Thursday, December 06, 2012

PCAOB Chair Examines Audit Committee Role and Economic Analysis in Audit Standard Setting

In an effort to increase the credibility and transparency of the outside audits of financial statements, noted PCAOB Chair James Doty, the Board will deepen its inspection analysis and improve its reporting for inspections and remediations.  In remarks at an AICPA seminar, the PCAOB Chair also said that he anticipates more summary reports on insights from inspections, on more topics. He noted that these reports will be prepared with an eye on getting useful information to audit committees, which builds on the Board release issued in August on how audit committees can learn more from the results and implications of the PCAOB's inspection findings. The Chair expects that audit committees, armed with more and better information, should be in a better position to champion audit quality.
PCAOB outreach to audit committees is an important component, emphasized Chairman Doty, adding that outreach to and interaction with audit committees is one of the Board’s near-term priorities. He believes that outreach and interaction should help audit committees promote audit quality.
Audit committees have a role in fostering not just integrity in management's reporting, emphasized the Chair, but the vitality and viability of the independent audit. In his experience, when an audit committee meets with internal audit or compliance staff, the first question they ask is, "do you have enough resources?" This is a question that all audit committees should also ask of the external auditor, he said,  and the good ones do. The audit is the linchpin of the investing public's confidence in the company; he emphasized, not something to be procured from the lowest cost supplier.
With regard to the Board’s standard setting, the Chair said that auditing standards should reflect a contemporary review of the challenges that auditors face, which the Board can see through its inspections. At the same time, the standards must be sufficiently clear and concrete to be enforceable fairly, for enforcing them is an important element of what the Board does.
The Board should also take good ideas from wherever else they come. For example, the International Auditing and Assurance Standards Board is moving forward with its paper on using the auditor's reporting model to communicate useful information from the audit to investors. PCAOB staff and Board members have had numerous discussions with the IAASB, noted Chairman Doty, and the PCAOB’s project on the Auditor's Reporting Model has benefitted greatly from this interaction. But he added that there is no presumption for simply adopting, off-the-shelf, other standards-setters' work in order to trade out an interim standard expeditiously.
Above all, emphasis should be placed on identifying and reacting appropriately to risk, and on establishing counterweights to circumstances that could detract from the ultimate goal of obtaining a high level of assurance that the financial statements are free of material misstatement. This is why he believes that it is so important to reexamine how the Board protects the auditor's independence, including by considering term limits.
Finally, Chairman Doty noted that economic analysis can help in the review of the PCAOB's standards-setting framework by prompting critical questions, such as what is the problem and what are the alternatives, both to rulemaking and by rulemaking. More broadly, the analysis should ask what is the most cost-effective solution for society.
Indeed, continued the Chair, economic analysis may tell the Board that if audit quality can be improved through certain kinds of structural changes, such as by enhancing independence, introducing more transparency, or infusing the audit report with more insight, turning the auditor's focus more squarely toward communication with the investing public, the Board may be able to avoid the incremental cost of requiring additional audit procedures.
Economic analysis may also help the audit profession overcome market obstacles and realign incentives to promote sustainable excellence. Chairman Doty would like to see the audit profession compete on quality more than price. Audit standards that give audit committees and the public tools to distinguish on the basis of quality may help the audit profession get there.