A Preparer’s Perspective on The Auditor’s Report ChangesPosted: July 25, 2016
The PCAOB recently issued several proposed changes to the auditor’s report. The first change is for the auditor to include their tenure in auditing the entity in their report. This one is intriguing because there are those that believe long-term auditor tenure somehow reduces auditor skepticism, maybe even independence, and is therefore a bad thing. I think most preparers would vigorously dispute that position, but whatever your belief, under this proposal the auditor tenure will be more transparent to investors. With auditor tenure being more transparent it will be interesting to see if investors prefer long tenure, shorter tenure or simply don’t care.
The second change will be the inclusion of CAMs (Critical Audit Matters) in the auditor report. CAMs are matters that required significant judgment, greater audit effort or more detailed scrutiny. Disclosure of CAMs was proposed a few years ago, but the new proposal has a critical difference. CAMs are now material items that were discussed (or should have been discussed) with the audit committee. One of the concerns with the earlier proposal was that CAMs could include too many items and were infringing on the responsibilities of the audit committee. By limiting CAMs to matters discussed with the audit committee, the current proposal seems to address both of these concerns, but it brings a question to my mind. With auditors basically listing all of the material critical matters they discussed with the audit committee in their report, will the audit committee feel compelled to address their perspective on those matters in their audit committee report? The audit committee report format is certainly flexible enough to allow for such a discussion, and it might actually enhance investor confidence in the audit committee to see what they are doing as the investor advocate in the governance of the company.
The final change I want to address is the requirement to include a statement that the auditor’s responsibilities are to provide reasonable assurance about the financial statements being free of material misstatements whether “due to error or fraud.” This may not sound like a huge change at first, but embracing a requirement to take on responsibility over fraud is a giant step over the “expectation gap” that has existed for decades. As a preparer this one word scares me a lot. Not because I don’t think investors will love it, but because I am worried about how auditors will react to it. My concern as a preparer is due in part because of the potential for auditors to increase, or maybe better said significantly increase, their audit work and demands on me as a client because of the perceived increase in responsibilities to detect fraud. More concerning to me is that such a requirement will change the auditor’s perception of me as a client. Auditors are already required to view me, as a preparer, with skepticism. For example, inquiry – asking me a question and getting and answer – is not sufficient standalone audit evidence. But it is one thing to be skeptical of what I say, i.e. ask me to prove it, and a completely different thing to think I may be committing fraud and trying to hide it. It is human nature to react negatively to be falsely accused of doing wrong and that is potential exactly what this new phrase in the auditor report will do to the relationship between auditor and preparer. It will take a skeptical relationship to an adversary relationship which will not benefit preparers, auditors or investors.
I hope that my fears are not true or can be addressed in the final rules that ultimately are issued by the PCAOB. Either way, I think this is one auditing standard that preparers might want to follow and even consider writing a comment letter to the PCAOB prior to the August 15, 2016 deadline.