Friday, August 08, 2008

IFAC Chief Says Professional Judgment Crucial to Principles-Based Global Audit Standards

Echoing a theme that an SEC advisory committee has examined, the President of the International Federal of Accountants said that the global adoption of principles-based auditing standards is linked to allowing the auditors of company financial statements to make professional judgments without fear of being second guessed. One recommendation of the advisory committee was that the PCAOB issue a policy statement articulating the factors it uses when evaluating the reasonableness of auditing judgments.

In remarks at a recent accounting seminar in Istanbul, Fermin del Valle said that, since the practice of auditing is a technique not a science, independent auditors of financial statements must exercise their professional judgment. In addition, the implementation of principles-based audit standards will necessarily entail an increase in the use of professional judgment by auditors that, in turn, will lead to an increase in uniformity in the preparation of financial statements. He added that the principles-driven audit standards being developed by the International Auditing and Assurance Standards Board provide a framework within which auditors can exercise their professional judgment and interpret a given standard in a given circumstance.

Principles-based auditing standards will become the global benchmark, he asserted. Rules-based standards increase the complexity of the financial reporting system, he noted, and they also allow the restructuring of transactions to achieve a particular result that may be inconsistent with both the economic substance of the transaction and the underlying purpose of the rules.

His remarks came against the backdrop of a growing international consensus for international audit standards developed by the IAASB and converged with PCAOB standards. Cross-border support for international audit standards is nearly unanimous, he said. At one time regulators and standard setters spoke of the harmonization of accounting and auditing standards, he noted, but now they speak of convergence. In his view, convergence better conveys IFAC’s goal of many interested parties moving simultaneously towards the global use of a consistent set of high quality professional standards.

He praised the IAASB’s Clarity project as an effort to ease the process of convergence to international audit standards, making them easier to translate and implement. The Board expects to finalize all 35 international audit standards by the end of this year, he said, and they will be effective for financial periods beginning on December 15, 2009. IFAC believes that the project is crucial to removing any barriers to convergence to global auditing standards. He is convinced that the Clarity project will be seen as one of the significant milestones in the history of auditing.

The Clarity Project has been a major focus of the international regulators' attention over the past two years, with IOSCO and SEC officials coordinating the Board’s activities and discussing proposed standards. PCAOB Chair Mark Olson has said that global auditing standards are inevitable, but that they will be years behind global accounting standards. The PCAOB is currently tailoring its auditing standards to minimize the differences with the standards adopted by the IAASB

In addition, the PCAOB serves as an observer with speaking rights on the IAASB. Chief Auditor Tom Ray has noted that, in that capacity, the PCAOB both influences the debate and learns from the IAASB members about the rationale underpinning their standards. In connection with each of its standard setting projects, the PCAOB uses the related international standard on auditing as a significant influence.

The recent final report of the SEC’s Advisory Committee on Improvements to Financial Reporting also endorsed a professional judgment framework as a main theme of its work. The SEC committee believes that a framework should be consistent with principles to cover judgments made by auditors based on the application of PCAOB auditing standards. Thus, the committee proposed that the PCAOB develop a professional judgment framework for the application and evaluations of auditing judgments.

According to the committee, professional judgments should be based on a critical and reasoned evaluation made in good faith, prior to the exercise of the judgment, of an identified issue, including the nature and scope of the issue based on a number of factors, including an analysis of the transaction, the substance and business purpose of the transaction, as well as the material facts reasonably available at the time that the financial statements are issued.