Tag Archive: CAQ

Updating the Auditor’s Report: Opportunities and Challenges

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Scott Zimmerman, Phillip Austin, Marty Baumann, Dan Sunderland, and the author discuss “Challenges Facing the Audit Profession” at the AAA’s 2018 Auditing Section Midyear Meeting.

“The new audit report is a great opportunity for the profession.” So spoke Marty Baumann, chief auditor and director of professional standards at the US Public Company Accounting Oversight Board (PCAOB), at a panel during the American Accounting Association (AAA) Auditing Section’s midyear meeting this past January.

I agree wholeheartedly with Marty.

Updating the auditor’s reporting model in the United States represents an extraordinary opportunity, as it has in the United Kingdom and elsewhere. Yet as we discussed on that January panel, with opportunities come challenges—and I have put together some strategies for addressing those challenges.

The Standard

To understand the opportunities and challenges associated with updating the auditor’s report, it helps to start with the basic elements of the new PCAOB auditing standard.

The standard features a phased implementation approach. The first phase—which affects PCAOB audits of companies with fiscal years ending on or after December 15, 2017—includes disclosing auditor tenure and other changes to the form and content of the auditor’s report.

The second phase of implementation requires communication of critical audit matters (CAMs). The standard defines a CAM as any matter arising from the audit of the financial statements that meets all the following criteria:

  • was communicated or required to be communicated to the audit committee;
  • relates to accounts or disclosures that are material to the financial statements; and
  • involved especially challenging, subjective, or complex auditor judgment.

The effective dates for CAMs to be included in the auditor’s report are (1) fiscal years ending on or after June 30, 2019 for audits of large accelerated filers and (2) fiscal years ending on or after December 15, 2020 for audits of all other companies to which the requirements apply.

Opportunities

What opportunities will these changes bring? Conversation at the AAA panel covered a range of possibilities.

  1. Possible insights for investors. Scott Zimmerman, a partner at EY and its Americas Assurance Innovation division said that each audit should result in “some type of meaningful insight.” Baumann suggested that such insights can “add to the total mix of information that investor use in making decisions,” and offered his view that the audit report could, for some investors, even become “the first place to go in a very big 10-K with a complex set of financial information.”
  2. Differentiation via technology. As a digital expert, EY’s Zimmerman knows how technology can be a competitive differentiator for audit firms, particularly as use of data analytics and artificial intelligence grows. He noted that EY, like many firms across the profession, is examining how technology can be leveraged in the context of the CAMs that will be communicated in an expanded auditor’s report.
  3. Future academic research. As each audit generates insights, academics can sift through the data to track broader patterns in financial reporting. Baumann noted that researchers might investigate possible correlations between CAMs and stock prices, for example, or financial disclosures.

Challenges

While acknowledging the excitement around these and other opportunities, panelists also recognized challenges.

  1. Boilerplate potential. In December 2017, US Securities and Exchange Commision Chair Jay Clayton quipped that it would be a “bummer” if CAMs devolved into boilerplate language of little or no use to investors. At the AAA meeting, panelist Dan Sunderland, chief auditor and national leader for Audit and Assurance Services at Deloitte & Touche LLP, noted that the nature of the disclosure in CAMs would be the “keys to the kingdom”—and that auditors are well aware of the importance of avoiding boilerplate.
  2. Interference with audit committee communication. Panelist Phillip Austin, the national managing partner of Auditing at BDO USA, noted that, with the new disclosure of CAMs, some company executives might be tempted to “manage” communication between the auditors and the audit committee.
  3. Disclosure tension. In the discussion, panelists contemplated scenarios where auditors may disclose in CAMs information that management is not obliged to disclose. “That’s going to be tricky,” said Austin. Baumann indicated this would be an area that the PCAOB would track carefully.

Strategies for Success

To make the most of the opportunities presented by the new report, panelists discussed strategies to address the challenges of implementing the new reporting models. Audit committee members should become familiar with the following strategies for success.

  • Maintain open dialogue between auditors and audit committees. As with many items related to the financial reporting process, strong and ongoing communication will be critical around the new auditor’s report. Baumann cited the importance of dialogue around challenging issues, such as revenue recognition or significant and unusual transactions that a company might have, that could be critical audit matters. To foster this dialogue, the Center for Audit Quality (CAQ) has produced a tool for audit committees regarding changes to the auditor’s report.
  • Pilot-testing. For auditors, “the critical thing is to try to pilot things in the short run,” said Sunderland. This pilot-testing should involve auditors talking through the process with the audit committee, he added.
  • Pay close attention to the post-implementation review. For regulators, it will be vital to monitor implementation of the standard, particularly given risks such as creeping boilerplate. Marty Baumann voiced the PCAOB’s strong commitment to robust post-implementation review, starting with the implementation of CAMs.

What challenges, opportunities, and necessities do you see regarding updating the auditor’s report? I welcome your thoughts in the comments. And be sure to visit the CAQ’s resource page on auditor reporting for more information.

Cindy Fornelli is a securities lawyer and has served as the Executive Director of the Center for Audit Quality since its establishment in 2007.

NACD Spearheads Alternative Solution to Mandatory Audit Firm Rotation

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Next week, the Public Company Accounting Oversight Board (PCAOB) will hold its second public hearing on a proposed rule that would mandate audit firm rotation for all publicly traded companies. One concept the PCAOB has floated is a requirement that public companies rotate audit firms at least every 10 years.

The concept has been floated as a way to address flagging investor confidence in the ability of public audit firms to maintain strict independence.  However, the proposal could have an unintended adverse and far-reaching impact on public companies, not only for directors but also for executives, investors and shareholders.

NACD members across the nation are raising concerns about this concept.  In response, NACD is leading an initiative to engage the corporate governance community and propose an alternative solution—one that allows directors to retain their governance authority while also addressing what the PCAOB perceives to be a lack of investor confidence in the processes by which companies ensure auditor independence.

Audit quality and independence are important issues for directors, and reassuring investor and regulator confidence is a worthy goal.  But in our view, mandatory auditor rotation devalues and undermines the important role boards—and audit committees in particular—play in helping auditors maintain independence, objectivity and skepticism.

In our formal comment letter to the PCAOB, NACD expressed concerns about this proposal on behalf of our members and the entire boardroom community.  We objected to a mandated “one-size-fits-all” solution that would detract from the authority of the audit committee, supplant the board’s governance process and possibly generate unintended risk for the company.

The NACD was not alone in raising questions about the concept. The public comment period triggered a record-breaking volume of comment letters to the PCAOB and vigorous discussion at a roundtable in which NACD participated here in Washington last March.  Several roundtable panelists suggested that NACD was a key source to weigh in on board-level solutions, and the PCAOB noted that it would be receptive to our input.

The NACD Audit Committee Chair Advisory Council is spearheading this initiative, building a coalition comprised of investor representatives (including the Council of Institutional Investors) and the audit profession (including the Center for Audit Quality).   This coalition has a dual mission:

  1. Identify and evaluate with the corporate governance community an alternative solution to mandated regulations on auditor rotation.
  2. Promote this solution within the community and advocate its beneficial effects to the PCAOB and other influencers.

Our goal is to provide our recommendations and rationale to the PCAOB no later than December 2012, in anticipation of the PCAOB finalizing its recommendations in early 2013.

We need your input.  As a first step to formulating an alternative solution to mandatory auditor rotation, we are asking our 12,000 members to offer their own insights on how boards—and audit committees in particular—can apply leading practices to build investor and public trust.

Click here to provide your thoughts through a brief electronic survey. Responses are anonymous and will only be reviewed in aggregate form.

Your participation in this initial survey is a first step in shaping a framework for recommendations that will guide audit committee behavior and actions on matters of auditor independence, objectivity and skepticism.  These recommendations will be shared with the director and investor communities over the course of the coming months.

Ultimately, NACD will deliver these recommendations to the PCAOB by the end of the year, and we will position those concepts as representative of the will and the expertise of the public company directors and boards.

At NACD, we are committed to advancing and promoting best practices of companies to ensure proper board oversight that protects shareholders, investors and employees.