Will Audit Firms Go Public with Financial Results?

A Treasury advisory committee recommends that audit firms should file GAAP financial reports with the PCAOB.
Marie Leone and Tim ReasonSeptember 26, 2008

Privately-held audit firms could be reporting annual financial results under generally accepted accounting principles, and releasing those financial statements to the public, if the wishes of a Treasury Department advisory board are taken to heart. The Advisory Committee on the Auditing Profession, set up by Treasury Secretary Henry Paulson a year ago, approved its final report on Friday by a 14-to-1 vote.

The report, which includes about 30 recommendations separated into three topic areas, cited a controversial issued raised during deliberations regarding whether large audit firms should report their financial results using GAAP and then make those results public. Stopping short of a full recommendation, the advisory committee said it would leave that decision up to the Public Company Accounting Oversight Board, which regulates audit firms that have public companies as clients.

Big Four audit firms, and most smaller ones, are not public companies and do not have to comply with U.S. GAAP or report their financial results. While all of the Big Four firms do historically announce their annual revenues, they do so in part to try to establish bragging rights over their rivals, and they openly admit their numbers are pro forma and not GAAP-compliant.

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While the call to go public with financial statements was not one of the committee’s official recommendations, committee co-chairs Arthur Levitt and Donald Nicolaisen included an addendum to the report in which they “voice strong support” for the auditing profession to present audited financials to the public, Levitt told at a press conference following the vote. Levitt is a former Securities and Exchange Commission chairman and is now senior adviser at the Carlyle Group. Nicolaisen is a former chief accountant with the SEC and a senior adviser at Kroll Zolfo Cooper.

The single dissenting voice came from Lynn Turner, a former SEC chief accountant under Levitt. Turner said his dissent was rooted in the audit firm reporting issue, and that he believed that “in light of what is transpiring in the market today, and the critical role that audit firms play in the capital markets, audited financial statements should be made public.”

Turner continued that the final report contains many solid recommendations, but the committee members were asked to vote on the entire package rather than on each recommendation separately. Faced with that choice, he said, he voted down the entire final report.

Other committee members held similar opinions to Turner about the audit firm reporting issue, but elected to vote in favor of the package. For example, Gaylen Hansen, a partner with regional audit firm Ehrhardt Keefe Steiner & Hottman, said he too favors public disclosure and said if the recommendations were voted on separately, he too would have voted against leaving the issue in the hands of the PCAOB. “The goal is more transparency,” remarked Hansen.

Asked whether a separate vote on the auditor reporting question would have yielded a thumbs-down from her, Ann Yerger, executive director of the Council of Institutional Investors, noted that “the Council doesn’t have a policy either way on this issue. We are supportive. It was a consensus document. I really do commend the Treasury Department for establishing such a diverse panel, and I think the document reflects that diversity.”

Calls made seeking comment from the Big Four accounting firms — KPMG, Deloitte Touche Tohmatsu, PricewaterhouseCoopers, and Ernst & Young — were not immediately returned. However, earlier this year Deloitte was the first of the Big Four to announce its annual revenues, claiming $27.4 billion, the sixth-consecutive year the firm claimed its revenues had grown by a double-digit percentage.

In 2007 Deloitte, and all the other Big Four firms, did not release results until the fall. Ernst & Young reported 2007 revenues of $21.1 billion, KPMG announced revenues of $19.8 billion, and PwC reported revenues of $25.2 billion, with all three firms also boasting double-digit growth. Deloitte reported 2007 revenues of $23.1 billion.

At the press conference, Levitt said he expects that in “a very short time” at least one audit firm would be filing public financial results, and once that happens, “the others will follow.” Asked whether the recommendation to make audit firm results public was a controversial subject during the year-long process, Nicolaisen simply replied: “there was a lot of discussion.”

The recommendations were separated into three areas: audit firm structure and finances, concentration and competition, and human capital. The financing and structure subcommittee, headed by Robert Glauber, a director at Moody’s, XL Capital, and Quadra Realty Trust, also recommended the creation of a national center for the exchange of fraud prevention and detection ideas, procedures, and data. The center would coordinate efforts among audit firms and other market participants and be housed at the PCAOB. Further, the subcommittee called for granting what would amount to a national certified public accounting license, giving accountants licensed in one state mobility to practice in other states.

In addition, the subcommittee called for enhancements to disclosure requirements related to public company auditing changes, as well as improvements in the auditor’s standard reporting model that would include key accounting estimates and judgments. It also suggested that audit engagement partners should be mandated to sign the auditor’s report to improve accountability among firms.

The subcommittee on concentration and competition, led by Damon Silvers, associate general counsel at trade union AFL-CIO, urged more auditor liability protections. For example, the subcommittee recommended that the PCAOB monitor potential sources of catastrophic risk at audit firms — such as being named a defendant in a lawsuit related to a major corporate scandal — to prevent the collapse of a large firm. What’s more, it recommended that a plan be put in place for rehabilitating large “troubled” firms and keep them afloat while they reorganized. Such a plan, the report said, would require congressional action.

The centerpiece of the recommendations put forth by the subcommittee on human capital, which was headed by Gary John Previts, president of the American Accounting Association and an accounting professor at Case Western Reserve University, was an effort to bring more minorities into the auditing profession. The group proposed mentoring programs and recruitment at colleges that traditionally have a large African-American student enrollment.

In light of the SEC’s proposal to switch U.S. companies to international accounting standards, the subcommittee also recommended new accounting curricula, ensuring an adequate supply of qualified accounting faculty, and a “scholars and sabbatical” program to foster an exchange of ideas related to accounting education.