Wednesday, November 09, 2011

PCAOB Standing Advisory Group Views Auditor Independence as Core to Auditing of Financial Statements

The members of the PCAOB Standing Advisory Group view auditor independence as being at the heart of the outside audits of the financial statements of public companies. Mandatory audit rotation received a mixed reaction at the most recent SAG meeting, but professional auditor skepticism was almost uniformly viewed as critical by SAG members.

On August 16, 2011, the PCAOB issued a concept release to solicit public comment on ways that auditor independence, objectivity and professional skepticism can be enhanced, including through mandatory rotation of audit firms. Mandatory audit firm rotation would limit the number of consecutive years for which a registered public accounting firm could serve as the auditor of a public company.

Former SEC Chief Accountant Lynn Turner said that auditor independence is key to the financial statement audit process. If you do not have independence, you do not have an audit. The focus on auditor skepticism is exactly right, said Mr. Turner. Mike Gallagher of PricewaterhouseCoopers said that independence is at the core of what auditors do. It is crucial to credibility. He added that, since business dynamics are changing constantly, a process is needed to keep independence rules up with the business changes.

Scott Showalter, formerly of KPMG and currently a professor at North Carolina State University, called for clarified and streamlined auditor independence rules, and for simplicity, which he said would aid enforcement and improve independence. Gaylen Hansen, Ehrhardt Keefe Steiner & Hottman, advocated a codification of auditor independence rules. Currently, there are three sources of guidance on auditor independence, the SEC, PCAOB, and AIPCPA, he noted, and it should be codified so it is all in one place. Mr. Hansen also said that auditor skepticism should be developed, adding that it is intrinsically linked to the duties of the audit committee. Mr. Hansen served as a member of the U.S. Treasury Department's Advisory Committee on the Auditing Profession.

Professor Showalter said that audit committees have been backsliding since Sarbanes-Oxley; and he urged the PCAOB to use the bully pulpit that it has with audit committees. Echoing these concerns, Joseph Carcello, Professor at University of Tennessee, noted that the issue is a big one and that he has been informed that in half of the audits, the audit committee gets it and in half they do not. He also said that, while AS 5 discusses audit committees, how often do we see material weakness repots due to audit committees. Professor Carcello noted that audit committees are more engaged since the enactment of Sarbanes-Oxley, but still defer to company management too often. Mr. Turner noted that there is a growing consensus that CFOs are still driving the process of hiring auditors despite Sarbanes-Oxley.

Board Member Steve Harris agreed that auditor independence is the key to the audit, and that the importance of auditor independence has been confirmed by the US Supreme Court. Member Harris also noted that, while Sarbanes-Oxley bolstered auditor independence, Board inspections show that there is room for improvement. He mentioned that the PCAOB concept release discusses mandatory audit form rotation as a way to resist management pressure and bring a fresh look at the audit process.

Denny Beresford noted that he wrote a comment letter on the concept release from the perspective of an audit committee member. He believes that mandatory rotation would lessen quality and does not take the role of the audit committee into full consideration. He also said that the SEC’s definition of audit committee expert is deficient, and sets too low a standard. Professor Beresford urged the Board to require that inspection results be shared with the audit committee. He also disagreed that audit committees have been backsliding. Patricia Harvey, Vice President, Corporate Audit, Delta Air also urged that inspection reports be shared with the audit committee.

Professor Showalter said that the case has not been made for auditor rotation, but has been made for auditor skepticism. Lisa Lindsley, Director of Capital Strategies, AFSCME said that, while auditor rotation is not sufficient by itself, it could be a key component to independence. Gail Hanson, Chief Financial Officer, Aurora Health Care, said that audit rotation is potentially disruptive by taking one audit firm out of mix in a post-Sarbanes-Oxley environment where issuers employ different firms for some non-audit- related services.

John Archambault of Grant Thornton acknowledged that there are valid concerns around mandatory audit rotation. There is a question as to the extent to which auditor objectivity is affected by long-term engagement and when it is affected. Auditor rotation could be a viable component of protecting auditor objectivity, he said, but the rotation period cannot be too short or it would be extraordinarily disruptive. The Grant Thornton partner also said that flexibility should be built into the rotation process. For example, a company could be in the middle of a major acquisition. He supports a rational consideration of auditor rotation as one tool to achieve objectivity. He also urged that the global impact of auditor rotation be considered in order to avoid inconsistency. Coordination globally is critical to any auditor rotation regime.

Former SEC Chief Accountant Lynn Turner sees auditor rotation as a reasonable step; and suggested ten years as a reasonable rotation period. He downplayed the depth of knowledge on audit as an impediment to auditor rotation, noting that we had depth of audit knowledge on Enron. Mr. Turner observed that thousands of companies have changed auditors in the last decade, and that restatements actually dropped.

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