PCAOB Proposes Changes to the Auditor's Reporting Model

Posted by Investment Management Group on Sep 21, 2011 11:38:44 PM

On June 21, 2011, the PCAOB issued a concept release that may change the auditor’s reporting model as we know it. The concept release results from an “outreach” project concerning the effectiveness of the auditor’s reporting model conducted by the PCAOB staff from October 2010 through March 2011. The purpose of the concept release is to present a number of alternative potential changes to the auditor’s reporting model with a goal of increasing transparency and proving more relevant information to investors. The concept release offers four alternative changes to the current reporting model. Included among them, and easily viewed as the largest component of the proposed concept with the potential to drastically change the reporting model, is the addition of an auditor’s discussion and analysis of the financial statements (“AD&A”). The AD&A will give the auditor the ability to discuss significant matters that may not otherwise be expressed in the strict layout of the opinion language. This could include an explanation of the audit procedures performed, a statement stressing the independence of the auditor, or even the auditor’s overall view of the statements themselves. Other potential modifications to the reporting model included in the concept release are the expanded use of emphasis paragraphs, required auditor assurance on information ranging beyond the financial statements, and modification of the standard wording used throughout the opinion. All of these proposed concepts have one thing in mind: to ensure auditor’s communications are transparent to the investor. Further, the concept release makes it clear that these four alternatives are not mutually exclusive. Any changes to the auditing standards could include one or any combination of these components. The PCAOB also notes that there may be other alternative changes to consider, which will presumably come through the comment process. Written comments on the concept release are due to the PCAOB by September 30, 2011.

The concept release comes in response to the current financial crisis. It has been an ongoing debate as to whether auditor’s reports have truly served the needs of the investor in their current form. Martin F. Baumann, PCAOB Chief Auditor and Director of Professional Standards, explained on the day of the release that “the auditor is in a unique position to provide relevant and useful information, because of the auditor’s extensive knowledge of the company and as an independent third-party.” It is thought that these modifications will increase clarity between the auditor and the investor, allowing auditors to give a more detailed communication on their findings and giving investors a greater chance of making sound financial decisions.

While the ultimate goal of the concept release is a potential standard-setting project aimed at improving the auditor’s reporting model, the PCAOB does acknowledge in the release that there may be practical challenges and unintended consequences in adopting one or more of the four alternative proposals. Further, such changes will likely involve the development of new auditing standards and possibly a new management reporting framework. Such changes would have to involve PCAOB and SEC collaboration. Finally, the concept release does acknowledge that the four proposals (particularly the AD&D) will likely expand the the auditor’s responsibilities and scope of work which will in turn lead to increases in audit fees.

The three paragraph opinion, composed of the familiar introductory, scope, and opinion paragraphs, took a step closer towards it’s demise following a roundtable discussion held on September 15, 2011. The meeting was open to the public. A podcast of the roundtable meeting is available on the PCAOB’s Web site at www.PCAOB.org. Also available on the website are the concept release itself, comment letters received to date and a written transcript of the roundtable meeting. During the roundtable meeting, PCAOB chairman, Jim Doty, made it clear that this project was in its very early stages and that additional roundtable meetings may be held on this topic. We will keep you updated as this very important process develops.

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