Accounting & Compliance Alert:  Compromise May Be Hard to Find on Auditor's Report
November 19, 2012

Summary: The PCAOB is planning to write a proposal to satisfy investor demand for more useful information in auditor reports. But auditors are resisting giving out more information. Some investors are telling the board that a final standard that doesn't produce real changes will be deemed a failure.

The PCAOB has a difficult job ahead in writing a proposal that satisfies investor demands for more useful information in auditor reports and auditors’ reluctance to give them the information.

The board plans to issue a proposal in the first half of 2013.

The PCAOB “really runs the risk of having this project viewed as abject failure in the investor community,” said Joseph Carcello, a professor of accounting at the University of Tennessee, as he warned the board against writing a standard with only limited changes.

Carcello debated the expansion of the auditor report during a November 16, 2012, meeting of the PCAOB’s Standing Advisory Group.

In June 2011, the board issued 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 view the pass-fail model in regulatory filings as inadequate because it doesn't require auditors to divulge information about a client's financial condition. Some investors are pressing the board to demand more information from auditors.

Some board members would like to seek a compromise between the opposing views of investors and auditors. But satisfying both camps won't be easy.

A broad consensus of investors wanted the auditor’s report to provide a real discussion from the auditor's perspective, Carcello said.

“If at the end of the day, if investors don’t know more about risks, if they don’t know more about judgments and estimates, and if they don’t know more about unusual transactions, there is going to be a significant percentage in investor community that’s going to say you have failed,” Carcello said.

Jeff Mahoney, general counsel of the Council of Institutional Investors, agreed. He said investors want auditors to provide more information.

“If you move forward, if you are just pointing to other footnotes and not providing auditor insights…I think there is a question as to what is the benefit of this change that you are making in the auditor’s report,” he said.

The investors want auditors to discuss the client's finances in some detail and employ a report similar to the management discussion and analysis section in SEC filings, which could be called the auditor discussion and analysis. The statement would provide an auditor’s views regarding significant issues facing the client and issues that arose during the review of the client's financial reports.

The report could include an auditor’s views on the company’s financial statements, such as management’s judgments and estimates, accounting policies, and difficult or contentious issues.

In general, companies and auditors prefer leaving the auditor report alone. They're willing to lengthen the report's emphasis paragraph to highlight significant matters and cite where in the financial statements the issues are disclosed.

Michael Gallagher, assurance partner with PricewaterhouseCoopers LLP, said auditors shouldn't have to provide the lengthy discussion some investors want. But he said the expanded emphasis paragraph could serve as a roadmap for providing additional information.

Martin Baumann, the PCAOB’s chief auditor, said there seemed to be some support among SAG members in using the emphasis matters paragraphs. But there was little enthusiasm for a limited expansion of the report.

There is “desire for some commentary as to why that matter was emphasized,” Baumann said.

Baumann asked what the standard would need to be considered successful.

The “important thing is there needs to be new information… either from management or from the auditor,” Carcello said.

In the meantime, the PCAOB has floated the idea of using the information relayed to directors under Auditing Standard (AS 16) No. 16, Communications with Audit Committees, and reporting it to investors in a company's regulatory filings. The PCAOB adopted AS 16 in August, and the standard requires the SEC’s approval before it becomes final.

Much of the extra information that investors want is covered by the information exchanged between auditors and directors under AS 16. The PCAOB wanted to know if some of the information company directors receive should also be relayed to investors.

Baumann said SAG members felt that the emphasis matters shouldn't be tied to AS 16 specifically. But the material that's emphasized should involve accounting issues that often draw investor scrutiny, such as unusual transactions, related party transactions, complex accounting, and financial reporting decisions that require significant judgment.

“They are matters that are discussed with the audit committee,” he said. “There may be some tonal aspect that says don’t use AS 16 necessarily as a checklist for this. But the types of things that you would discuss with audit committees are likely to be the types of things you emphasize.”

© 2012 Thomson Reuters/RIA