Audit Reports Could Face Biggest Shake-Up Yet

A new proposal by the PCAOB could bring sweeping changes to audit reports and what auditors sign off on.
Kathy HoffelderAugust 13, 2013

Audit reports could face a transformation not seen in more than 70 years, if a new proposal by the Public Company Accounting Oversight Board to include more “critical audit matters” in them gets passed.

The move is controversial, since corporate executives are often at odds over how much information needs to be disclosed in their financial statements, while regulators and accounting overseers have called for enhanced transparency for the benefit of investors.

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Until now, a typical audit report included a couple of paragraphs or boilerplate rundown of whether a firm received a passing or failing grade; in other words, if the company could continue as a going concern. But the PCAOB is looking to change that.

Though it will still keep the pass/fail audit test, the PCAOB is looking for a longer report that will also require auditors to communicate critical matters as determined by the auditor. This includes explaining the quantitative significance, if any, of corrected misstatements that may have to be made as well as referring to the specific financial statements and disclosures that relate to a critical audit matter.

The report also calls on auditors to evaluate other material information pertinent to a company to evaluate if there is a material misstatement of fact or if there is a material inconsistency in the audited financial statements.

Those specific responsibilities are needed, according to Martin F. Baumann, chief auditor and director of professional standards at the PCAOB, to give what he calls “comfort” to investors. “An auditor will have to think twice when it states, ‘as part of our evaluation we did not identify any material inconsistencies with the financial statements, material misstatements of fact, or both,’” he said on a press call Tuesday. Many investors, he said, were not aware of auditors’ responsibilities in these areas. 

Chairman James R. DotySimilarly, PCAOB chairman James R. Doty described the proposal as a “watershed” event but one that is not without its critics. “It’s important to know how the water runs downhill after the watershed,” he said.

Corporate issuers are concerned about potential increases in cost from having more disclosure under the new proposal, but Doty notes that the cost or even the liability concerns that auditors may have should not hold back the progress of enhancing audit reports.  

“Audit firms and a number of issuers think something like this is overdue,” he said. “I think this is more than a promising start. This is a highly disciplined, highly rigorous, economically analyzed and justified proposal for change.”   

The PCAOB, for its part, is listening to concerns expressed after the 2011 launch of the original concept release. For example, in today’s open meeting Jeanette M. Franzel, PCAOB board member, said that after extensive outreach the board has not found any direct impact from audit tenure on audit quality, which is part of its new disclosure requirements. Franzel asked, “Does this disclosure belong in the auditor report or should it be disclosed by the audit committee, or just be disclosed publicly?”

The board also heeded concerns about requiring an auditor “discussion and analysis” section as originally planned. That requirement also was left out of Tuesday’s proposal. As Cindy Fornelli, executive director at the Center for Audit Quality, noted, “Auditors should not be the original source of information about an entity; management’s responsibility should be preserved in this regard.” 

Regardless of which audit report requirements make it into the final standard, one thing is clear — a global movement to improve audit quality is afoot. The International Auditing and Assurance Standards Board (IAASB), for one, proposed a set of similar standards in July.

In its proposal, the IAASB is calling for auditors to include specific statements about a company’s ability to continue as a going concern; to make explicit comments about the auditor’s independence; and, in the case of listed companies, to disclose the name of the engagement partner. 

“The quality of audits and the perception of quality audit reporting are very much linked,” says Professor Arnold Schilder, chairman of IAASB. “Users really would like additional reporting by the auditor about the audits performed and about the audited entity.”

Comments are due on the IAASB’s exposure draft by November 22, 2013, and on the PCAOB’s proposal by December 11, 2013. The PCAOB plans on holding a public roundtable in 2014.