The Public Company Accounting Oversight Board held a public meeting Wednesday to solicit feedback from experts on its proposals for changing the auditor’s reporting model.

Wednesday’s session was the first of a two-day meeting in Washington, D.C., and focused on the critical audit matters, or CAMs, section of the PCAOB’s proposal.

The board’s August 2013 proposal would require the auditor to communicate in the auditor’s report “critical audit matters” that would be specific to each audit, focusing on the matters that the auditor addressed while auditing the financial statements that involved the most difficult, subjective or complex auditor judgments or posed the most difficulty in obtaining sufficient audit evidence or forming an opinion on the financial statements. The idea is to go beyond boilerplate disclosures, but also retain the pass-fail model.

“By requiring and providing a framework to report critical audit matters, the proposed standards would keep the auditor within its area of expertise—the audit,” said PCAOB chairman James Doty. “No one wants to return to the days before the pass-fail model was instituted, when auditors’ free-writing could obscure a disclaimer of assurance on misleading financial statements. As many commenters have confirmed, there is a real public interest in retaining the binary, pass-fail opinion. The proposed framework is intended to set forth concrete criteria to consider and apply in light of the specific audit at issue, in order to limit both the discretionary ability to avoid disclosure as well as the opportunity to fall back on boilerplate.”

International Standards
Gaylen Hansen, former chairman of the National Association of State Boards of Accountancy, noted that he was a member of Treasury Department’s Advisory Committee on the Auditing Profession, or ACAP, whose recommendations in a 2008 report led to the PCAOB’s proposals for changing the auditor’s reporting model. He noted that other groups have also been working on changing the audit reporting model, including the International Auditing and Assurance Standards Board.

“There is a clarion call from many quarters for greater auditor accountability and transparency,” he said. “Other major players on the international scene are moving rapidly to require more informative auditor reports—with or without the U.S. in tow. The IAASB anticipates finalizing its reporting project in the second half of 2014.”

IAASB chairman Arnold Schilder told the PCAOB the topic has been on its radar screen for some time, and it first commissioned academic research jointly with the AICPA’s Auditing Standards Board. “The topic of what we refer to as key audit matters or KAM, similar to the PCAOB’s critical audit matters, is viewed by many as the most significant enhancement to auditor reporting,” he said. “We proposed to require auditors of listed entities to communicate KAM in the auditor’s report. We define KAM as those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements of the current period. KAM are selected from matters communicated with those charged with governance—thereby providing transparency about communications investors have said are important to audit quality. Investors, regulators and auditors largely support what we have proposed but have asked for more guidance on how auditors should apply the decision framework. They have also urged us to take steps to ensure that both the matters identified, and how they are described in the auditor’s report, results in meaningful communication to investors.”

Former SEC chief accountant Lynn Turner, who also served on the ACAP committee with Hansen, said the project has the potential to provide investors with useful information that will improve their capital allocation decision making and returns. He said it was important to avoid meaningless boilerplate disclosures. “All too often such disclosures are the result of attorneys trying to avoid litigation,” he pointed out. “Rather, the required disclosures should be made in a transparent, plain English manner that an average investor can comprehend. I believe any final rule should highlight such an objective in black and white. I believe the disclosures by the auditor should encompass all CAMs prepared in any given year.”

He noted that the current auditor’s reporting model is out of date and provides a minimal amount of information. “It has led to questioning of the value of an audit to investors,” said Turner. “The time for action by the PCAOB is now, if not past due, with respect to all the ACAP recommendations, including improving the audit report. The purpose of an independent audit is to ensure investors receive timely, complete and credible information important to their decision making. They are not done for management, who can get whatever information they need with respect to the company, in whatever format they desire. When we find, as we have in the past, auditors are aware of information important to investors, but fail to disclose it to investors, it stands to reason that any trust in an audit, and its value quickly evaporate. For that very reason, the board should move forward in a timely fashion to adopt an expanded audit report, providing information they believe is important and useful. A model that fails to provide independent auditor insights or simply repeats the disclosures made by management should not be accepted.”

Sir David Tweedie, the former chairman of the International Accounting Standards Board and current chairman of the International Valuation Standards Council, argued that audit reports must provide genuine value. “Everyone knows if there has been a bad audit —it is all over the press!” he said. “No outsider, however, knows if there has been a good or an outstanding audit.”

Tweedie believes the standard for audits in the U.S. should match similar standards across the world. “We should not risk confusing investors by having auditors performing to different standards of behavior and reporting depending on where they are conducting the audit,” he said. “International standards are critical in all aspects of the financial system, whether that be accounting, auditing or valuation.”

Accounting Firms
Kevin Reilly, the Americas vice chair of professional practice at Ernst & Young, said the firm supports improving the informational value of the auditor’s report and the concept of CAM disclosure, but has some concerns with the PCAOB’s proposals. “In practice, CAMs typically tend to be those matters involving a greater level of audit committee discussion and interaction, and we believe this important filter should be added to the CAM identification process in any final standard,” he said. “This filter would have the added value of responding to requests from some for further insights into auditor/audit committee communications.”

EY also had some concerns about the examples provided by the PCAOB in its proposal. “Overall, we believe the biggest ticket concern on the CAM front revolves around the question, ‘What should an auditor say about the CAM in the audit report?’ The proposing release notes that the description of the CAM should identify the CAM, describe the considerations that led the auditor to conclude the matter is a CAM, and note where the matter is covered in the company's financial statements,” said Reilly. “We understand these objectives and think the general approach makes sense. However, we have significant concerns with how this framework has been applied in crafting the examples in the proposing release. While we fully appreciate that the board wanted to stir the debate and purposefully intended these examples to be provocative, I believe it is these examples that have led to the significant pushback on the CAM proposal, for many good reasons, and have caused some to suggest we may want to throw the baby out with the bath water.”

Joan Waggoner, a partner in the professional standards group of Plante & Moran, had concerns about the costs for smaller accounting firms and issuers. “From reviewing the comment letters of the smaller accounting firms, I find there is a reluctance to totally embrace the inclusion of CAMs in the auditor’s report,” she said. “From discussing the issue with my partners, we also have some worries about certain aspects of CAMs, although we are supportive of the board’s objective to make the auditor’s report more meaningful to investors.”

She noted that some of the reluctance may come from accounting firms’ lack of history in disclosing original information. “I believe many CAMs would correlate with other disclosures already present in the 10-K, or that arguably should be in the 10-K,” she said. “However, we may end up with some instances where we are faced with the potential disclosure of original information. The disclosure of original information is not natural to auditors, as, since the beginning of recorded time, we have been following the model of ‘management asserts; we attest.’ This model has been reinforced over time as the auditor’s responsibilities have changed, most recently with the Sarbanes-Oxley internal control work, where again ‘management asserts and we attest.’ The force is strong within us that original information should be authored by management.”

Waggoner pointed out that the Center for Audit Quality has initiated a field-test of the PCAOB’s proposed auditor’s reporting model, and she said she is interested in reviewing the results of the testing once it has been completed and vetted.

Investor Perspective
CFA Institute managing director Kurt Schacht observed that investors and members of the CFA Institute support enhancements to the standard auditor’s report. “Today’s world of professional investment analysis has evolved dramatically in terms of the speed, quality and richness of available information,” he said. “And while significant efforts and costs go into an audit, investors are provided very little information in the current three-paragraph report provided by today’s SAR. Through increased transparency, a revised auditor’s reporting model would simply be evolving along with markets. In the view of CFA Institute, it will heighten user confidence in the audit process specifically and financial statements generally.”

Litigation Concerns
Some panelists warned about liability exposure for audit firms and public companies. University of Chicago accounting professor Douglas Skinner warned that the proposals could lead to greater litigation costs and other unintended consequences.

“By expanding the auditors’ role and disclosures in the manner envisioned in these proposals, I think we can confidently predict that the plaintiffs’ bar will not have to work very hard to expand both the extent to which auditors are held liable for client firm problems and the magnitude of the associated damages claims,” he said. “It therefore seems hard to imagine a world in which audit fees will not increase if these proposals go forward.”

An attorney also said he sees legal risks in the PCAOB’s proposed standards. “Both standards will cause heightened litigation exposure under the securities laws and impose the resulting costs,” said Andy Beller, a partner in the New York office of the law firm Cleary Gottlieb. “The proposed other information standard, in particular, will significantly increase litigation exposure by requiring auditors to affirmatively state their findings, even in cases where nothing has been found or in cases where preparers have made modifications satisfactory to the auditors as to matters the auditors have identified.”

But others emphasized the need to update the auditor’s report. Andy Bishop, chief financial officer and chief accounting officer at Hallador Energy Company, pointed out that he has not seen substantial changes in the auditor’s report over the 39 years he has been involved in accounting. “Now is the time for change,” he said. “Nobody likes change but a wet baby.”

“Enhancing the auditor’s report will play an instrumental role in ensuring a vibrant audit profession that is rooted in quality,” said Joseph B. Ucuzoglu, national managing partner of regulatory and professional matters at Deloitte LLP. “In fact, the benefits of an enhanced auditor communication will extend beyond the additional information content in the report. The very act of an auditor crafting a tailored communication to external constituencies stands to enhance the connection of the auditor to the user of the audit report —the investing public. This connectivity further reinforces the auditor’s public interest responsibility, and fosters the healthy exercise of independence, objectivity and skepticism—attributes that lie at the foundation of a high-quality external audit.”