PCAOB Releases a Proposal to Enhance the Auditor’s Reporting Model

Yesterday the Public Company Accounting Oversight Board issued a concept release detailing a number of potential changes to the auditor’s reporting model and seeking public comment on each.

Together the changes focus on enhancing the relevancy of audit reports by expanding upon and improving the utility of the information contained within them. Specifically, the PCAOB is seeking comment on four alternatives which it may pursue individually or in any combination:

An Auditor’s Discussion and Analysis – The release proposes a supplemental narrative to the audit report, described as an auditor’s discussion and analysis (AD&A), which would provide an auditor’s perspective on significant matters associated with an audit. As proposed, the AD&A might address:

• information about the audit itself, such as audit risks that were identified, the audit procedures and results, or an auditor’s independence;

• an auditor’s perspective on matters related to the financial statements, such as management’s judgments and use of estimates, accounting policies and practices, or difficult or contentious issues;

• material matters where a company is in technical compliance with the financial reporting requirements, but where disclosure might still be enhanced to provide a better understanding of the matters and their impact on the company’s financial statements; and

• areas where management could have applied different accounting standards or disclosures in the financial statement preparation.

The release notes that the purpose of an AD&A would not be to provide separate assurances regarding specific matters, but simply “to facilitate an understanding of the auditor’s opinion on the financial statements taken as a whole.”

See: Concept Release pages 15-18

Emphasis Paragraphs – The release proposes potentially requiring and expanding the use of emphasis paragraphs in all audit reports. Emphasis paragraphs, such as statements that: “the entity is a component of a larger business enterprise” or “the entity has had significant transactions with related parties” are currently discretionary.

See: Concept Release page 21

Assurance on Information Outside of the Financial Statements – The release also proposes potentially requiring auditors to provide assurances on information outside of the financial statements, such as information contained in management’s discussion and analysis, non-GAAP financial information or earnings releases. Currently an auditor must only read and consider whether information outside of the financial statements is materially consistent with the financial statements; there is no requirement to provide assurances on any such information (unless separately engaged by a company, in its discretion, to do so).

See: Concept Release pages 24-26

Clarification of Language in the Standard Auditor’s Report – The release proposes clarifying certain language used in standard auditor reports, such as including an explanation of what:

• constitutes “reasonable assurance”;

• does it mean to be “independent”;

• is the auditor’s role with respect to the detection of financial statement fraud;

• is the auditor’s responsibility for financial statement disclosures;

• is management’s responsibility with respect to the preparation and presentation of the financial statements; and

• is the auditor’s responsibility with respect to information outside of the financial statements.

This concept release only marks the beginning of the potential revision process. The adoption of any one or combination of these proposals, in whatever form they end up taking, will require additional rulemaking and standard setting by the PCAOB and the Securities and Exchange Commission. If you’re interested, the release also contains a brief overview of the history of audit reports in the United States, and prior attempts to revise them, which is worth a quick read (see Appendix A).

Initial comments can be submitted in writing or through the PCAOB’s website until September 30, 2011. The PCAOB will also hold a public roundtable to  discussion the concept release sometime in the the third quarter of 2011.

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