As someone who managed to graduate college in just three terms - Nixon's, Ford's and Carter's - I was, as you can imagine, always somewhat relieved when the grading process in a particular course consisted of the basic "pass-fail" options. Several of my smarter and more ambitious colleagues, of course, disagreed with my position, contending that they wanted to know exactly where they stood in terms of a GPA. In effect, they were clamoring for more "disclosure," years before I would encounter that noun on a rather prolific basis as I began to report on the accounting profession.
Apparently, the Public Company Accounting Oversight Board wants auditors to disclose more than the basic "pass-fail" as noted on annual reports, evaluating whether a company has represented its financial statements fairly - or not. Absenta "going concern" notice, auditors don't, as a rule, put forth a detailed opinion about their views of the client, and thus investors are not privy to the same information as the audit team - such as any concerns or doubts they had that were not sufficient to prevent the company from earning a passing mark.
But that all may soon change.
Recently, the audit overseer unveiled a concept release that specifically aims to overhaul the traditional auditor's reporting model, including several alternatives to provide investors with more information on public companies. Among those are an "Auditor's Discussion and Analysis" section, and audit assurance on information outside financial statements, such as non-GAAP information on earnings releases.
Another possible auditing change under a separate proposal - one that has gained considerable momentum, particularly in Europe - has been the idea of implementing term limits for audit firms - requiring companies to rotate audits after a predetermined number of years. There's an inherent conflict of interest in an auditor-client relationship because the firm is paid by the client. That's not unlike a restaurant paying a health inspector to check for sanitary conditions and evidence of rat droppings.
As with any break from the traditional mindset, inevitably a number of issues emerge under the greater disclosure scenario, some of them from the PCAOB members themselves. Board members questioned whether auditors should move beyond their traditional attest role toward information put forth by company management, pointing out that auditors are neither analysts nor investment advisors, and therefore lack the training to provide an op-ed on the overall business and strategic risks.
Another pointed out that auditors might be called upon to characterize specific auditing judgments in which a firm's decision to issue a clean audit opinion is predicated on what he termed "close calls."
With regard to mandatory audit rotation, skeptics claim that the first year's audit engagement is a steep and often risk-laden learning process for the team, especially when dealing with larger clients. It may also result in higher audit fees.
But with the number of companies that received clean audit opinions only to require bailouts during the financial crisis, investors now more than ever are demanding greater disclosure. In a recent survey by the CFA Institute, nearly 60 percent of its members opined that the auditor's report should provide more specific information than it currently does.
The PCAOB said that it expects to formally propose changes by the end of 2011 and approve a final rule by the end of 2012. We will probably know sometime before then whether the profession will weigh in on the proposals with a P or an F.
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