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 Assignment: Book Report

DATE: March 22, 2011
SPEAKER: Jay D. Hanson, Board Member
EVENT: PCAOB Open Board Meeting
LOCATION: Washington, DC

We heard recently from the PCAOB Investor Advisory Group on several topics, including the usefulness of the auditor's report and their criticisms of the role auditors played, or did not play, in the financial crisis. From this group and many others, the consistent theme is that investors are not getting adequate information to make their investment decisions.

There are many parties with roles in the financial reporting process. Management is on the ground every day as the transactions are happening. Audit committees have responsibility to oversee management, hire the auditors and satisfy themselves that both are doing their jobs. Counsel is actively involved in writing the annual report and other securities filings. The auditor reports on the overall fairness of the financial statements and the financial reporting controls. Analysts interpret the financial information and make predictions of the future. Rating agencies evaluate the creditworthiness of companies and debt securities.

Who should be responsible for providing investors with the information that they are not getting today?

In considering this issue, I am reminded of my school days when the teacher asked for a book report. I loved to read, but writing the report was always painful. As parents, many of us share these same feelings when watching our children struggle … counting the words to make sure they reach the minimum number. Writing the report on a short story was one level of challenge. But writing a book report on Moby Dick was an altogether different task. I wonder how many different interpretations of that book teachers have seen over the years from their students.

In many respects, an entity's financial statements and annual report are like a book report. The many thousands or millions of transactions in a given area are summarized into accounts that appear in the financial statements. The footnotes describe some of the accounting policies and details behind the numbers. Management's discussion and analysis explains the numbers and the trends. The auditor's report contains a simple pass/fail statement that the numbers in the financial statements are presented fairly in accordance with the accounting standards being followed. The financial statements and annual report are sometimes hundreds of pages long.

What we have heard is that investors are asking for an executive summary of the book report, with further discussion around the question, "How good are the numbers?"

There is a fundamental question at the heart of this issue as to what the role of the auditor is or should be. Having spent the last 32 years as an auditor, I know what auditors understand their role to be… expressing an opinion on the fairness of the financial statements. Hearing from some investors recently, I am getting the picture of what they think the auditor's role should be, which includes a much broader role to report on the business model, management and risks. All that is clear is that we have a long way to go to bridge the gap between the two, and articulate what the auditor's role will be in the future.

The issues being discussed in today's meeting are narrower that the broad question of the auditor's role. In many respects the issues have nothing to do with accounting or auditing, but rather, they are about communication. The PCAOB staff has performed significant outreach that they will be describing today. The input received from various constituents, not surprisingly, differs. The Board is considering a concept release to obtain further input. A proposed standard would follow after evaluating the concept release responses.

The Board is faced with the difficult task of using our professional judgment, and reconciling the views and input we receive, to provide investors more of what they need, as well as creating clear standards that auditors can follow, establishing a framework that promotes consistency in reporting — all against the backdrop of being timely and cost-effective.

Meanwhile, there are other very important changes possible to the audit, due to work underway at the Financial Accounting Standards Board. Accounting standards are in a constant state of evolution to keep up with new types of transactions and products. The FASB and the International Accounting Standards Board are nearing completion of new converged accounting standards that will dramatically change the numbers reported by many companies and change the accounting analysis used to arrive at those numbers. Some believe the effort to adopt these new standards will be greater than the initial effort made by firms to adopt the internal control standards under section 404 of the Sarbanes-Oxley Act. The question is still looming about when or if the United States will convert completely over to the International Financial Reporting Standards used abroad. We are evaluating whether changes to auditing standards will be necessary after the new accounting standards are issued.

All of this reminds us why any standards we propose to change the auditor's report also will need to be mindful of the increased complexity businesses are facing in today's challenging economic times and the ever expanding global reach of many companies.

Now is the time when the Board is weighing how best to protect investors as we consider changes to the auditor's reporting model. And we have to ask ourselves — if we ultimately set new standards that require the auditor to prepare a "book report" on their audit and the company's financial statements — will the auditors' interpretations be as diverse as school teachers have seen on Moby Dick over the years? Will investors find those interpretations to be what they needed?

With this in mind, I look forward to your presentation today. And I want to thank the Chief Accountant, Marty Baumann, and his staff, Jennifer Rand, Dan Mutzig, Diane Jules, and Jessica Watts, for all the time and attention they devoted to bringing these outreach results to the Board.

 

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