Reporting on information outside the audited financial statements could empower auditors and educate investors, but it could also reduce useful disclosures from management, experts told the PCAOB on Thursday.
During the second of two days of public hearings on the PCAOB’s auditor’s reporting model proposal, panelists debated the merits of having auditors evaluate and report on “other information” that is included in an annual report filed in Form 10-K but is outside the audited financial statements.
Jeremy Perler, CPA, director of research for forensic accounting consultancy Schilit Forensics, said enhancing auditor responsibility will help provide assurance for investors that information presented by management is accurate.
“I recognize that evaluative scrutiny likely means added procedures,” he said. “However, the benefits to investor protection and public disclosure far outweigh the costs.”
But Michael Young, a partner with law firm Willkie Farr & Gallagher, said the proposal would reduce the useful information available to investors. He said the proposal would give management incentive to present objectively verifiable information that is easier for auditors to evaluate.
Young said that could mean management would provide less information that connects the dots for investors and describe what the numbers mean for the company. He is concerned that would make financial reports less useful for investors.
“In my opinion, that’s the opposite of where we want to go,” Young said.
A more hopeful view was presented by Peter Nachtwey, CPA, CFO of asset management firm Legg Mason. He said being able to report on other information would give the audit community better leverage.
“Currently there is no recourse for audit firms if they disagree with any management assertions outside of the financials, other than a nuclear option of pulling their audit opinion and resigning from the client,” Nachtwey said. “So I believe the proposal, properly structured, could promote a more useful dialogue between auditors and management.”
Definition of “evaluate”
Nachtwey and Michael Gallagher, CPA, managing partner, assurance quality for PwC, agreed that a poor definition of the term “evaluate” in the proposal is a problem.
Gallagher said that rather than requiring auditors to “read and evaluate,” a standard should require the auditor to read all the other information regardless of whether it is directly related to the audited financial statements. He suggested that the auditor should then perform a prescriptive set of procedures, similar to comfort letter procedures, with respect to material other information directly related to the audited financial statements.
“We need to develop a more clear understanding of what the word ‘evaluate’ means,” PCAOB member Steven Harris agreed.
As with the previous day’s panelists, some speakers expressed a desire for standards to move forward to give auditors a stronger voice, despite some of the logistical concerns. PCAOB Chairman James Doty is concerned that the cost of doing nothing could be significant, particularly as new U.K. standards—which call for more feedback from auditors—are receiving positive reviews from investors, auditors, and management.
If investors get better information from audits outside the United States than they do from U.S. audit reports, the value of U.S. securities may decrease, Doty said. “There is the potential that after some years, it will translate into some differential in the premium which our equity markets enjoy,” he said.
But Young is concerned that the PCAOB proposal would result in reporting that is less useful to investors.
“Form 10-K disclosure would be driven further in the direction of recitation of objectively verifiable data and boilerplate at the expense of the sort of meaningful communication that can help investors see what is really going on,” he said in written remarks to the board.
—Ken Tysiac (firstname.lastname@example.org) is a JofA senior editor.