct. We will have a comment process. It will be useful, but we have done those things which people wanted us to do. We have not done those things that people were concerned about. We have avoided the auditor’s discussion and analysis. We have not put the auditor into the position of evaluating the audit committee or evaluating the company’s own estimates. There are a number of issues set forth in the forepart of this release that delineate clearly why we did not do some of the things that others had spoken of doing.

“But speaking for me,” Doty added, “what I am going to be interested in seeing is whether in this comment process and in this review process, the audit profession seizes the opportunity that this represents, and whether that watershed leads the audit profession to meet the challenges that are discussed in this release, for the audit profession to say, ‘Yes, we want the public to know we are required to be independent. We have the following tenure as the auditor. We have been the auditor continuously since … We perform procedures to assess the risk of material misstatement, whether due to error or fraud. Then here are the critical accounting matters we found and here are the evaluation procedures that we have evaluated.’ These are the five new elements of the audit opinion that are set forth clearly. If the audit profession takes the view that they will figure out a way to do this in a way that is meaningful for investors, they will make the right choice and they have a lot of people to help them do that. They have professional associations and professional organizations. If the audit profession takes an approach, which I do not expect them to take, that this is just too tough, the liability risk is too great, the change is too big, if that is where the audit profession goes, it will indeed be a different kind of watershed.”

Auditor's Discussion and Analysis Left Out
Cindy Fornelli, executive director of the Center for Audit Quality, said she was glad the PCAOB wasn't requiring an auditor's discussion and analysis section in the report, as some investor advocates had hoped.

“The PCAOB should be commended for its efforts on this important issue," Fornelli said in a statement. "The CAQ is committed to embracing calls for responsible change to the auditor’s report. We support a holistic approach that examines opportunities for improvement in the roles and responsibilities of all members of the financial reporting supply chain including those charged with governance as this will best serve the interests of financial statement users

 “I was encouraged that the Board acknowledged concerns with an auditor’s ‘discussion and analysis’ approach," Fornelli added. "The CAQ believes that auditors should not be the original source of information about an entity; management’s responsibility should be preserved in this regard. The PCAOB has proposed disclosure regarding auditor tenure. As noted by several board members at today’s open meeting, there is no demonstrated correlation between auditor tenure and audit quality. After a thorough review of the standards, the CAQ will provide detailed comments to the PCAOB.”

Comments on the proposed standards and related amendments are due by Dec. 11, 2013. A fact sheet is available on the proposal.

The PCAOB is considering holding a public roundtable in 2014 to discuss the proposed standards and the comments it receives. It hopes for the new standard to take effect in 2015, but Doty indicated that the PCAOB may need to repropose the standard first to include the changes that come out of the roundtable and the other comments it receives.

“What we do in the release is articulate why we think what we came up with here offers advantages and benefits and avoids unintended consequences that an auditor’s discussion and analysis might involve,” said Doty. “I think we feel we have got a better mousetrap. One of the things I feel strongly about, having seen the effort that has gone into this and pored through all of the pieces of it, and the board having had extensive staff discussions about how it fits together, I feel very good that this has intellectual rigor and analytical integrity. You can’t characterize this by nomenclature, and I am in hopes that the investor community will see this as a very significant step forward in giving insight into the audit and that the auditors will themselves see the benefit of that, and that management and audit committees will likewise see the benefits. This is a win-win. There’s a benefit here for every participant in the market process if they choose to look for it.”

Baumann agreed that the proposal should satisfy various constituencies, even though it leaves out the auditor’s discussion and analysis section that some investor advocacy groups had hoped the PCAOB would require in the auditor’s report. “I hope the investor advocates carefully analyze what we’re proposing here today before they make any rash decisions about how it’s not the AD&A that they asked for,” he said. “I hope they will carefully analyze what we’re requiring to be disclosed, and the nature of those requirements, the most difficult subjective complex matters, difficult to obtain evidence, the documentation requirement around this, the requirements for additional procedures and reporting on other information, and look at this whole package, and say, ‘I’m getting a lot more information that can shine a lot of sunlight into the key issues in the financial statements,’ and explain that carefully before they reach any conclusions.”

Comparison with IAASB Proposal
Baumann said he did not think the PCAOB would try to issue a joint proposal with the International Auditing and Assurance Standards Board, which also recently issued an exposure draft of a proposal for changing the structure of the future auditor’s report (see IAASB Proposes Fundamental Overhaul of Audit Reports). He sees some important differences between the PCAOB and IAASB approaches, but also some similarities.

“They have a proposal out where they’re waiting for comment also,” said Baumann. “There are some differences from our proposal and some similarities. The definition of what we call 'critical audit matters' is, I think, more comprehensive than the definition of what they call 'key audit matters.' We have a documentation requirement in ours, which we think puts a lot more strength to the requirement of the standard. They don’t have a documentation requirement, which really just leaves it up to the auditor whether they disclose something or not, so we think that’s a big difference with the documentation requirement. We also have, with respect to other information, additional procedures that the auditor has to perform around their evaluation, which the IAASB does not have. Having said that, we also see some similarities, and I don’t think that’s surprising, given the years of outreach that we’ve had and the years of outreach and commenting that they’ve had, and both of us determining that there were more negatives to having the auditor talk directly about the financial statements and interfering with the audit committee process than talking about the audit and shining sunlight into this whole process through the audit. So it’s not surprising that we reached generally similar conclusions.”