Standard to expand audit report likely to be finalized in December

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

“There is a reasonable expectation that we will accomplish this before the end of the year,” PCAOB Chairman James Doty said in a brief interview on Oct. 27, 2016, at the PCAOB’s Investor Advisory Group (IAG) meeting in Washington.

Several other officials also acknowledged that the board is in a good position to complete the project in December.

If the rule is adopted, it would represent a major change in the content of the auditor’s report and would require auditors to provide more information about what they did in scrutinizing a public company’s financial statements.

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.

The final standard will be based on the proposed 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. The release 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 board’s effort to finish the long-running project in December, there is still uncertainty about whether the SEC, which has oversight of the PCAOB, will be able to sign off on the rules in December. The commissioners have to vote on all major decisions that the board makes, including its standards and budget.

The SEC has not had a full complement of commissioners since Daniel Gallagher left in October 2015 and Luis Aguilar left in December 2015. Democrats on the Senate Banking Committee have also put a hold on two nominees — Lisa Fairfax and Hester Peirce — over concerns about how they would vote on a corporate political spending disclosure requirement. Shortly after the presidential election in November, SEC Chair Mary Jo White is likely to leave the agency, which would leave only two commissioners, Kara Stein and Michael Piwowar, whose votes are uncertain.

Moreover, the PCAOB still needs to work out a minor but controversial provision in Release No. 2016-003 that requires auditors to disclose in the audit report the number of years they have worked for a client. Currently, PCAOB members are split on the issue.

The tenure requirement has been 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. 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.

Some investors want the information because they believe a long tenure leads to too close of a relationship between auditors and their clients and chips away at an auditor’s skepticism and independence. Investors say putting the information on the auditor’s report would ensure it is put in a consistent location for all companies and reduce search costs and emphasized that the auditor’s report is the primary means by which auditors communicate with investors.

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.

Chairman Doty said he would not speculate “what’s likely or apt to go out” in the final rules. But he emphasized he supports “retaining in the standard. I just think it’s the right thing to do.”

Board members Jay Hanson and Jeanette Franzel have been public about their opposition to putting tenure on the auditor’s report.

Board member Steve Harris backs putting the information on the auditor’s report, but it is less clear where member Lewis Ferguson stands on the issue.

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