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A Fresh Look at the Auditor’s Report and Proposed Standards

Maria L. Murphy, CPA

On August 13, the PCAOB released proposed standards on the auditor’s report on audited financial statements and on the auditor’s responsibilities for information outside of the financial statements. Not unexpectedly, there has been much debate and discussion about whether the proposed new report formats are the right answer—and whether there is really any need to change the existing formats, which have been in use for more than 70 years.

Is This the Right Answer?

The goal of the proposals is to improve the current reporting model and address concerns that the current audit report does not contain information specific to the particular audit and does not provide insights from the auditors about areas of audit difficulty or judgments they needed to make. Auditors would be required to add new communications about their assessment of critical audit matters, their independence from and tenure with audit clients, their evaluation of and responsibility for information outside of the financial statements, and their responsibility for fraud.

Proponents, including regulators, standards setters, investor groups, and many audit firms, say that the proposals will communicate more specific information about the audit and the auditor’s relationship with the client. Auditors who favor the proposals believe they provide an opportunity to publicly disclose difficult and complex audit matters that today are only discussed privately with audit committees. Investor confidence might increase with these additional insights. Although there might be some need to adjust audit processes and to publicly communicate items that are already reported to audit committees, there should not be significant additional audit work overall.

Opponents believe there will be more exposure to litigation, particularly if auditors do not correctly select the “critical audit matters” and are second-guessed if something goes wrong at a company in the future. They also believe there will be expanded audit procedures and that reporting on additional information will be time consuming and costly. Presenting additional information could actually confuse users and create a bigger expectations gap about the purpose of an audit than exists today. Many audit firms are not set up for creative writing exercises that could be difficult to manage and review. In addition, many oppose the new disclosure of audit tenure because it has not been demonstrated to correlate with audit quality.

What is to be gained from the proposals is a move away from boilerplate reports that many do not even read. The standard audit report includes a statement that the financials are “fairly stated” in accordance with GAAP (with all its complexities), and possibly also that internal controls are “effective.” That statement is based on the fundamental concept of “materiality,” which is a threshold that varies from company to company and from period to period and is never disclosed in financial statements. It also includes a statement that the auditors performed their procedures using GAAS, which the average financial statement user is unfamiliar with.

Considering Other Options

Most “clean opinions” today are multi-paragraph “pass” reports that do not provide details about the quality of financial reporting, the integrity or financial reporting capabilities of the company’s management, or the significant risks that the company faced in the past fiscal period— and certainly not any forecast of what is to come. Management provides assessments of critical accounting matters and of risks and uncertainties in limited financial statement disclosures, and they are not necessarily the areas of most difficulty for the auditors.

The challenges are these: will auditors be able to communicate whether management’s judgments are appropriate, and can they report contentious audit matters for a client that is paying their bills? There is also the question of whether auditors have the expertise to express opinions about the company’s prospects or risks.

The best answer, in my view, would be a report more tailored to the company being audited. This could include critical risk areas, but management should provide these as the source of information about the company; auditors would then provide their attestation/agreement with management’s assessment. It would not require a laundry list of individual audit issues that were resolved through the audit process and have no bearing on the company’s financial statements overall. The revised standards should provide auditors with report templates or frameworks that would provide some consistency between companies and guidance on which matters to emphasize. That way, auditors’ report writing will not take longer than performing the audit, and users will be better able to understand the reports. Auditors should have more responsibility for the consistency of other information provided to investors (selected data, non-GAAP information, management’s discussion and analysis) than they do today, when all they must do is “read” and “consider” it.

The PCAOB is seeking feedback on the proposals and practical implementation issues, and the comment period ends on December 11, 2013. I hope that the cry for “more transparent information” does not result in auditors being put in an untenable position with their clients. I also hope that the discussion will result in final standards that improve visibility by giving users better information—and that auditors rise to the challenge of sharing what they have learned about the companies they audit through higher-quality audit reports.

The opinions expressed here are my own and do not reflect those of the NYSSCPA, its management, or its staff.

Maria L. Murphy, CPA. Editor-in-Chief. Assistant Manager of Peer Review.

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