Monday, October 31, 2011

PCAOB Moving in Step with International Counterparts to Reform Financial Audit Says Member Harris

Both the PCAOB and its foreign counterparts are considering regulations that could fundamentally change the accounting and auditing profession, said Board Member Steven Harris, all with the goal of improving audit quality, enhancing the public's confidence in financial reporting, and protecting investors. In remarks at the Utah State University 35th Annual Accounting Conference, he noted that European policy makers and audit oversight bodies are considering several ambitious proposals. For example, in the UK, reports have emerged detailing auditors' failure to challenge managements' assumptions, lack of independence, and inadequate disclosures to investors in the lead up to the financial crisis.

Recently, Stephen Haddrill, Chief Executive of the Financial Reporting Council, the PCAOB's counterpart in the UK, questioned the form of the audit report and asked if there is a need to make it more useful with more information being provided in the front of the report about risks, and with the auditor providing greater assurance about risks.

Also, calling the outside audit report on company financial statements a wholly uninformative product of an opaque audit process, the Financial Reporting Council said it would propose an expanded audit report that includes a new section addressing the completeness and reasonableness of the audit committee's report and identifying any matters in the annual report that the auditors believe are incorrect or inconsistent with the information contained in the financial statements or obtained in the course of the audit.

European Commissioner for Internal Market Michel Barnier has also begun an inquiry into the future of the auditing profession. The European Commission has published a Green Paper on audit policy, noted Member Harris, the stated purpose of which is to launch a debate on the role of the auditor, the governance and the independence of audit firms, the supervision of auditors and the international co-operation for the supervision of global audit networks. Since the Green Paper was issued, Commissioner Barnier has suggested audit only firms, mandatory audit rotation, and joint audits for the largest companies. Member Harris noted that the PCAOB is looking at a number of these issues as well including revising the auditor's report, enhancing auditor independence, objectivity and skepticism and improving transparency.

The Board has issued a Concept Release on changing the auditor's reporting model. Generally, noted Member Harris, investors are not looking for more audit work to be performed by auditors but for a public discussion of those things that should be obvious to an auditor following a well-performed audit. At a basic level, he said, investors want auditors to ask themselves what is it that, if they were investing in the company, they would want to know; and for the auditors then to highlight or provide that information. Investors also want to know those issues that came up during the audit and "kept the auditor up at night."

According to Member Harris, possible alternatives for changing the auditor's reporting model, as described in the Concept Release, include an Auditor's Discussion and Analysis; required and expanded use of emphasis paragraphs in the auditor's report; auditor assurance on other information outside the financial statements such as, assurances on Management's Discussion and Analysis, non-GAAP information, and earnings releases; and clarification of language in the standard auditor's report such as, the meaning of reasonable assurance; the auditor's responsibly for fraud; the auditor's responsibility for financial statement disclosure; management's responsibility for the preparation of the financial statements; the auditor's responsibility for information outside the financial statements and auditor independence.

In his view, the issue is how best to provide the information that investors want in a cost effective and efficient way. Because investors are asking for information that auditors already know, he is hopeful that the Board will be able to find a way for that information to be provided in a relatively easy and cost effective manner.
He also noted that investors have made clear to the PCAOB that they do not understand how, during the height of the financial crisis, virtually all companies that received government assistance, or went bankrupt, were given clean audit opinions and investors remain concerned with the lack of progress at the FASB, PCAOB and SEC in modernizing the standards relating to going concern opinions.

The PCAOB is also focused on ways to improve auditor independence, objectivity and professional skepticism, said Member Harris. Over the years, PCAOB inspectors have raised numerous concerns about professional skepticism in their inspections of both large and small firms. Notably, the 2010 inspections have generated more issues than in prior years, with a troubling increase in the volume of significant issues.

He observed that other regulators have found similar problems, with inspection reports from Australia, Canada, Germany, the Netherlands, Singapore, Switzerland and the United Kingdom citing similar deficiencies in professional skepticism as persistent problems at audit firms. The PCAOB issued a Concept Release to solicit public comments on ways that auditor independence, objectivity and professional skepticism can be enhanced, including through mandatory rotation of audit firms.

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