Statement on the Board's Discussion of the Auditor's Reporting Model

Thank you Mr. Chairman.

Since the early 1900's, the auditor's report has undergone many changes. In the beginning, when no authoritative accounting or auditing standards existed in the U. S., auditors wrote individual, free-form audit reports for every engagement. As an example of such a report, in 1905, the Sears Roebuck auditor's report included the following statements:

  • We have visited the stores and warehouses and found them well kept, swept clean, orderly and proper for efficient business….
  • We have checked the figures and found them to be in order. The records were orderly and well kept.
  • We met Mr Sears and Mr Roebuck and found them to be men of character and integrity; good Christian gentlemen.

By the 1930's, the audit profession adopted a standard form for the auditor's report because they believed that uniform report language 1) would make audit reports more readily comparable and consequently reduce misunderstandings due to ambiguous or vague wording, and 2) make qualifications in audit reports more easily recognizable.

Since then, the form and content of the auditor's report has been studied and debated in the U.S. and internationally. By the 1970's, the phrase "expectation gap" was being used to describe the difference between the levels of expected performance as envisioned by the auditor and by the users of financial statements. In 1979, the Cohen Commission and then in 1985, the Treadway Commission, were established to reexamine both the auditor's responsibilities and the form of the auditor's report and the related "expectations gap" between auditors and financial statement users. These analyses resulted in the addition of the scope paragraph to the auditor's report, which sets forth the respective responsibilities of management and the independent auditor, describes the work performed by the auditor, explains the limitation of an audit, and emphasizes the fact that sufficient evidence is gathered to provide a reasonable basis for the auditor's opinion.

Although the auditor's report changed in light of these recommendations, the expectation gap continued to exist. In 2008, the Treasury Department's Advisory Committee on the Auditing Profession, known as the ACAP Committee, released its report recommending that the PCAOB undertake a standard-setting initiative to consider changes to the auditor's standard reporting model because the "standardized wording does not adequately reflect the amount of auditor work and judgment." One reason ACAP cited for suggesting changes to the content of the audit report is that the increasing complexity of global business operations are compelling a growing use of judgments and estimates, including those related to fair value measurements, and that an enhanced auditor's report may strengthen investor confidence in financial reporting.

I am pleased that the Office of the Chief Auditor has undertaken a project to consider improvements to the auditor's report.

Business operations, particularly those of large global enterprises, grow ever more complex. Financial markets spawn new investment vehicles at dizzying speed, many of which rely on assumptions, judgments and estimates about valuations and future events. Although issuers' financial statements have evolved to include disclosures concerning those estimates and assumptions, and presumably the auditor's work has evolved to test and verify those estimates and assumptions, the auditor's report has remained the same.

The current auditor's report gives only a limited hint about the amount of work and effort that auditors put into auditing an issuer's financial statements and related disclosures, as well as the issues that the auditor found to be significant. Although the pass/fail auditor's report is uniform, concise and to the point, and provides admirable comparability with other audit reports, it doesn't provide investors and other users of financial statements any information beyond the auditor's final opinion.

The auditor's report is the vehicle auditors use to let investors know whether the company's financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of the entity being audited in conformity with GAAP. Typically, the auditor's report is addressed to the Board of Directors and the shareholders, or said another way, the owners in the company, those with capital at risk. The auditor's role is to be objective, independent, and to conduct an audit of the financial statements and related disclosures on behalf of the investors.

For many decades, investors have been asking for the auditor to provide more information than just their opinion in the auditor's report. Following the recent financial crisis, when many investors felt they had inadequate warning of brewing problems, and in light of the evolution of global financial markets and business practices, the time has come to evaluate holistically both the investors' needs and what auditors reasonably can be expected to provide in an audit report or a supplemental document that goes beyond just their opinion on the fairness of the financial statements.

The goal of this project is not to increase the number or type of audit procedures the auditor performs during an audit; presumably auditors are already evaluating issues such as audit risk, management's estimates, judgments, and fair value measurements, before they express their opinion. The goal of our exercise is to determine what type of information investors feel that they need from an independent party as they are making their investment decisions, and whether the auditor or someone else can reasonably be expected to provide that information. The information investors are seeking is already available to the auditor, and the goal is to determine what information should be provided to the investor. It is obvious to me that, although the auditor's report has changed in the last several decades, the changes have not addressed the investors' perceived needs and have not materially reduced the so-called "expectations gap."

As standard-setters, we need to do a better job of addressing the needs of investors. I believe this project is a step in the right direction. I applaud the Office of the Chief Auditor for conducting such an extensive outreach to investors, preparers, audit committee members, and auditors. I look forward to the issuance of a concept release and the staff's recommendation on how to address the investors' concerns.

Finally, I would like to thank the many PCAOB staff members who are working on this project — Marty Baumann, Jennifer Rand, Dan Mutzig, Jessica Watts, Diane Jules, 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 many investors, preparers, auditors and audit committee members who took the time out of their busy schedules to meet with the staff and provide their views on how to potentially improve the auditor's report.

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

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