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 Concept Release on Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements

DATE: June 21, 2011
SPEAKER: Lewis H. Ferguson, Board Member
EVENT: PCAOB Open Board Meeting
LOCATION: Washington, DC

Thank you Mr. Chairman.

I am pleased that the Board has undertaken a project to examine the auditor's reporting model and whether the auditor's report can be improved and made more useful. Although the Board has undertaken a number of important projects during its eight year life, I believe that this is potentially one of the most significant projects that the Board has yet undertaken. I support issuing the concept release for public comment.

Time For Change

This project was undertaken in response to what appears to be a fairly widespread dissatisfaction on the part of investors and other financial statement users with the current form and content of the auditor's report. This dissatisfaction is not new but, as the concept release states, has been expressed by financial statement users for decades. The current auditor's report provides a general level of information for investors and financial statement users — that the issuer's financials statements and footnote disclosures are presented fairly in all material respects. Unfortunately, this pass/fail model does not provide the types of specific information that investors and other financial statement users are seeking. I believe that the auditor's reporting model can be improved to provide additional information of the type sought by investors and other financial statement users without inappropriately compromising management's primary responsibility for conveying financial information to the public.

Increasing Complexity

Increasingly, financial statements and footnote disclosures are comprised of numbers that are based on ranges or management's estimates of things such as the fair value of assets and liabilities rather than amounts that can be measured precisely. The increasing use of financial instruments such as derivatives and the global operations of many public companies with their exposures to currency fluctuations have made financial reporting and financial statements much more complex than in the past, and in some ways, imprecise. Auditors today, for example, must test the valuations and range of estimates in these financial statements, ascertain if they are fairly presented, and express their views in the auditor's report. Unfortunately, the truncated pass/fail model only conveys the auditor's final conclusion to users of the financial statements that the financial statements are or are not fairly presented and gives little or no clue to the many analytical processes and risk assessments that underlie those conclusions.

The Auditor's Role

Auditors provide a valuable service for preparers, investors and other financial statement users, and the US capital markets. However, I believe that the time has come for the auditors to expand their reporting to include certain other information that investors and financial statement users are seeking. We know that auditors, assuming they are doing their jobs, bring expertise and experience to the audit and learn a tremendous amount about the company's financial condition during the audit. The auditors read, review, test, and corroborate the financial information presented by management. The auditors formulate their views regarding the financial information, communicate and discuss with the audit committee the results of testing and the significant risks and issues identified during the audit, and determine if the financial statements and footnote disclosures are presented fairly in all material respects. Unfortunately, under the present auditor's reporting model, this information is largely masked from public view.

In considering this issue, the Board is aware of, and sensitive to, the fact that the financial statements are the responsibility of management and the board of directors, and we are fully cognizant of the risks involved in having a third party, such as an auditor, express subjective views about a company's financial condition.

Some commentators in the Board's outreach process on this issue expressed the view that any additional information that investors and other financial statement users are seeking could and should be provided by management or the audit committee of the company's board of directors, and not by the auditor. Other commentators have argued, equally forcefully, that investors want the auditor to provide this information because the auditor is an objective, unaffiliated, third party having unique technical expertise to assess and determine the fairness of the financial statements and the areas of financial and audit risk faced by the company.

Alternatives to the Current Auditor's Report

The concept release outlines different potential alternatives to the auditor's report which would provide a range of information to investors and other financial statement users. The alternatives are not mutually exclusive, and a revised auditor's report could include one or a combination of these alternatives or elements of these alternatives. I would like to note that the Board has not made a decision at this time regarding which is the most appropriate approach to take. This is the beginning, not the conclusion, of a process to determine whether the auditor's report needs to be modified and, if so, the best solution for improving it. The Board is interested in what information the investors and other financial statement users feel that they need to make their investment decisions, and how that information can best be provided while preserving management's primary responsibility for financial information, the comparability of audit reports between companies and industries, and the independence of auditors. As we move forward, the Board will be mindful that the auditor's role only extends to opining on the financial statements and disclosures of the company and does not extend to analyzing the company's business model and related business risk.

Call for Comments

The Board is also aware that a number of the proposed alternatives would require the PCAOB to issue new auditing standards to guide auditors in performing these new tasks. The staff is recommending issuing the concept release for more than a hundred-day comment period. I hope that the longer-than-typical comment period will provide investors, other financial statement users, preparers, auditors and audit committee members with sufficient time to provide their thoughtful views on the different alternatives presented in the concept release.

I would like to note that some of the alternatives outlined in the concept release potentially could increase the cost of the audit. Personally, I am particularly interested in hearing from investors and other financial statement users regarding whether they believe an increase in audit cost would, in fact, occur under the various scenarios proposed and whether any additional cost would be justified.

Additionally, one of the alternatives includes the potential for the auditor to supplement the pass/fail auditor's report with an auditor's disclosure and analysis, which could be written differently for each issuer audit. The Board is interested in knowing whether investors and other financial statements users would find such an analysis valuable and what advantages or disadvantages it would offer.

Finally, I am interested in learning about what other alternatives the Board should consider that are not presented in the concept release.

Closing

In closing, I would like to thank the many PCAOB staff members who are working on this project — Marty Baumann, Jennifer Rand, Jessica Watts, Nina Mojiri-Azad, and Bob Burns. Without their hard work and creativity, we wouldn't be here today discussing the potential improvements to the auditor's report. I would also like to thank the SEC's Office of the Chief Accountant for their support and guidance. And, I would like to thank in advance the many investors, preparers, auditors and audit committee members who will take the time out of their busy schedules to provide their views on how to proceed with improving the auditor's reporting model. This project will not succeed without your thoughtful and insightful comments.

I now would like to ask the staff a few questions.

 

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