Society to PCAOB: Keep pass/fail audit report

Certain changes to the audit report proposed by the Public Company Accounting Oversight Board (PCAOB) could have unintended negative consequences, the NYSSCPA told the audit watchdog in response to a concept release that proposes a new standard audit report based on rich analysis of an entity’s financial information.

The PCAOB’s June 21 concept release, while not explicitly endorsing any one measure, also suggested a required and expanded use of emphasis paragraphs, auditor assurance on information outside the financial statements and clarification of language used in the standard auditor’s report. Comments were due to the PCAOB by Sept. 30.

The Society’s Sept. 27 comment letter defended the current pass/fail model and warned against requiring an AD&A—auditor’s discussion and analysis—which would provide the auditor’s view of significant matters and how they were addressed in the audit engagements. The Society called this proposal “the most difficult to implement, the most problematic and the least beneficial” of all the proposals.

“If the objectives of the report are not readily understood in the marketplace, we suggest providing clarification through other means such as through education effort,” the NYSSCPA said.

The NYSSCPA also brought up concerns about potentially “dueling” information “in a perceived difference about what is said and what is disclosed” in the financial statements, which could harm the credibility of both the auditor and management, as well as potentially confuse shareholders. Further, such a change would wholly alter the nature of the auditor’s report, noted Renee Mikalopas-Cassidy, chair of the International Accounting and Auditing Committee and one of the letter’s principal drafters.

“It fundamentally shifts the role of what the auditor’s report is supposed to do,” she said. “It’s supposed to comment on management’s financial statements, whether they are reasonable and prepared in accordance with [U.S. Generally Accepted Accounting Principles]—that is their job.”

Robert W. Berliner, who sits on the NYSSCPA Board of Directors and is another of the letter’s principal drafters, said that the sort of information that people would be looking for in an AD&A “should be provided by the company itself,” rather than have “the auditor do a lot more … and take on many functions which really should not be up to the auditor.”

Requiring mandatory emphasis paragraphs would also be problematic, the NYSSCPA told the PCAOB. Under current practice, auditors use emphasis paragraphs to call attention to issues such as significant related-party transactions, whether a noteworthy subsequent event occurred or when a matter affecting financial statement comparability took place. Mandatory use of emphasis paragraphs “will dilute the financial reporting objectives,” the Society said.

Required emphasis paragraphs could also open the auditor up to legal liabilities if the auditor chooses to emphasize one thing but not another that could later be deemed relevant, said Mikalopas-Cassidy, who observed that if the auditor cannot find anything requiring emphasis, this “starts to put a different kind of onus on the auditor.”

Though the NYSSCPA said it recognizes that some investors “have voiced concerns about the need for ‘richer’ information available about the financial statements,” it does “not believe that the current pass/fail audit report is deficient” and, therefore, does “not see an overriding need to substantively revise the format of the audit report.” According to the Society, “expanding the content and reorganizing the format would not impact the effectiveness of the audit report substantively.”

The current standard audit report, with its pass/fail model, has worked effectively for more than 50 years, and while there has been some tweaking here and there, it’s remained largely the same for a good reason, said Berliner, who is also a current member and former chair of the Society’s Auditing Standards Committee.

“If there are complaints about it, it’s sure taken a long time for them to emerge,” he said.
If the problem is centered on the perception that investors are not getting enough information out of the standard audit report, the solution is to manage expectations by educating the public as to what the audit report can and cannot do, as well as to teach investors how to get the most out of the data already presented in the standard report, said the Society, a sentiment shared by the Government Accountability Office (GAO). To that end, the NYSSCPA suggested that the PCAOB launch an education campaign, as well as clarify key language in the standard report by, for example, including a glossary of terms with the report.

There was, however, one PCAOB proposal that the Society did agree with, which would be to require auditors to examine certain information outside the financial statements, particularly critical accounting estimates contained in management’s discussion and analysis. Reporting on this particular portion “is likely to improve the quality of such disclosures as a result of the increased attention given to these matters,” the Society stated.

The Society issued a similar response to the International Auditing and Assurance Standards Board in a Sept. 14 comment letter on a consultation paper outlining possible changes to the standard audit report. See the October Trusted Professional for a full report.

GAO: retain pass/fail
In its Sept. 30 response to the PCAOB’s proposal, the GAO echoed the Society’s stance that the current pass/fail model should be retained, calling the current setup “clear, consistent, comparable, and easy for the investing public to digest.” The pass/fail model also encourages management to make all necessary and appropriate disclosures, said the GAO.

The GAO also felt that management should be ultimately responsible for the disclosure of information required for fair, accurate and timely reports―while the role of the auditor is to assess the presentation of the financial statement, including management disclosures. This, said the GAO, is consistent with both auditing standards as well as years of accepted practice.

“If there is a situation in which management does not provide the required disclosures, or such disclosures are not fairly presented, then the auditor considers the effect on the auditor’s opinion and report,” said the GAO, which pointed out in its report that this has been the case historically.

While the GAO supported the expanded use of emphasis paragraphs, it mirrored the Society’s position that requiring them would not be worthwhile, as “they may not always be appropriate, necessary, or useful and could be confusing for report users … and may result in boilerplate paragraphs that provide little value and distract users from more relevant information contained in the report.”

“I am not surprised that the GAO would take a similar position as those who have worked with the U.S. system of accounting and reporting for many years,” said Mikalopas-Cassidy. “We have seen how this system has evolved and how more times than not [it] has worked and served its purpose effectively.”

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