A Return to Roots: General Responsibilities of the Auditor in Conducting an Audit

Remarks as prepared for delivery

Today, the Board considers a staff recommendation to create a new standard entitled "General Responsibilities of the Auditor in Conducting an Audit," to ensure that auditors understand and fully comply with their professional responsibilities.

I thought I would start my remarks this morning with a quote from the testimony before Congress of the President of the New York State Society of CPAs (Certified Public Accountants), Colonel Arthur Carter, in April 1933:

"It is generally regarded that an independent audit of any business is a good thing."¹

While no single figure was personally responsible for the establishment of the independent public company audit, independent audits of the financial statements of public companies became the cornerstone upon which investor confidence in the capital markets would be rebuilt after the Great Depression.

This organization, the Public Company Accounting Oversight Board, was created almost 70 years later to help preserve and strengthen that cornerstone.

Colonel Carter’s vision² of certified public accountants assuring the accuracy of financial statements included in public securities offerings and in the follow-on annual reports of public companies was enacted into law.

Expectations were set without clearly defined roles and responsibilities. Foundational terms, such as “accepted principles of account” were left out – because there were none.

In its report on the Securities and Exchange Commission’s (SEC) first major financial fraud investigation, the SEC described the shift in loyalty when accepting the audit of a public company:

“[T] he auditor must realize that, regardless of [previous] positions[s]…of reporting to managers or to owner-managers, [the auditor] must recognize fully [the] responsibility to public investors by including activities of management [] within the scope of work and reporting [] to investors.”

From 1933 to 2002, the accounting profession defined for itself what it believed to be its roles and responsibilities. However, the expectations of investors and the public, and auditors’ own view of their work, differed.

• Some members of the profession sought to weaken the obligation to detect fraud, which was deeply rooted in the accounting profession’s first mission.

   

•  By 1977, the “expectation gap” between what an auditors thought their role and responsibilities were, compared to what the public thought they were, had become increasingly untenable.

   

• The independent Cohen Commission noted that “any gap” was one-sided. Investors and other users had “reasonable expectations of the auditor.”³

   

• Regardless of any expectation gap, in 1984, the U.S. Supreme Court ruled that the “public watchdog” role of the auditor transcends loyalty to clients: 

“[I]t is [] not enough that financial statements be accurate; the public must also perceive them as being accurate.

Public faith in the reliability of a corporation’s financial statements depends upon the public perception of the outside auditor as an independent professional.”³

That is why I am particularly pleased that the proposed standard before us this morning anchors the role of the auditor in the obligation to protect investors.

This fundamental obligation of the auditor is clearly and unambiguously set forth in the first paragraph:

“.01     Auditors have a fundamental obligation to protect investors…”⁴

This paragraph further instructs the auditor that investor protection is the touchstone for their work, and it is how their work will be judged:

“…[A]nd that obligation governs the auditor’s work under the standards of the PCAOB.” 

This paragraph will provide certainty and confidence to auditors about what their responsibilities are in executing an audit. Moreover, as with the requirements in any auditing standard, the provision can be evaluated by inspections or through firm monitoring, and, if necessary, enforcement.

I hope each standard this Board promulgates going forward will include a paragraph on how that standard relates to the auditor’s public duties.

Today’s proposal attempts to articulate auditor behaviors that are vitally important to providing an independent, third-party audit of public company and broker-dealer financials:  

• reasonable assurance,
• due professional care,
• professional skepticism, and
• professional judgment.

All of these are considered foundational to an auditor's ability to rebut and challenge management of an issuer. The concepts are integral to an audit, but it is hard to fully capture their significance and meaning.

For example, professional skepticism lies at the heart of an auditor’s challenge to management. An auditor’s exercise of professional skepticism involves the auditor’s mental attitude, knowledge, and biases.

Auditors are uniquely situated with privileged access to management, and privileged access to both public and nonpublic information. They need to have the freedom and willingness to decide issues in an unbiased and objective manner. This is especially important when the auditor's conclusions may be contrary to the interests of management.

Historically, an auditor’s failure to maintain professional skepticism has been revealed to the markets at the same time as misrepresentations or fraud.  That is why professional skepticism is foundational to everything else that an auditor does.

Investors can have no tolerance for an independent auditor's work that nods without challenge. There should be no doubt in the minds of auditors, company management, investors, or other stakeholders about an auditor’s professional and legal obligations to exercise professional judgment and professional skepticism free from bias and interference in order to challenge and evaluate financial information freely. Or about the Board’s commitment to preserve the exercise of that obligation.

The proposed standard also clarifies the auditor’s obligation to exercise due professional care “in all matters related to the audit. In addition, the proposal clarifies the engagement partner’s responsibility for all phases of an audit, including accountability for ensuring the appropriate disposition of findings or audit issues concerning significant estimates, or assumptions by management prior to issuance of the audit report.

The proposal enhances an auditor’s evaluation of the presentation of the financial statements. This includes requiring an auditor’s determination of whether additional information or disclosures, beyond those required by the financial reporting framework, may be necessary.

Finally, I am keenly interested in hearing from investors and other commenters about the attributes of professional conduct.

• Are the general principles and responsibilities described in the proposal appropriate for audits performed under PCAOB standards? Have we gotten it right, or are there other attributes we should be considering?
• Are the general principles and concepts fit-for-purpose? If not, how should they be changed?
• Is the creation of one standard for generally applicable responsibilities, concepts, and principles the right approach?

I cannot end without acknowledging and thanking the entire standard-setting team on this project. In particular, Dominika Taraszkiewicz; Jessica Watts; Ekaterina Dizna; Akiko Upchurch, and Hunter Jones from the Office of the Chief Auditor, as well as Dylan Rassier from the Office of Economic and Risk Analysis.