Category: Legislative & Regulatory

NACD Submits Comment Letter to the PCAOB

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Yesterday, NACD submitted a comment letter to the PCAOB regarding its new concept release on audit firm rotation. In an effort to promote professional objectivity and skepticism, the PCAOB believes that more frequent turnover of audit firms may help promote these goals. Proponents of such a proposal argue that changing audit firms would “free the auditor, to a significant degree, from the effects of management pressure and offer an opportunity for a fresh look at the company’s financial reporting.” While the overall intent of increased auditor independence and high quality audits is laudable, NACD believes that this approach is not practical and may have strong negative consequences.

NACD believes that auditor independence, reinforced through the rigorous application of professional objectivity and skepticism, provides the foundation for a quality audit. Further, NACD believes that the audit committee has, and should retain, responsibility for overseeing the work of auditors in an effort to ensure that they perform at a high level of quality. While auditor rotation can be beneficial at times and should periodically be considered by the audit committee, we do not support making this rotation mandatory. 

Our primary concern is that the PCAOB seems to be implying that audit committees, acting on behalf of all shareholders, are not able to determine the best auditor for their companies on an ongoing basis. To that end, the PCAOB seems willing to interfere with private contracts between audit committees and auditors. This interference may constrain the ability of audit committees to select the audit firms that are best able to meet the particular accounting and auditing challenges presented—including an incumbent firm.  

Additionally, mandatory audit firm rotation may engender significant disruption and prohibitive cost for companies without offering substantial benefits. For example, the impact of mandatory firm rotation may be particularly severe if it occurs at a time when a company is going through a significant event such as a corporate financing, merger or acquisition, or change in management. Changing auditors at such a time would greatly expand the cost of the transaction or transition, and potentially affect the ability of the company to execute a transaction.

As an alternative to mandatory rotation, audit committees could employ some of the following practices to improve audit quality:

  • Evaluating the audit plan in a more diligent fashion, taking a close look at the auditor’s risk assessment and the procedures planned to address those risks, as well as milestones for completion.
  • Using the annual evaluation of the audit firm to gauge the firm’s understanding of the business and its helpfulness in the early identification of important issues.
  • Analyzing and discussing the results of the annual evaluation and being responsible for providing feedback to the audit firm.
  • Taking the lead role in interviewing and selecting the lead engagement partner.
  • Monitoring the auditor’s performance by inspecting the firm’s quality and competency.

While NACD supports the PCAOB’s efforts to enhance audit quality, we do not believe that mandatory auditor rotation is the way to do so. We look forward to working with the PCAOB in the future to develop ways of improving the professional objectivity and skepticism of auditors.

The SEC Provides Some Breathing Room

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This week, the SEC decided to delay their decision on whetherU.S. companies will be required to convert from GAAP to IFRS. The decision came after nearly two years of anticipation. In February 2010, the SEC stated that it would decide whether or not to require a change in accounting standards after completion of its own work plan as well as convergence projects being undertaken by FASB and IASB. The SEC originally planned to make a final decision in mid-2011, but then extended the date to late 2011. In a speech on Monday, James Kroeker, chief accountant for the SEC, announced that both the work plan and the convergence projects were delayed and consequently a final decision from the SEC is “still many months away.”

The SEC’s delay is due, in part, to a determination by FASB and IASB to slow down and continue consideration on several “key” projects. This decision came after multiple convergence observers suggested adding time for deliberation and due process. This highlights the difficulty in crafting final standards that “represent long-term, implementable, and sustainable improvements,” according to Kroeker.

The delay may relieve many executives across the United States. According to a 2011 PwC survey, 43 percent of respondents believed the pace of recent standard-setting activity was too fast. The same respondents also indicated that the proposed changes to accounting standards would have a “pervasive impact” on their companies. Given the significance of a potential change in accounting standards, the SEC’s decision to delay a decision may be welcome for many in Corporate America.

Update on PCAOB Activity

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This week, the Public Company Accounting Oversight Board (PCAOB) formally issued proposed rules on audit reporting standards (Docket 029: Improving Transparency Through Disclosure of Engagement Partner and Certain Other Participants in Audits). Following a concept release originally issued in 2009, the proposed rule would require the engagement partner—along with any additional firms that participated in the audit—to be disclosed in the audit report. The window for public comment is open until January 9, 2012.

The PCAOB also has several outstanding concept releases that have the potential to change the relationship between auditors and the board of directors. The comment period for Docket 034: Concept Release on Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements and Related Amendments to PCAOB Standards closed September 30th, but included the use of an “auditor’s discussion and analysis,” (AD&A) as well as expanded use of emphasis paragraphs. Docket 037: Concept Release on Auditor Independence and Audit Firm Rotation is currently open for comment on whether mandatory audit firm rotation would improve auditor objectivity.

While NACD sees room for improvement in the current auditor’s reporting model, in our comment letter to Docket 034, we urge the PCAOB to carefully examine the proposed changes to ensure the benefits of the additional work outweigh the costs. There is concern that these proposals could upset the role management and auditors play in asserting and attesting to information. Additionally, these additions —especially the proposed AD&A—may create confusion regarding responsibilities for oversight of the financial reporting and external audit processes.

NACD continues to comment on the other developments arising from the PCAOB. We plan to alert our membership as future comment letters are released.

PCAOB Chairman James Doty recently spoke at the 2011 Board Leadership Conference. Read the highlights of his commentary at the NACD Blog.