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Update on the current board issues: April 2014

April 2014
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BoardroomDirect®<br><span>Update on the current board issues: April 2014</span>

At a glance

The Public Company Accounting Oversight Board (PCAOB) has proposed standards and amendments setting out a new auditor’s reporting model and the auditor’s responsibility regarding other information. Earlier this month these were the focus of a two-day public meeting of the PCAOB in Washington, D.C.

Issue in focus

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Proposed changes to the auditor’s reporting model

The Public Company Accounting Oversight Board (PCAOB) has proposed standards and amendments setting out a new auditor’s reporting model and the auditor’s responsibility regarding other information. Earlier this month these were the focus of a two-day public meeting of the PCAOB in Washington, D.C. The meeting, which included directors, audit firms, investors, and other parties involved in the financial reporting process, focused on:

  • The proposed inclusion of critical audit matters in the auditor’s report;
  • The proposed changes to the auditors’ responsibility regarding “other information” outside the audited financial statements; and
  • International developments on the auditor’s report.

The proposed standards were released for comment August 2013. The comment period, which originally ended in December 2013, was reopened and now ends on May 2.

The proposed standard titled The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, and related amendments, would require the auditor to disclose additional information in the auditor’s report about the audit and the audit firm, including, among other matters, a discussion of critical audit matters specific to the audit. [For more information on this proposed standard, read PwC’s In brief: PCAOB proposes significant changes to the auditor’s report.]

The proposed standard titled The Auditor’s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor’s Report, and related amendments, would require the auditor to perform additional procedures with respect to other information, and to communicate certain information in the auditor’s report. [For more information on this proposed standard, read PwC’s In brief: PCAOB proposes new auditing standard on other information.]

“The proposed standards are intended to make the audit report more relevant to investors by establishing criteria and a framework for the auditor to provide deeper insights from the audit based on information the auditor already knows from the audit,” PCAOB Chair James Doty said at the public meeting.

He made sure to point out that while these proposed standards and amendments could result in major changes to the auditor’s report, the PCAOB will retain the pass/fail model of the opinion.

“By requiring and providing a framework to report critical audit matters, the proposed standards would keep the auditors in their area of expertise — the audit,” he said. “No one wants to return to the days before the pass/fail model was instituted, when auditors’ free-form writing could obscure disclaimers of assurance on financial statements.”

Critical audit matters

Joan Amble, a director for three public companies, told the PCAOB members that she had discussed the proposal to include critical audit matters in the auditor’s report with several audit committee members.

“Along with the vast majority of audit committee members with whom I have had the opportunity to discuss this matter . . ., I believe including Critical Audit Matters in the auditor’s report would lead only to much longer, but not more useful, reports by including information already adequately provided by management in footnotes or MD&A,” Amble said.

Mike Gallagher, Managing Partner, Assurance Quality at PwC, stressed to the PCAOB members that while the firm supports including critical audit matters in its report, it believes such matters should be limited to those that were material to the financial statements and resulted in the most significant interaction with the audit committee.

“We believe these changes, and the others we suggest in our comment letter, would add meaningful information to the audit report while not placing the auditor in the position of being the original source of information about the company,” Gallagher said. “It will also minimize the potential that including critical audit matters in the audit report will chill the dialogue between auditors and management, something which could have an adverse effect on audit quality.”

Peter Clapman, a director for Wi-Fi network provider iPass and former investor counsel for TIAA-CREF, also spoke at the PCAOB meeting and called the PCAOB’s critical audit matters proposal a modest change to the reporting system that should be embraced. He mentioned that while the current pass/fail system would be retained, it should not be to the exclusion of providing more information to investors.

“Often a company might ‘pass’ but only after the auditor had to reconcile serious questions in the audit process,” Clapman said in written testimony. “In my view, the fact that serious questions surfaced should be disclosed to investors.”

Other information

The crux of the issue regarding the inclusion of other information in the auditor’s report is whether it enhances the current reporting model and if the benefits of that extra effort exceed the costs. Jeremy Perler, director of research at Schilit Forensics, explained to the PCAOB members why he believes it is worth the extra effort.

“Enhancing auditor responsibility over this information by, as the Board proposes, requiring the evaluation of these disclosures with a focus on material inconsistencies and material misstatements is common sense and will no doubt strengthen and add robustness to our financial reporting system,” Perler said. “Ultimately, it will lead to fewer cases of willful or negligent misrepresentation.”

Gallagher stated that PwC supports the Board’s intent to enhance the existing standard by requiring communication about the nature of the auditor’s responsibility for other information in the auditor’s report but that the proposed standard as drafted poses significant challenges and should be carefully examined, including to determine that the costs don’t exceed the benefits. He said the firm believes the proposed other information standard will lead to a significant increase in the audit effort for information not directly related to the audited financial statements.

In order to meet the spirit of the proposed standard, which is to have the auditor report on other information based on work performed under existing practice, Gallagher suggested that some of the language be changed.

“We recommend replacing the proposed performance standard of ‘read and evaluate’ …Specifically, we believe the proposed other information standard should include an overall requirement that the auditor read all of the other information regardless of whether the other information is directly related to the audited financial statements,” he said. “The auditor should then perform a prescriptive set of procedures, similar to comfort letter procedures, with respect to material other information directly related to the financial statements.”

International developments

At the PCAOB’s public meeting, there was discussion about international developments, including in the UK where a new requirement for the auditor’s report and enhancements to audit committee reports are now effective. Further, there was discussion that enhanced audit committee reporting requirements that exist in the UK can be looked to as an example because they might mitigate some of the concern about the auditor being the original source of information about the company.

In June 2013, the Financial Reporting Council (FRC) in the United Kingdom finalized its auditor reporting standard. The following month the International Auditing and Assurance Standards Board (IAASB) released for comment its proposed standard on auditor reporting. On April 28, 2014, the IAASB re-proposed its standard that addresses other information, with comments due by July 18. [For more information, read the IAASB’s exposure draft Reporting on Audited Financial Statements: Proposed New and Revised International Standards on Auditing (ISAs), the press release announcing its other information standard reproposal and PwC’s In brief: IAASB proposes fundamental changes to the auditor’s report.]

In part, the FRC standard requires the auditor’s report to describe the assessed risks of material misstatement that had the greatest effect on the overall audit strategy, the allocation of resources in the audit, and directing the efforts of the engagement team. The proposed IAASB standard includes certain elements consistent with the FRC standard ─ most notably requiring auditor reporting for listed entities of “key audit matters,” similar to the PCAOB proposal for critical audit matters.

What directors should consider

  • Follow the developments regarding the PCAOB’s auditor reporting model proposals and the international developments related to this topic as the projects continue to influence each other.
  • Determine how those proposals could potentially affect what is included in company filings as it pertains to what the auditor reports on regarding possible critical audit matters and the increased.
  • effort related to the auditor’s responsibility regarding other information.
  • If interested, express their point of view on these proposals to the standard setters.

For more information about the proposed changes to the auditor’s reporting model, you may want to read the Center for Audit Quality’s comment letter.