Financial statement disclosures have become a key component of public company financial reporting. Over the years, the FASB has expanded the nature and scope of the disclosures that are required in financial statements, and disclosures have become more qualitative. The notes to a public company's financial statements frequently run many pages in length and cover topics ranging from the selection of accounting principles to the assumptions underlying fair value determinations. The transformation of financial statements from simply a series of line items into a more comprehensive presentation that includes extensive narrative is the result of the increasing complexity of business transactions, of the increased use of fair value and other accounting estimates, and of demands from financial statement users for more relevant information.
Financial statement disclosures are still evolving. In particular, some recent and proposed accounting standards contain disclosure requirements that are objectives-based and explicitly depend on preparer judgment. For example, the proposed Financial Instruments ASU requires the reporting entity to "determine, in light of facts and circumstances, how much detail it is required to provide * * * and how it disaggregates information into classes for assets with different risk characteristics." The proposed ASU also states that an entity "should strike a balance between obscuring important information as a result of too much aggregation and overburdening financial statements with excessive detail that may not assist financial statement users in understanding the entity's financial instruments and allowance for credit losses." How that balance should be struck is left to the preparer. Complying with this sort of requirement will require the exercise of considerable judgment.
The financial statement audit encompasses the disclosures, and therefore, as the scope and complexity of disclosure increases, so should the scope and sophistication of the auditor's work. Under existing PCAOB standards, auditors are required to plan and perform the audit to obtain reasonable assurance about whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework. This includes performing procedures to test the disclosures and to evaluate whether the financial statements contain all of the disclosures required by the reporting framework and all of the information essential for a fair presentation.
The Board's interim standards took financial statement disclosures into account, and the recently adopted risk assessment standards call for auditors to devote still more attention to disclosures. For example, Auditing Standard No. 12 requires the auditor to develop expectations about the disclosures that are necessary for the company's financial statements to be presented fairly in conformity with the applicable reporting framework. PCAOB standards also require auditors to perform procedures to assess the risk of omitted, incomplete, or inaccurate disclosures and to identify and test significant disclosures. In an integrated audit, Auditing Standard No. 5 requires the auditor to test controls over significant disclosures.
During the discussion today, the Board is interested in learning about the challenges that the financial statement disclosure requirements — and the trends toward more qualitative disclosure and more preparer judgment concerning the content of disclosures — pose for auditors. We would also like to understand how auditors are addressing those challenges and how preparers and investors see the auditor's role in this area. The Board is particularly interested in the SAG's views concerning whether there are further changes to the auditing standards that the Board should consider and whether there are other forms of guidance that the Board should consider issuing in order to ensure that auditors devote proper attention to disclosures.
To lead that discussion, I will now turn the floor over to Deputy Chief Auditor Keith Wilson.