Audit, Compliance and Risk Blog

This is the second of a two-part discussion on the August 13, 2013, the Public Company Accounting Oversight Board (PCAOB) proposal that would result in two new auditing standards. In the first article, I discussed the proposed concept of “critical audit matters” or CAMs. In this article, I discuss the proposed requirements to disclose how long the auditor has been auditing the company and to provide some assurance on “other information” that a registrant must file in an annual filing with the Securities and Exchange Commission (SEC). I conclude this article with some summary thoughts.

Auditor Tenure

The PCAOB is proposing that the auditor be required to state, in its audit opinion, how long it has been the auditor for the company. Some would argue that the longer this time frame, the greater the likelihood that an auditor might be complacent or “too close to management” to be independent. The flip side of this argument is that the longer an auditor has been auditing a company, the better the firm understands the business and related risks and therefore performs a better audit. Each argument has its merits.

As proposed, the new standard would require the audit firm to state in its audit opinion how long it has been engaged by the company to perform the independent audit function. This would add at least another paragraph to the standard audit report. One might argue that the PCAOB is proposing this “tenure disclosure” to provide investors with information that may give this important stakeholder group the desire to push the PCAOB to require mandatory audit firm rotation—a requirement adopted in certain jurisdictions outside the United States. Previously, the PCAOB issued a “concept release” dated August 16, 2011, that discussed the rotation concept and sought feedback on the idea. Concept releases are short of a proposed rule. This release triggered nearly 700 comment letters, many of which, particularly those submitted by audit firms, were not at all supportive of mandatory auditor rotation.

By itself, the requirement to make this disclosure in the audit report will not likely be controversial because such information can be typically found in other SEC filings. All it does it highlight the matter.

Information Outside the Financial Statements

The PCAOB is also proposing new requirements for auditors relating to information outside the basic financial statements. This part of the proposal would cover only annual reports filed with the SEC, for example, those filed on Form 10-K, Form 20-F, etc. It would not cover interim reports. The PCAOB has identified the following sections of a registrant’s annual report subject to proposed requirements:

• Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)

• Risk Factors

• Selected Financial Data

• Certain Relationships and Related Transactions

• Director Independence 

• Exhibits

The auditor would be required to perform and report on certain procedures concerning this “other information.” Such procedures would be based on the audit evidence obtained and the auditor’s conclusions reached during the audit. The auditor would consider whether such other information contains any material inconsistencies with amounts or disclosures in the financial statements, or the manner in which data is presented. The auditor would be required to state in its audit opinion the results on such procedures—adding yet another paragraph or so to the growing auditor’s report.

This portion of the PCAOB proposal should be much less controversial than the proposed requirement to add the CAMs to the audit report. Why? Most audit firms already perform this effort even if not technically required (although they are required to “read and consider” such information), as the firm does not want to be associated with erroneous or misleading data elsewhere in a registrant filing. However, auditors will likely spend more time performing these tasks since they will be required to actually document their work in the audit report.

Summary Thoughts

A likely unstated goal of the PCAOB was to get financial statement users to read the auditors’ report. This proposal, if adopted as is, would probably achieve that goal. The PCAOB proposal is now subject to constituent feedback—effectively, the required due process the PCAOB must adhere to before issuing any new rules. The PCAOB is seeking comments through December 11, 2013. Upon completion of the exposure period, the PCAOB staff will consider the comments submitted and then work with the five voting PCAOB board members to finalize the proposed rule, start over, withdraw the proposal, or propose other “solutions” that give effect to comments received in the first release.

During the PCAOB board meeting to approve issuing the proposal held on August 13, 2013, there was fairly strong support for the proposed rule changes. In fact, the decision to issue the proposal was unanimous; however, one member thought it did not go far enough whereas one of two sitting CPAs on the board (the maximum permitted by the Sarbanes-Oxley Act of 2002), thought reproposing the rules after considering constituent comments was desirable.

It should be noted that once any new rules of the PCAOB are issued, they are not effective until approved by the SEC.

On a related matter, the PCAOB has a separate proposal outstanding. That proposal, issued on October 11, 2011, would require the independent auditor to disclose, among other matters, the name of the engagement partner in the auditor’s report. As of this writing, that proposal has not been finalized.

About the Author

Ron Pippin is an experienced CPA based in Wheaton, IL. His 40 plus year career includes being an audit partner in Arthur Andersen, a member of Andersen’s Professional Standards Group (“national office”) in Chicago, the Director of Financial Reporting for a Fortune 50 company and most recently, the editorial director of CCH’s Accounting Research Manager. Currently, Ron does independent writing and analysis together with accounting consultation on a variety of topics.