Robust Auditor Reports Lure Investors: PCAOB Audit Chief

But CFOs have felt that auditor reports shouldn’t say more than that their companies’ financials were reported fairly.
David KatzDecember 12, 2013

While CFOs have opposed proposals to make auditor reports more than pass-fail check-offs of company financials, adding information to the report could attract capital markets investment, the chief auditor of the Public Company Accounting Oversight Board contends.

Speaking at the eighth annual auditing conference held by the Zicklin School of Business and Baruch College, Martin Baumann, the chief auditor of the PCAOB, said that two new board proposals to expand the auditor’s report could lead to improvements in financial reporting that investors have been seeking. “I think both those standards will have a benefit to financial reporting quality and to capital formation overall,” he said.

Yet by and large, the attitude of financial preparers toward adding more information to the auditor’s report has been that “we should be talking about the financial statements and auditors should simply say whether they are presented fairly or not,” according to Baumann.

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Among finance chiefs who commented on the idea prior to the PCAOB’s issuance of its August 13 proposal to amplify the auditor’s report, Carol Tomé, CFO of Home Depot, seems fairly typical. She wrote, for example, that management, “with the oversight and input from the audit committee, is in the best position to determine whether our financial disclosures are complete, accurate and provide our investor community with appropriate insight into our business.”

In contrast, the company’s auditor “is not well suited to independently report information about the company beyond what is required to be disclosed by management under GAAP and [Securities and Exchange Commission] regulations,” Tomé wrote.

While the proposed standard would retain the pass-fail model in the auditor’s report, it would mark the first substantial changes to the report since the 1940s, according to Baumann — changes that could provide a view of an auditor’s state of mind as he or she assesses whether a client’s financials have been represented fairly. (The comment period on the proposal ended Dec. 11, and Baumann said that the PCAOB would hold roundtable discussions on the comments, “probably at the end of the first quarter of 2014.”)

In one of the more prominent changes, the PCAOB proposed that the auditor’s report detail “critical audit matters [CAM] as determined by the auditor.” Such matters would be the ones “the auditor addressed during the audit of the financial statements that involved the most difficult, subjective, or complex auditor judgments or posed the most difficulty to the auditor in obtaining sufficient appropriate audit evidence or forming an opinion on the financial statements.” If the auditor found no critical matter, he or she would have to state that in the report.

The proposed additions also would include “new elements” related to auditor independence and auditor tenure and “enhancements to existing language in the auditor’s report related to the auditor’s responsibilities for fraud and notes to the financial statements.”

In tandem with the proposed standard on the auditor’s report, the PCAOB issued a proposed “other information” standard. That standard would require the auditor to describe in the audit report the scope of what’s revealed in the “other information” section of the client’s 10-K as well as the procedures the auditor is required to perform relative to that information. The information could appear in the Management’s Discussion and Analysis or elsewhere in annual reports outside of the actual financials.

The procedures include what the auditor does when he or she “identifies a material inconsistency between the other information and the audited financial statements, a material misstatement of fact, or both.”

If an auditor finds such a misstatement, for instance, she or he would have to tell management that “you’ll have to change that information or we’ll have to modify our audit report to say there was a material misstatement of fact,” said Baumann.

The changes have been mainly advocated by investor groups. The American Institute of Certified Public Accountants has proposed its own, mostly similar, changes to the audit report. Yet it’s not just in the United States where there’s been a call for change, Baumann said, adding that “it’s really a global issue.”

In the United Kingdom, he noted, the auditor’s report has been changed to include such things as how the auditor assesses whether an issue is material; the significant risks identified by the auditor; and the scope of locations visited by the auditor. “So there really is a global call to change the auditor’s report. It’s about time we do something in this area,” he contended.

Baumann said that under the proposal, auditors wouldn’t have to do anything new other than to communicate existing information. Such matters were most likely ones auditors will have dealt with in the course of the audit. “They’re most certainly matters that were communicated to the audit committee,” he said.

In response to a question from the floor by CFO, conference panelists said that while an amplified audit report could make finance chiefs more careful about their companies’ financial reporting, it could add some confusion about how to interpret the financials as well.

An effect of the increased disclosures in the audit report “may be that management thinks more carefully about disclosures they’ve already made, and perhaps enhances disclosures they’ve made as a result of the auditor’s highlighting a particular area,” said Brian Croteau, a deputy chief accountant at the SEC.

Yet too much information in some cases may not be a good thing. “Certainly you can envision at least some auditors taking an approach of trying to draft language in an auditor’s report that could … make it more difficult to understand something,” said Croteau.

Similarly, Bruce Webb, a partner at McGladrey & Pullen and chairman of the AICPA’s auditing standards board, said the presence of CAMs in audit reports “may cause management to think more about the quality and the robustness of their processes and controls.”

But Webb also worries that the new audit-report standard might provide excessive — and perhaps therefore misleading — assurance to investors on a particular metric. “I don’t want them to think that the auditor is giving more assurance on a particular critical audit matter than on the financial statements as a whole,” he said.