Rewriting The Audit Report: The PCAOB Moves Closer
To investors, the auditor’s report has long been a minor element of the financial statement package. It merely assures an investor that the financial statements comply with thousands of pages of accounting standards. That’s not a lot of assurance, and in a post-financial crisis world, investors wonder why auditors cannot play more of an investor’s advocate role in their reporting to them.
In the summer of 2011, the Public Company Accounting Oversight Board issued a concept release intended to improve the way auditors communicate with investors.The 2011 concept release was ambitious enough. It proposed the inclusion of an “Auditor’s Discussion and Analysis;” would have required and expanded the use of “emphasis paragraphs” in the auditor’s report; proposed auditor assurance on other information outside the financial statements; and would have clarified language in the standard auditor’s report, particularly with regard to auditor responsibilities.
Two years later, the PCAOB has issued a proposal after much feedback on the Concept Release. The two changes above do not appear in the same form in the proposed rule, but in their place, perhaps, the PCAOB has proposed that the auditor disclose “Critical Audit Matters” (CAMs). Essentially, the auditor would be required to report to investors the particular audit matters that keep them awake at night. This is the most contentious part of the proposal, for it will put the auditor in a difficult spot. Discuss matters too openly, and they may raise investor concerns about the honesty of client accounting; discuss too little, and they may provoke PCAOB inspections for investigating a lack of CAMs.
If it becomes a requirement, auditors are likely to be very cautious about any “new and improved” information they provide to shareholders, and will take care to insulate themselves from any additional liability. Investors should reasonably expect costs to increase, and the “cost argument” is likely to be used by the proposal’s opponents. Surprisingly, perhaps, we’ve found that audit fees for the S&P 500 could increase by nearly $2.5 billion before they would nick another penny from earnings per share. There is room for audit fees to increase without undue cost or pain to investors – if the additional fees are worth it.
In November, "The Analyst's Accounting Observer" presented an outline of the proposal's most important features, along with estimates of how much audit fees could change for S&P 500 firms before biting into earnings per share. For a free copy of the abbreviated report, send an email to Brenda Rappold at email@example.com with the word "PCAOB" in the subject.
For for subscription information about The Analyst’s Accounting Observer, click here.