August 2011
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The Audit Reporting Process
The standard audit report was adopted during the 1940s to provide uniform language in an effort to ensure comparability and consistency. Since then, little has been done to address the inadequacies of this cookie-cutter approach for auditors' communication with users of this report, despite the growing complexities in the financial and business environments today.
Because many CPA Journal readers have heard the hype before regarding expected changes to the audit report, only to be disappointed, skepticism is understandable. This time, however, may be different. As a new PCAOB concept release notes, “Though the auditor's reporting model has been studied by many groups that have provided recommendations over time, they were not in a position to effect change as they did not have standards-setting authority.” The PCAOB has an opportunity to oversee real, fundamental changes that could help to protect investors' interests—and now that opportunity is knocking, let's answer the door.
Possibilities
On June 21, the board issued PCAOB Release 2011-003, “Concept Release on Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements” (pcaobus.org/Rules/Rulemaking/Docket034/Concept_Release.pdf). Some of the possible changes suggested in the concept release include the following:
Auditor's discussion and analysis,
Required and expanded use of emphasis paragraphs,
Auditor assurance on other information outside the financial statements, and
Clarification of language in the standard auditor's report.
The document makes clear that these are just some of the possibilities under consideration. Perhaps they also can tackle the timeless question of how auditors can truly represent investors' interests when the company being audited (the “client”) hires, fires, and pays the auditor. Even though SOX shifted hiring and oversight responsibilities to the audit committee, in practice, the auditors depend on the support of management to recommend their continued engagement. Does anyone else sense an inherent conflict of interest here? Yet there is still resistance to the idea of inserting a third-party intermediary between the auditor and the auditee. There isn't an easy answer—but that doesn't justify ignoring this key issue. After all, it goes to the heart of auditor independence, which is a main premise of the Code of Professional Conduct of both the AICPA and the NYSSCPA. Simply stated, it requires that the CPA must be independent “in fact” and “in appearance” from the client when providing auditing or other attestation services. The time has come again to have a dialogue about “who” engages the auditor. Appropriately structuring the relationships among the involved parties is critical to improving the credibility of the audit.
In an effort to reduce liability, auditors have devoted much time and resources to limiting their responsibility, particularly in the area of detecting financial statement fraud. This has simply opened the audit process to questions regarding its relevance. But in the current “pass/fail” audit report model, auditors don't have the breadth of options they need to adequately assess the risk of material misstatement in the financial statements. A pass/fail system generally promotes mediocrity and increases the risk related to marginal passing grades. A more detailed ranking of the auditee's operational environment and controls could help to better identify risks and alert investors and others of potential problems. The audit profession can take a page from a growing trend in academe on this matter and expand the choices to include the following: excellent, pass, low pass, and fail.
Share Your Ideas
There is no doubt that communication between the auditor and users of the audit report leaves room for improvement. Enhancements to the integrity, clarity, and comprehensiveness of the auditors' work and communications thereof are long overdue. CPAs have a historic opportunity to participate in this important discussion and help the PCAOB shape the audit reporting process of the future.
Those interested in submitting comments to the board on this concept release should send them in writing to the Office of the Secretary, PCAOB, 1666 K Street, N.W., Washington, DC 20006-2803, or by e-mail to comments@pcaobus.org or through the board's website at www.pcaobus.org by 5:00 p.m. EDT on September 30, 2011. Refer to PCAOB Rulemaking Docket Matter 34.
As always, I welcome your comments, and, in this case, so does the PCAOB.