Auditors know a lot about what lurks between the extremes of “pass” or “fail” – the only grades they are now permitted to assign to corporate financial statements – and the U.S. board that oversees auditors wants them to speak up more.
The Public Company Accounting Oversight Board on Tuesday unveiled a proposal that would, for the first time in 70 years, allow auditors to provide some commentary and color on their audit judgments.
Under the proposal, which would not do away with the pass-fail model, auditors would have to communicate so-called “critical audit matters” to investors.
These would include issues on which auditors had to make difficult or subjective judgments; had trouble gathering information; or that posed difficulty in forming an opinion on the financial statements.
In addition, auditors would have to disclose more details about their independence and how long they have been performing audit work for each client.
The proposal would, however, not require a full-blown discussion or analysis of audit results, something that might disappoint consumer advocates.
The proposal has a long way to go. PCAOB officials said any possible changes would not likely take effect until December 2015, at the earliest.
The PCAOB polices corporate auditors including the Big Four firms: PricewaterhouseCoopers, Ernst & Young, KPMG and Deloitte.
Still, the five-member PCAOB’s unanimous decision to formally issue the proposal was a step toward what could be the biggest overhaul of the corporate audit report since the 1940s.
Some companies and auditors caution against too sweeping an overhaul. Auditors have concerns about legal liabilities they could face, especially if their opinions conflict with those of company managers or might be taken out of context.
‘WATERSHED’ FOR PCAOB
PCAOB Chairman Jim Doty called Tuesday’s vote a “watershed moment.”
“The proposed standards before the board today would make the audit report more relevant to investors,” Doty said.
At present, an audit report offers little of value to investors, according to its critics.
Auditors now adhere to a boilerplate, three-paragraph audit opinion attached to company annual reports.
The opinion simply gives the company’s books either a passing or a failing grade and says whether the financial statements are fairly presented and adhere to generally accepted accounting principles (GAAP).
Investor groups have criticized the existing audit report as little more than a rubber stamp that fails to give investors enough insight into the auditor’s findings.
Such complaints were widespread after auditors often issued clean opinions for big financial companies that collapsed in the 2007-2009 credit crisis.
Vineeta Anand, a chief research analyst for the AFL-CIO, said the labor coalition was “pleased that the PCAOB is proposing far-reaching changes to the audit report that will give investors better information.”
Officials from accounting giants PricewaterhouseCoopers and KPMG said on Tuesday that they strongly support the PCAOB’s efforts to enhance the current auditor reporting model.
Joseph Carcello, an accounting professor at the University of Tennessee and a charter member of a PCAOB investor advisory group, said the regulator has to tread carefully with the proposal. Imposing too many requirements or providing too little guidance could actually result in less disclosure.
“They have to walk a real fine line,” Carcello said. “I think they tried to do that in the proposal.”
ANSWER TO ENRON
The PCAOB was set up under 2002’s Sarbanes-Oxley Act, a response to the downfall of companies such as Enron, Worldcom and Tyco. The board inspects auditors, establishes audit standards and disciplines lawbreakers.
It started formally considering enhancement of audit reports in 2011, when it sought public input on the issue. Reform advocates urged that auditors offer investors assurances beyond the financial statements, such as an “auditor’s discussion and analysis” of audit conduct and company accounting policies.
Tuesday’s plan does call for auditors to be more open, but it falls short of requiring a discussion and analysis. That may disappoint investor advocates who favored tougher reforms.
But Martin Baumann, the PCAOB’s chief auditor, said the investor advocates should carefully read the plan over before rushing to judgment.
“I hope the investor advocates carefully analyze what we’re proposing here today before they make any rash decisions,” he said.
The public has until Dec. 11 to submit comments on the plan. The PCAOB said it will hold a roundtable to discuss the feedback it gets. Officials may re-propose it before voting on it.
Even then, the U.S. Securities and Exchange Commission would still need to sign off on it before it could take effect.