In comment letters to the PCAOB on the Board’s Concept Release on the audit report on company financial statements, the Big Four accounting and auditing firms recommended overarching and holistic principles to guide reform of the audit report model. Two audit firms, Ernst & Young and KPMG, endorsed the five principles set forth by the Center for Audit Quality in its letter to the Board, while Deloitte and PricewaterhouseCoopers set forth separate but similar principles. The Big Four also see a key role for audit committees in auditor reporting on the financial statements.
While recognizing the clear calls for improvements to auditor reporting, E&Y said that the auditor’s report is just one element in the suite of information provided to users of the financial statements. Broadly, E&Y believes that it is important to consider changes to the auditor reporting model in the context of other initiatives aimed at enhancing overall corporate financial reporting. Attempts to address concerns with corporate financial reporting solely through changes in the auditor’s reporting model will not be successful, cautioned E&Y, and could result in significant change to or expansion of the auditor’s role, which would be neither appropriate nor cost-effective.
Ernst & Young also endorsed the five principles for audit report reform set out in an earlier letter to the PCAOB from the Center for Audit Quality and urged the Board to evaluate any proposed changes to the auditor reporting model against each of them. First, auditors should not be the original source of disclosure about the issuer-company, rather, management’s responsibility should be preserved in this regard. This principle is based on the belief that a substantive shift in responsibility from the auditor attesting to information prepared by management to the auditor providing original information about the company being audited could result in unintended consequences that are not in the best interest of investors.
Second, any changes to the reporting model need to enhance, or at least maintain, audit quality; and third, any changes to the reporting model should narrow, or at least not expand, the expectations gap.
Fourth, any changes to the reporting model should add value and not create investor misunderstanding. Specifically, said E&Y, any revisions should not require investors to sort through dueling information provided by management, the audit committee and independent auditors.
The fifth principle to guide reform is that auditor reporting should focus on the objective rather than the subjective. Financial reporting matters assessed by an auditor can be highly subjective; noted E&Y, however, it is important that auditor commentary communicated in a widely distributed report provide objective information about such matters. Requests for an auditor’s subjective views or impressions on financial reporting matters cannot be effectively communicated and understood without the existence of an appropriate two-way discussion protocol. Without such dialogue, said the firm, the communication of subjective views and impressions could lead to a misunderstanding and harmful consequences.
KPMG also endorses the CAQ principles and, in accordance with those principles, believes that the existing relationship between the auditor, audit committee and management is appropriate and should be retained, and that management should continue to be the original source of information about the company’s financial position, results of operations and cash flows and related disclosure. Moreover, KPMG emphasized that the audit committee is in the best position to provide oversight of the auditor’s risk assessment and audit response relative to the most significant matters affecting the financial statements and the audit.
While the performance of audit procedures enables an independent auditor to attest to the fair presentation of a company’s financial statements, reasoned KPMG, management, being tasked with supervising the company’s daily operations, is in a superior position to provide enhanced disclosures of operations and is responsible for such information. For its part, continued KPMG, the independent auditor is best positioned to add value to investors by providing assurance about the completeness and reliability of the information provided by management, and such assurance would provide a basis for increased confidence in the information
In its comment letter, PwC evaluated the alternatives for additional auditor reporting in the Concept Release against four overarching principles. The firm described the principles as useful guideposts to identifying constructive changes and avoiding changes that may not accomplish the stated objective in the Concept Release of increasing auditor transparency and relevance, while not compromising audit quality.
According to PwC, the first principle is that changes made to auditor reporting should maintain or improve audit quality, which is paramount and could be negatively affected if a proposed solution inadvertently reduced the auditor’s ability to obtain sufficient audit evidence, enhance the value of the audit to users so that users see substantive value from the changes and increase the reliability of information the company provides in public reports. Providing assurance on information that previously was not subject to audit assurance directly affects its reliability. A corollary of the first principle is that, to be sustainable, the incremental benefits of the additional information should exceed the costs involved.
The second principle is that changes should maintain or enhance the effectiveness of the relationships and interactions of auditors, audit committees and management in the financial reporting process. The audit model depends on effective communication among the participants in the financial reporting process, noted PwC, and professional skepticism and challenge are key elements of an audit. Audit effectiveness also depends on the ability of the auditor to have effective communication with and obtain information from management and audit committees. The impact of the proposed solutions on the interrelationships among auditors, audit committees and management needs to be considered so that they do not have a negative impact on audit quality by impeding these important interactions.
According to PwC, the third principle is that auditor reporting should be sufficiently comparable. Any move away from a completely standardized report and opinion will inevitably introduce some variation, said PwC. Financial reporting and auditing also require significant exercise of professional judgment. Any solutions proposed must result in information that can further contribute to market confidence in audited financial statements. In PwC’s view, auditor reporting on information that is subjective or variable such that two auditors given the same fact pattern and information could come to different conclusions and issue substantively different reports will not meet this criterion.
The fourth PwC principle, similar to the first CAQ principle, is that auditor reporting can provide greater insight based on the audit but the auditor should not be an original source of factual data or information about the company. Factual data or information about the company should be reported by the company, emphasized PwC, in order to avoid blurring the responsibilities of auditors, management and audit committees. This is also important to avoid confusion and market disruption by providing competing views of the true underlying picture of the company's financial performance.
In its comment letter, Deloitte said that, similar to CAQ, the firm supports detailed recommendations for clarifying what an audit is and how it is performed. There is a need to provide additional standard information on what an audit is, including an explanation of technical terms such as reasonable assurance, materiality and material misstatement. This standardized wording should include an explicit statement that the footnotes are an integral part of the financial statements that are covered by the audit report.
Also, the auditor’s responsibility should be clarified by adding descriptions of the
auditor’s responsibility with respect to other information in documents containing audited financial statements. Deloitte believes that some users of financial statements place undue reliance on other information in documents containing the audited financial statements because they are of the belief that, because such information is included with the financial statements, it has been audited.
Similarly, Deloitte said that it is important to clarify the role of professional judgment within an audit, to inform users that procedures selected and performed go beyond simple adherence to a checklist, and may vary from audit to audit. In addition, there should be an expanded discussion on the responsibilities of management and the audit committee for financial statements and the Form 10-K.