Auditors could be required to better explain how they graded a company’s financial statements under a proposal that would trigger the first change in 70 years to how auditors report their findings.
The Public Company Accounting Oversight Board is scheduled to vote today on a plan meant to amplify the information investors receive from the auditor’s report. The PCAOB has studied ways to overhaul such reports since the 2008 financial crisis.
The PCAOB has said it could seek to force auditors to provide a supplemental report explaining their findings. Alternately, the board said it could seek to make audit firms provide a few sentences highlighting the most critical parts of the financial statements.
“The concern coming out of the financial crisis was that auditors had more information into judgment calls and business risks than they conveyed in their opinion,” said Daniel L. Goelzer, a partner at Baker & McKenzie LLP and former PCAOB member. “Some insight from the auditor about what the challenging part of the audit was and what the risks are would provide some additional insight. The question is, at what cost.”
The board’s vote will open a period of public comment during which audit firms, public companies and investors lobby to shape a final standard, which would have to be approved by the Securities and Exchange Commission. The PCAOB was created by the Sarbanes-Oxley Act of 2002 and sets standards for auditors of U.S.-registered firms.
Some investors have pushed for more specific information about an auditor’s findings, which are disclosed in a brief, one-page opinion that states whether a company passed or failed the audit. Groups such as the Council of Institutional Investors support requiring auditors to provide a separate narrative that explains the company’s accounting judgments and estimates.
The largest accounting firms, represented by the Center for Audit Quality, have pressed the PCAOB to maintain the current reporting model while better explaining the roles of audit firms and management in preparing financial statements.
Instead of a separate narrative, the PCAOB could propose a requirement to use “emphasis paragraphs,” or disclosures of judgments behind accounting estimates and areas with measurement uncertainty.
“I suspect they are more likely to go down the emphasis paragraph road because it really would be challenging for auditors to write a free-form document with respect to each audit,” Goelzer said in a phone interview.
Lynn E. Turner, a former SEC chief accountant, said auditors are already allowed under current standards to emphasize particular areas of the audit within their report. The problem, he said, is auditors have instead chosen to issue reports with boiler-plate language that omits those questions.
“We have a track record of auditors being aware of serious problems and not saying anything about it,” Turner said. “Any new standard would have to be very specific about what the auditor would have to disclose if they knew about it.”
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