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 Remarks During a Panel Discussion Concerning Globalization of Accounting & Auditing Standards: Will U.S. Investors Benefit?

DATE Feb. 28, 2012
SPEAKER(S): Daniel L. Goelzer, Board Member
EVENT: DC Bar Association
LOCATION: Washington, DC

I appreciate the opportunity to be part of this discussion of global accounting and auditing standards. The topic is an important one, with far-reaching implications for financial reporting and investor protection in the United States. Special thanks to Jeff Mahoney, General Counsel of the Council of Institutional Investors, for organizing the panel and serving as moderator.

I have been asked to address four questions —

  • How are U.S. auditing standards established and what is the PCAOB's role?
  • How do U.S. investors benefit from PCAOB auditing standards?
  • How does the PCAOB interact with the International Auditing and Assurance Standards Board?
  • Would U.S. investors benefit from the adoption of a single set of global auditing standards?

Before I begin, I need to provide the usual disclaimer: The views expressed are my own and not necessarily those of the PCAOB, other Board members, or the staff.

I. How are U.S. Auditing Standards Established?

The answer to "Who writes auditing standards in the United States?" has changed over time. Prior to the enactment of the Sarbanes-Oxley Act in 2002, auditing standards were established by the Auditing Standards Board ("ASB"), which operates under the aegis of the American Institute of CPAs ("AICPA"), a professional association of accountants. Those standards were generally referred to as U.S. GAAS — U.S. generally accepted auditing standards.

In the wake of high-profile financial reporting and auditing failures like Enron and WorldCom, Congress concluded that there had been a breakdown in confidence in public company audited financial reporting and took significant steps to restore confidence by enacting the Sarbanes-Oxley Act. The Act created the PCAOB to oversee public company auditing.

In creating the Board, Congress shifted responsibility for public company auditing standards away from the profession. Section 103 of the Act gives the Board the option to write auditing standards itself or to, in effect, delegate standard-setting to professional groups of accountants. One of the first policy decisions the Board made after it began work in 2003 was that it would write auditing standards directly, rather than rely on the profession. [1] This is one of the foundation stones of the Board's approach to fulfilling its investor protection mission.

The Board's standard-setting authority expanded last Summer with the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"). Specifically, Congress extended PCAOB oversight and standard-setting to the auditors of all securities broker-dealers that file financial statements with the Securities and Exchange Commission. The vast majority of these broker-dealers are not public companies.

In summary, as a result of the seminal Board's 2003 decision, today the standards that govern the audits of all public companies that file reports with the SEC (and soon all broker-dealers) are written by the PCAOB. Other auditing standards, such as those governing private company audits, are still written by the ASB. Thus, there are now two sets of auditing standards in the U.S. — PCAOB standards and GAAS.

In order to ensure that it discharges its standard-setting responsibilities in the public interest, the Board has established an open and transparent process, which allows for input from a broad range of interested parties. In general terms, most standard-setting projects go through three phases.

  • Conceptualization: The process by which the PCAOB formulates proposed standards draws from many sources, including the Board's inspections and enforcement activities. In addition, the initial stages of most standard-setting projects include informal consultation with the Board's two advisory groups — the Standing Advisory Group ("SAG") and the Investor Advisory Group ("IAG"). The SAG is comprised of individuals with a broad cross-section of experience in financial reporting, including practicing auditors, preparers of financial statements, investors, and others.[2] The IAG's membership is focused on public company financial statement users. [3] The Board also makes a concerted effort to seek input on major projects through roundtables and public meetings, task forces, and targeted research and outreach.[4] In some cases, the Board also issues a concept release in which it describes the problem to be solved or objective to be accomplished by standard-setting or rulemaking and invites the public to offer suggestions.
  • Proposal: Regardless of the process by which they are formulated, all proposed standards are published for public comment. This affords an opportunity for auditors, preparers, users, and others to react to a specific proposal and suggest changes and improvements. If the resulting changes are substantial, the Board may publish a second version for additional comment.
  • Adoption and SEC Approval: Based on the public comments received, the Board formulates the final standard. Once the Board approves a standard, it is submitted to the SEC for approval. The Act requires the Commission to solicit additional public comment on the Board standards. After receiving comment, the Commission must either approve or disapprove the standard. No PCAOB auditing standard takes effect unless and until approved by the SEC.

II. How Do U.S. Investors Benefit?

Board releases proposing or adopting new auditing standards typically describe how the Board believes that the standard will benefit investors. The Board also seeks comment on whether a proposed standard would further the interests of investors in reliable financial reporting. For example, the release proposing new related party auditing standards, which the Board approved earlier today, notes three ways in which the auditor's evaluation of relationships and transactions with related parties is important to investor protection —

  • Transactions with related parties can pose significant risks of material misstatement, as their substance might differ materially from their form.
  • Related party transactions may involve difficult measurement and recognition issues that can lead to errors in financial statements.
  • In some instances, related party transactions have been used to engage in financial statement fraud and asset misappropriation. [5]

The release explains how the proposal would strengthen auditing in each of these areas.

At a more general level, investors benefit from auditing standards that result in better auditing. Reliable audited financial reporting is one of the bedrocks of investor protection. The PCAOB's goal is to increase reliability by developing high quality standards so that auditors will gather appropriate evidence to support their opinions and will be in a position to issue audit reports that provide investors with reasonable assurance on whether the company's financial statements fairly present the company's financial condition, results of operations, and cash flows in conformity with GAAP.

In this regard, investor confidence in U.S. public company auditing standards is, I believe, strengthened by the fact that the Board is not an association of accountants or of public companies. The Board is a quasi-governmental body, independent of the accounting profession, and its sole mission, as set forth in Section 101 of the Act, is to "protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports." As a result, the PCAOB's funding mechanism is created by statute — no one can decide to withhold or provide funding because they like or dislike Board standards — and its budget is subject only to SEC approval. Further, PCAOB standards are drafted with enforceability in mind. The Board wants to make sure that its inspection and enforcement staffs will be able to determine whether standards have been complied with. In contrast, when standards are written by professional bodies, there may be a tendency — conscious or otherwise — to draft in a way that leaves more room for the auditor to defend itself if there is an audit failure.

III. How Does the PCAOB Interact with the IAASB?

Although the Board sets public company auditing standards independently, it maintains open lines of communication with other auditing standard-setters, particularly the International Auditing and Assurance Standards Board ("IAASB"), and monitors their activities.

The IAASB, a committee of the International Federation of Accountants ("IFAC"), establishes the international standards on auditing ("ISAs"). Approximately half of the IAASB's members are current partners in auditing firms, and the IAASB is financially supported by IFAC, which in turn is funded by accounting firms and by national associations of accountants in many countries around the world, including the AICPA. [6]

The PCAOB and the IAASB have common goals and benefit from an open exchange of perspectives. The PCAOB board members meet periodically with the Chair and other members of the IAASB to discuss their respective standard-setting agendas and to explore common issues and challenges. (For example, both Boards are currently engaged in projects exploring possible changes to the auditor's reporting model.) In addition, the PCAOB is an observer, with speaking rights, to the meetings of the IAASB's Consultative Advisory Group. Similarly, the IAASB is an observer, with speaking rights, to the meetings of the Board's Standing Advisory Group.

In developing new standards, the PCAOB strives to avoid needless inconsistency between its standards and the ISAs. The staff considers the work of other standard-setters and prepares a comparison of the analogous standards of the IAASB and the ASB. This comparison is one of the inputs that informs the drafting of new or revised PCAOB standards. Where relevant, the staff also may read comment letters received by the IAASB or other standard-setters on projects that are similar to those the PCAOB is undertaking. Further, the release accompanying a proposed new PCAOB standard includes an appendix containing a narrative comparison of significant differences between the proposed standard and the analogous standards of the IAASB (and the ASB). This appendix also explains the reasons for differences between the Board's standard and the analogous IAASB (and ASB) standard.

IV. Would a Single Set of Global Auditing Standards Benefit U.S. Investors?

Conceptually, it would be attractive to have a single, worldwide set of auditing standards so that an audit opinion meant the same thing, and was supported by the same work, regardless of where it was prepared. However, on a bit deeper analysis, I do not think creating a single set of global auditing standards is a realistic near-term goal or one that would benefit U.S. investors.

The United States has a different audit environment than much of the rest of the world. We have a much more investor-driven economy, with wider retail investor participation in our markets than anywhere else. This is one of our economic strengths. However, it also means that rigorous, investor-focused auditing may be more important here than elsewhere. As a corollary, we also have a more sophisticated business and legal infrastructure than much of the rest of the world. Because of the broad retail participation in our markets and because of the importance we place on the ability of companies to raise capital from the public, we have a highly developed securities regulatory structure. Rigorous auditing and auditor oversight is a key part of that structure. As a result of this investor-centric environment, capital is cheaper here than in most other countries, and foreign companies that cross-list capture a U.S. listing premium reflecting the high confidence that investors place in the accuracy of information reported under our securities laws.

A single set of global auditing standards would, by definition, not be constructed with only the U.S. capital markets and regulatory framework in mind. A worldwide set of standards would have to be workable everywhere, including in cultures with a low rate of public participation in the securities and a correspondingly low emphasis on investor legal protections. In that sense, global standards would necessarily reflect a lowest common denominator approach.

Comparison of PCAOB standards and the ISAs illustrate these points. While the fundamental underpinnings are similar, there are some significant differences in audits under PCAOB standards as compared to those under the international standards. Those differences can be traced to the different expectations we have for an audit in the U.S. and the more investor protection-oriented legal framework. For example —

  • To accommodate different audit environments, the ISAs are divided into requirements and non-mandatory "application material." PCAOB standards are much more precise about what must be done in an audit. In a legal and oversight environment like the U.S., this approach is appropriate, in other legal and regulatory environments it may not be.
  • PCAOB standards are constructed with an integrated financial statement and internal control over financial reporting audit in mind. Most other countries do not require an ICFR audit, and accordingly the ISAs do not address ICFR auditing.
  • PCAOB standards require that the audit be performed with due professional care. This requirement underpins much of the U.S. auditor's liability jurisprudence. The ISAs contain no comparable requirement.
  • The PCAOB has proposed enhancements to its auditing standards on communications with audit committees to harmonize with the audit committee role that the Sarbanes-Oxley Act envisions. For example, the PCAOB proposals would require the auditor to make certain inquiries of the audit committee. The ISAs, which are not, of course, designed to align with the Act, do not require the auditor to make any inquiries of the audit committee. The ISAs must necessarily be workable in jurisdictions in which audit committees play little or no role — or do not exist.
  • The PCAOB's standards presumptively require confirmation of receivables, and the Board has proposed to expand the confirmation requirements.[7] In many business cultures outside the United States, obtaining reliable third-party confirmations is notoriously difficult, if not impossible. In light of this reality, the ISAs do not require confirmation.

I do not mean to suggest that the PCAOB's standards are "better" than the ISAs. However, I am suggesting that the PCAOB's standards are better aligned with the U.S. legal, regulatory, and business environment. Given the importance we place in the United States on investor protection, I do not think U.S. investors would benefit from a switch to standards — the ISAs or anything else — that were designed to operate worldwide and without regard to the U.S. environment.

V. Conclusion

In light of the increasingly globalized nature of auditing, it is important for the Board to continue to interact with other standard-setters, to explore common issues and challenges, and to understand the reasons for differences in approach to audit challenges. The PCAOB does not, however, seek auditing standards conformity or convergence for its own sake. Audit cultures, audit risks, and audit inspection and enforcement regimes differ around the world. PCAOB standards address the U.S. securities markets and are written with that environment in mind.

At the same time, it is important that we avoid needless differences. I believe that over time the differences are likely to narrow, as the differences between the legal and business environments around the world narrow. But, in my view, U.S. investors would not benefit from a precipitous rush to a single set of worldwide auditing standards.

[1] See Compliance with Auditing and Related Professional Practice Standards; Advisory Groups, PCAOB Release No. 2003-009 (June 30, 2003).

[2] See Compliance with Auditing and Related Professional Practice Standards; Advisory Groups, PCAOB Release No. 2003-009 (June 30, 2003).

[3] See Charter of the Public Company Accounting Oversight Board Investor Advisory Group at The IAG charter states that the group is comprised of "individuals of the highest integrity with the expertise and experience in relevant areas, including investing in public companies."

[4] For example, the PCAOB recently held a roundtable to discuss the auditor's reporting model, and plans to hold a public meeting on March 21-22, 2012 to discuss auditor independence and audit firm rotation. See PCAOB to Host Roundtable on Auditor's Reporting Model, PCAOB Press Release (August 25, 2011); PCAOB to Host Public Meeting March 21-22 on Auditor Independence and Audit Firm Rotation, PCAOB Press Release (February 2, 2012). The reporting model project also included a series of focus group sessions with investors, academics, preparers, auditors, and other interested persons.

[5] Proposed Auditing Standard — Related Parties; Proposed Amendments to Certain PCAOB Auditing Standards regarding Significant Unusual Transactions and Other Proposed Amendments to PCAOB Auditing Standards , PCAOB Release No. 2012-001 (February 28, 2012) at 2.

[6] Similarly, the ASB is a technical body of the AICPA, which is funded by the accounting profession. The ASB has worked closely with the IAASB for the last several years to converge its standards with the ISAs as part of its clarity project.

[7] The confirmation requirement arises from one of the seminal events in U.S. business history, the McKesson-Robbins case. As the Board recently noted —

The accounting profession in the United States has required confirmation of accounts receivable since 1939, when the American Institute of Accountants adopted Statement on Auditing Procedure No. 1 as a direct result of the McKesson & Robbins fraud case. In that case, the U.S. Securities and Exchange Commission * * * concluded that if confirmation of receivables had been accepted practice at that time, such a procedure would have revealed the fictitious nature of the McKesson & Robbins receivables (footnotes omitted).

Proposed Auditing Standard related to Confirmation and Related Amendments to PCAOB Standards, PCAOB Release No. 20010-003 (July 13, 2010) at 11.


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