Securities Regulation Daily PCAOB re-proposes standard to enhance the auditor’s report
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Wednesday, May 11, 2016

PCAOB re-proposes standard to enhance the auditor’s report

By Jacquelyn Lumb

PCAOB members voted unanimously to re-propose a standard that will enhance the auditor’s report beyond the current pass/fail model to include more information about the judgments that went into the auditor’s opinion. The re-proposal, which will be open for comment through August 15, 2016, includes a list of factors that auditors should take into consideration when determining the critical audit matters (CAMs) that should be included in the auditor’s report. While voting to seek comment on the re-proposal, Board members Jay Hanson and Jeanette Franzel both expressed reservations about the proposed requirement to include the auditor’s tenure in the report—Hanson because it may lend credence to some views that lengthy tenure can decrease audit quality, and Franzel because there is little evidence to support its disclosure.

The auditor’s reporting model project began with a concept release, followed by a proposal, a roundtable discussion, and consideration by the Board’s Standing Advisory and Investor Advisory Groups. The Board has received hundreds of comments. Many supported the concept of disclosing the CAMs that arise during an audit, but the definition of CAMs in the 2013 proposal was deemed too broad by many. In addition, many auditors viewed the proposed documentation requirement as too burdensome.

Revisions to original proposal. The re-proposal narrows the potential CAMs to accounts or disclosures that are material to the financial statements and narrows the documentation requirement to the basis for determining the issues that were communicated to the audit committee. The standard will not apply to broker-dealers, benefit plans, or investment companies, other than business development companies. The staff considered standards that have been adopted in the U.K. and the E.U. in drafting the re-proposal and noted that it incorporates many common themes. A comparison of the standards is included in the release.

PCAOB Chair James Doty, in opening remarks, emphasized that in describing their critical audit judgments, auditors will not be placed in the position of speaking for management. In his view, the re-proposal, and the economic analysis that supports it, reflect the right approach and will enable the Board to adopt final rules in the near-term.

Harris questions CAM definition. Board member Steve Harris said he was pleased the re-proposal requires additional information about the auditor’s independence, tenure, and responsibilities for fraud and financial notes. He expressed concern, however, that the proposed definition of a CAM may not be broad enough. The re-proposed definition limits the source of a CAM to any matter communicated or required to be communicated to the audit committee that relates to material accounts or disclosures and involves particularly challenging, subjective, or complex auditor judgment, he explained, but it retains an element of subjectivity which, in his view, provides too much discretion.

He would like to see a more objective standard to prevent auditors from finding ways to avoid disclosing certain information to investors, including a precise list of matters the auditor must discuss in the report, similar to the E.U. regulation. The E.U. requires auditors to describe the most significant assessed risks of material misstatement, including those due to fraud, he explained.

Harris also expressed concern that the descriptions of the audit procedures performed in CAMs may become too detailed, making them difficult to read. However, he concluded that the re-proposal is a positive, though limited, step in revising the outdated and uninformative auditor’s report.

Alignment with foreign initiatives. Lewis Ferguson said the re-proposal strikes a careful balance between investor’s wish for more information from auditors, while retaining the primary role of management in the financial reporting process. He added that the standard will bring the Board up to date with the rest of the world. He asked Chief Auditor Martin Baumann if he expects to see a wide variation in the description of CAMs.

Baumann noted that in the first year of expanded audit reports in the U.K, there was quite a difference, with some auditors providing substantial details and others providing more standardized disclosures. These discrepancies were noted by analysts, he said, and the second year saw more expanded reports with better quality disclosures. He added that the Board is sending the message that auditors must disclose matters specific to the particular audit, not boilerplate. He hopes the analyst community will drive better reporting in the U.S. as well.

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