By MICHAEL RAPOPORT
Regulators took the first step Tuesday toward requiring companies’ auditors to tell investors more of what they know about their clients—including, possibly, any concerns the auditors might have about the companies’ accounting.
The Public Company Accounting Oversight Board, which regulates audit firms, proposed a series of ways auditors might disclose more of the information they gather and the views they develop about the quality of a company’s financial reporting when they conduct an audit.
Proposals include requiring auditors to pass judgment on more of what a company does and says than is currently required, weighing in on the quality of a company’s disclosures in its earnings releases, for instance, or on what the company says in the narrative Management’s Disclosure and Analysis section of its annual report.
The intent of the proposals, which are still in the early stages, is to give investors more useful information and make the audit process more transparent, PCAOB Chairman James Doty said. “It’s about how audits can provide investors more insightful assessments of management stewardship,” he said at a PCAOB meeting Tuesday.
Currently, the auditor’s opinion included in every annual report is “pass-fail”: Either a company is fairly presenting its financial statements in the auditor’s eyes, or it isn’t. Typically, the auditor doesn’t discuss further its views of the company, unless it says the company is facing risks severe enough that there is doubt it can continue as a “going concern.”
But with large financial institutions failing or requiring government bailouts during the financial crisis even though they had clean audit opinions, investors want to know more about what auditors know. A March survey of its members by the CFA Institute, a group of financial analysts who work with individual investors, found 58% of those surveyed think the auditor’s report should provide more specific information.
The board’s most far-reaching idea is a new “Auditor’s Discussion and Analysis” report that would supplement the main audit opinion. Such a report could include information about the auditor’s views on matters like the judgments, estimates and accounting policies a company’s management uses to formulate its financial statements. That would enable an auditor to opine on whether management’s financial reporting is aggressive.
The board’s other ideas include required “emphasis paragraphs” in which the auditor would highlight the most significant matters in the financial statements, and opinions from auditors about matters outside the financial statements, like what a company says in earnings releases.
“We look forward to participating with investors, audit committee members, preparers and others in a constructive dialogue as to how audit reporting can be improved to better meet the needs of investors,” said Michael J. Gallagher, managing partner for assurance quality and transformation at PricewaterhouseCoopers LLP. It is important, he added, that “any changes at least maintain, if not improve, the quality of financial reporting.”
The Auditor’s Discussion and Analysis report is the approach that investors would prefer, said the CFA Institute’s Kurt Schacht. If an auditor can assess and discuss whether a company is being too aggressive in its financial reporting, “that’s a very important piece of information,” he said.
The PCAOB ultimately might adopt any or all of the proposals, or other ideas that might come up in public comments that are due Sept. 30. The board also plans to hold a public roundtable before then.
The board expects to formally propose changes by the end of 2011 and approve a final rule by the end of 2012. Any changes would be subject to Securities and Exchange Commission approval.
Another possible auditing change Mr. Doty recently floated, “term limits” for audit firms to require companies to change auditors after a period of years, will be the subject of a separate proposal that is still in the works.
