Enhanced Auditor’s Report – Latest Developments

You may recall that last August (click here) the PCAOB proposed a new standard designed to enhance the independent auditor’s report by requiring:

  • the communication of “critical audit matters” as determined by the auditor,
  • enhanced language relating to the auditor’s responsibilities for fraud and notes to the financial statements, and
  • new elements of the auditor’s report relating to auditor independence and tenure and the auditor’s responsibility for, and the results of, its evaluation of certain information outside the financial statements.

A few weeks ago, the PCAOB announced two additions to its August proposal that are being called “transparency amendments.” The August proposal plus the December transparency amendments are intended to enhance the usefulness of the auditor’s report.

Disclosure of the engagement partner…

The first of the December transparency amendments would require disclosure of the name of the audit engagement partner. The PCAOB and SEC believe that investors will benefit from knowing the identity of the individual in order to better evaluate the quality of the audit. That evaluation might include such information as the types of audits the engagement partner has led (for example, small or large, manufacturing or financial), whether any of those audits have been restated for error or whether he or she has been subject to disciplinary proceedings or litigation. Although investors are unlikely to have direct access to such historical information themselves, the thought seems to be that third-party data providers will begin to collect and disseminate individual partner information, as they now do with audit firms.

In my opinion, this type of disclosure is relatively meaningless to investors, who generally care only about the reputation of the audit firm, rather than the particular engagement partner. The idea of investors researching the partner’s history and making investment decisions based on an evaluation of his or her skills or track record seems farfetched.

Disclosure of other accounting firms participating in the audit…

The second transparency amendment would require disclosure in the audit report of the names, locations and extent of participation (as a percentage of total audit hours) of other accounting firms that participate in the audit. Here, the idea is that some large audits (particularly for multi-national corporations) involve many audit firms, sometimes to a significant degree.

In contrast to the engagement partner disclosure, this could actually be helpful information, particularly where participating audit firms are outside the PCAOB’s review and supervision.

Timing…

While it is still early in the process and an enhanced audit report remains highly controversial, the concept appears to be gaining momentum due in part to similar developments in the European Union and by the International Auditing and Assurance Standards Board. The comment period for the August proposals ended on December 11, 2013, while the comment period for the December proposals ends February 3, 2014. Public meetings will be held in the spring, after which will no doubt follow more rounds of revisions and comment.

It is possible (maybe likely) that some modification of the audit report will occur down the road, though the extent and timing remain uncertain. As I said back in August, it’s enough for now for legal departments and non-financial personnel to:

  • know that the proposals are out there,
  • be conversant in the basics since there will be buzz in finance departments and audit committees, and
  • watch as the issue unfolds in 2014.