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U.S. Watchdog Pushes Greater Disclosure in Audit Reports

Auditors would be required to disclose the most difficult parts of their opinion of a public company’s books under a proposal that would trigger the first change in 70 years to the reports.

The Public Company Accounting Oversight Board voted unanimously today to issue 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 credit crisis.

The PCAOB’s proposed standard would require auditors to tell investors about which accounting judgments proved the most difficult to verify. Auditors also would have to disclose how long they’ve worked for the company, data that could be useful in assessing the auditor’s independence.

“The proposed standards before the board today would make the audit report more relevant to investors by establishing criteria and a framework for providing deeper insights from the audit, based on information the auditor already knows from the audit,” PCAOB Chairman James Doty said in a statement for the meeting.

The board’s vote opens a 120-day public comment period during which audit firms, public companies and investors will 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.

Investor Information

“By communicating critical audit matters, the auditor would be providing investors and others previously unknown information about the audit,” PCAOB Chief Auditor Martin F. Baumann said. “This could enable investors and others to analyze more closely and carefully the related financial statements, accounts and disclosures.”

Critical audit matters could include judgments about items such as a bank’s loan loss reserves, Baumann said. Loan loss reserves proved to be underestimated during the years leading up to the credit crisis.

Today’s proposal doesn’t include a requirement for a separate auditor’s report that was considered in a discussion draft the PCAOB issued in 2011. The largest audit firms, represented by the Center for Audit Quality, opposed that option, saying it would have forced auditors to disclose financial information that should come from a company’s managers.

Missing Insights

“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.”

Instead of a separate report, the PCAOB’s proposal calls for auditors to disclose “critical audit matters,” which are typically communicated to the public company’s audit committee.

Auditors have discretion to determine what qualifies as a critical audit matter, board member Steven B. Harris said. Auditors don’t have to report any critical matters if their work papers document a reason for not doing so, Harris said.

“I remain concerned that the proposals are not strong enough to meet the needs of investors,” Harris said.

‘Responsible Change’

The Council on Audit Quality, whose members include Big Four audit firms PricewaterhouseCoopers LLP, Deloitte LLP, Ernst & Young LLP, and KPMG LLP, said in a statement that regulators should be “commended for the proposal.”

“The CAQ is committed to embracing calls for responsible change to the auditor’s report,” Cindy Fornelli, the council’s executive director, said in a statement.

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 risks.

“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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