Companies and their auditors are getting ready for the Public Company Accounting Oversight Board’s new audit reporting model, despite uncertainty over whether the Securities and Exchange Commission will approve the new standard.
The PCAOB voted for the new standard in June after years of work and a series of proposals that attracted extensive industry feedback (see PCAOB makes major changes to auditor’s report). The SEC has not yet approved the standard, although it typically has rubberstamped any new rules approved by the PCAOB. In this case, however, the U.S. Chamber of Commerce has lined up 27 major corporations and business groups in urging the SEC to reject it (see Business groups object to new audit standard). They argue that the discussion of so-called “critical audit matters,” or CAMs, that the new standard would require in audit reports could “result in the disclosure of immaterial information, replace management as the source of original information, create a chilling effect on the audit committee—auditor relationship, create liability for businesses and auditors, and impose additional expenses on firms.”
Last week, PCAOB board member Jeanette Franzel discussed the expanded audit report standard with a panel of auditing experts at an event sponsored by the New York State Society of CPAs. “The real question is transparency,” she said. “How much should the auditor say and how much information do people want from the auditor, from this oftentimes long process filled with a lot of work? The PCAOB has been working on this for a very long time. Long before I got to the board, a lot of progress had been made. The Advisory Commission on the Auditing Profession took this up as well. The various iterations that the PCAOB has done have refined this to something that could actually be proposed and tried in the marketplace. We also see the international market really taking up this same topic of transparency from the auditor.”
Jan Herringer, a partner in BDO USA’s National Assurance practice, pointed out that the new standard would change the traditional audit report from the pass/fail model. “For the last 70 years, we’ve been [asking] did the audit pass or did it fail, and that’s the information we’ve been giving to the investors,” she said. “Now the question is what do the investors want today? And today, it seems they want a lot more.”
“For quite some time, the investor community has indicated that they find quite significant value to the pass/fail model and they have for years,” said Jeff Mahoney, general counsel at the Council of Institutional Investors. “But for many years they have been asking for something more, and there’s been a lot of debate for years about what that something more should be.”
He recalled participating in the Treasury Department’s Advisory Committee on the Auditing Profession back in 2007. They recommended in a 2008 report expanding the auditor’s report, in part based on input from the investor community, who wanted to see more than boilerplate language about whether a company had passed or failed an audit. There were no specific recommendations, but investors were interested in seeing more insights from auditors about the judgments and estimates made by the company.
“I don’t necessarily see this as such a deep philosophical question,” said Thomas Ray, a former chief auditor and director of professional standards at the PCAOB who is now a distinguished lecturer at Baruch College in New York. “If you look at the auditor’s report, clearly the number one objective here is for the auditor to express an opinion and provide a basis for people to have confidence that those financial statements are fairly presented. But other parts of the audit report actually do talk about the audit and what the audit is. It’s just a little bit, but it does talk about what the audit is. This is a modest increase in the amount of information in the report about the audit. What did the auditor think were the most difficult areas, the most sensitive, the ones that needed the most judgment, and how did the auditor respond to that? I don’t necessarily see this as such a huge increase in information.”
Charles Abraham, an audit partner and the financial services practice leader at Mazars USA LLP, cautioned against a part of the new standard that said the expanded audit report should reduce the “information asymmetry” between the investors and the auditor. “My word of caution here on the difference in information between what an investor has and an auditor doesn’t go away because of the expanded audit report,” he noted. “I don’t think that was the intention to reduce it. Part of the concern is that it’s one-way communication. The expanded audit report is one-way communication, and I think the information asymmetry gets further reduced with a dialogue where really engaged audit committees and auditors are going back and forth discussing and collaborating. That really leads to a well performed audit with good communication and understanding. There are still some limitations that need to be understood and worked on here.”
Moderator Chris Gaetano, a staff writer at the NYSSCPA’s Trusted Professional publication, asked what the limitations are and what work still needs to be done.
“When you talk about how it’s one-way communication and you need a dialogue, these things happened to help improve audit quality and investors need to know that,” said Franzel. “What we’re talking about here is the expectation gap and how to reduce or narrow that expectations gap to an appropriate level. Investors are never going to have all of the information that management or the auditors have, but how can we reduce that expectations gap to an appropriate point, and there are going to have to be a whole lot of things done to help that. Auditor reporting is just one aspect of that. We’ve got the potential for audit committee reporting and other mechanisms to also help reduce that expectations gap, and clear standards for auditor performance and things like that.”
She suggested that it would be important for the PCAOB to eventually do a post-implementation review of how well the new standard works. Franzel acknowledged the fears about litigation risks in the new standard.
“That’s why we have three lawyers on the board and one CPA,” she said. “I’m the CPA. I think the board certainly considered these matters very seriously because it seems to come up very frequently anytime we try to change he financial reporting model or the auditing model. I think the way we cracked the definition should help because we’re not just having the auditors discuss their general thoughts and feelings about the financial statements. There are clear criteria, and these are material issues, and the auditor should be working with management. If the auditor is really doing sufficient work to support reasonable assurance over that opinion in the first place, that audit opinion and those financial statements should not be falling apart in these areas of critical audit matters. It will be really important for this to be studied as we go forward.”
As for whether or not the SEC will ultimately approve the new standard, Ray said he didn’t have a crystal ball, but he anticipates it will be approved. “The SEC ultimately has approved everything the board has adopted in final form,” he said. “The board went through one heck of a process over a significant amount of time, so I personally would be surprised if the SEC didn’t approve it. But who knows? I know there has been some significant comment from the corporate community who are worried about the potential negative impacts of this new disclosure.”
“We should know in a few weeks,” said Franzel. “It is interesting to note that the SEC has gotten more comment letters on this PCAOB proposed rule than on any other.”
A video of the full discussion has been posted on the NYSSCPA's Facebook page here.
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