Standard to expand audit report may be finalized by year end

After several years of effort, the PCAOB appears close to finishing a project to expand the auditor’s report and make it more useful for investors.

The PCAOB wants to adopt rules requiring auditors to provide more information about what they found while scrutinizing a public company’s financial statements in the fourth quarter of 2016, according to the latest update to the board’s standard-setting agenda, published on October 3.

The board released a proposed version of the requirements in May in Release No. 2016-003, Proposed Auditing Standard—the Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion and Related Amendments to PCAOB Standards. Comments were due August 15.

Release No. 2016-003 is a revised version of Release No. 2013-005, Proposed Auditing Standards on the Auditor's Report and the Auditor's Responsibilities Regarding Other Information and Related Amendments, issued in August 2013. It called upon auditors to disclose the critical audit matters (CAMs) from an audit, which are defined as the issues they found the most challenging and complex. The comment letters in response to the 2013 proposal from auditors and companies called the proposed CAMs too broad and said they would cause auditors to overstep their role and reveal information that a client’s management has not disclosed.

In response, Release No. 2016-003 limits the critical matters to issues arising from the audit of the financial statements and shared with, or required to be communicated to, the client’s audit committee. The information would have to be considered material to investors.

Despite the latest timing provided by the board, it is not clear that the PCAOB will wrap up the project by the end of 2016. The board—even at this late stage—has to perform a delicate balancing act given disparate concerns expressed by investors, auditors and companies on the latest plans.

In comment letters, companies said they did not want the board to move ahead, while investors said the PCAOB conceded too much to companies and their auditors by limiting the disclosure requirements. Audit firms in the meantime said the board should further narrow the information they provide.

Notwithstanding, there may be a strong resolve within the PCAOB leadership to finish the project by December. In May, PCAOB Chairman James Doty said in a brief interview that the upcoming standard may not be perfect and may need revision. Still, he is eager to move forward with a completed standard. The project dates back to 2008 and a recommendation from the Treasury Department’s Advisory Committee on the Auditing Profession (ACAP). The panel wanted the PCAOB to consider changes to the auditor report to make it more useful to investors.

The current auditor’s report is a simple pass-fail model, and many investors said adding more information may be one of the most important things the board could do for them. Auditors know many details about a client's financial condition, but the reporting model that has been in place since the 1940s provides no opportunity for the auditors to offer any insight to investors. In the aftermath of the 2008 financial crisis, some regulators and investors observed that external auditors said nothing in their reports about companies that soon failed.

In June 2011, the PCAOB responded by issuing Concept Release No. 2011-003, Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements and Related Amendments to PCAOB Standards. Many investors said they prefer to see a supplement to the auditor’s report, often described as an auditor’s discussion and analysis (AD&A) and compared to the management's discussion and analysis (MD&A) section of SEC filings. But audit firms, companies, and members of company audit committees have resisted a broad expansion of the auditor's report. They are concerned about auditors openly discussing the financial statements and fear the conflicts that could arise. Auditors were also concerned about the amount of time it would take to address the information in the financial statements and their views on it, including negotiations with management and board audit committees.

In response to their concerns, the PCAOB issued Release No. 2013-005, which proposed only the communication of critical matters.

In the meantime, it is unclear if the PCAOB will require auditors to disclose the number of years they have worked for a client in the auditor’s report as proposed in Release No. 2013-005 and Release No. 2016-003.

The tenure requirement is controversial because companies and auditors argue that putting tenure on the auditor’s report could give the false impression that there is a link between tenure and audit quality. In their view there is no evidence to support that argument. Some investors want the information because they believe a long tenure leads to a too close a relationship between auditors and their clients and chips away at an auditor’s skepticism and independence. Audit firms and their clients, however, believe a long relationship means auditors understand the company’s transactions better in an increasingly complex business environment. The time needed to understand a new client’s business underscores the value of a long auditor-client relationship, they said.

As a compromise, companies and audit firms said the board could put the firm’s tenure on a separate form, called Form AP, which is primarily used for the disclosure of the lead partner and the other firms that took part in a client audit.

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