The Case For Converging to a High Quality International Auditing Standard

Sponsored by the Academy of Accounting Historians and the Public Interest Section of the American Accounting Association

I welcome this opportunity for further interaction with the AAA, which began for me with a joint appearance with Chairman Mike Oxley at the AAA annual meeting in San Francisco in 2005.

As required by the PCAOB Ethics Code, let me begin by stating that these are my personal remarks and do not necessarily represent the views of the Board or staff of the PCAOB.

One outgrowth of PCAOB/AAA collaboration has been a series of symposia, the fourth of which will be held here in Washington later this month.

As a byproduct of these meetings with the Auditing Section of the AAA, scholars have prepared nine synthesis papers on subjects of importance to the PCAOB as it carries out its statutory responsibilities with the goal of improving audit quality. The completed papers cover: audit confirmations, audit firm quality control, the audit reporting model, auditor risk assessments, communications with audit committees, engagement quality review, fair value, financial fraud, and related party transactions.

Our focus through our inspection program is ensuring that generally accepted accounting principles are being applied properly but we, of course, do not write accounting standards, which in the United States is done by FASB. A major change is underway in the accounting field as international financial reporting standards for the first time can be used by foreign private issuers without reconciliation to GAAP with the possibility that the SEC may extend the use of IFRS to domestic issuers.

This move towards the use of international standards for accounting inevitably calls attention to the variation in auditing standards both globally and within the United States and raises the question whether convergence of auditing standards is a desirable goal for standards writers here and abroad.

At home we currently have two differing sets of auditing standards, one developed by the ASB of the AICPA and the other our PCAOB standards. And there are perhaps a dozen other auditing standards setters around the world, including the IAASB.

This year PCAOB will consider whether to move the issue of multiple auditing standards to the front burner. Specifically, our latest Strategic Plan, under the general goal of playing “a leadership role in international efforts to improve auditor oversight and auditing practices worldwide and reduce duplication of effort” commits us to “examine the implications for the PCAOB’s mission of multiple auditing standards and varying audit environments across global capital markets and consider how the Board should respond.”

A major part of such an effort is to reach out to groups such as yours which may be able to give the Board wise counsel based both on current and historical experience.

For the PCAOB the key to all our decision-making is always to stay focused on the impact of our actions on investors. Thus the policy question is whether investors would be better served if there were less variation in auditing standards.

Note that I do not say no variation in auditing standards. For example Section 404(b) of Sarbanes-Oxley requires that audits of US issuers include a separate but integrated audit to determine the effectiveness of internal controls over financial reporting. And there is – to say the least – less than a groundswell of support for using 404 or its equivalent elsewhere round the world.

For this reason I am not suggesting that international standards be adopted “as is” here at home but rather that we move towards “convergence” (or, if you prefer, “harmonization”) with International Standards of Auditing (the ISAs) and with standards promulgated by the Auditing Standards Board. A useful first step would be to bring into closer alignment ASB and PCAOB standards consistent with improving audit quality.

Questions have been raised, as you will note in the wording of PCAOB’s Strategic Plan, as to whether differing audit environments materially and negatively impact the quality of audits, a possibility that could seriously impact PCAOB’s degree of reliance on foreign audit oversight bodies in the inspection of non-US registered firms. As such differing audit environments and cultural differences are identified – some of which may be as simple as differences in translations and others much more difficult to deal with – it seems to me that discussions with other audit oversight bodies hold considerable promise of moving towards convergence not only in the written standards but in the way in which they are implemented.

As to the standards, two separate but related issues arise:

First, of course, the appropriateness of the objectives and requirements of the standards themselves, and second, and more of an operational issue but nonetheless important, the formatting of the standards, that is the clarity of the wording, organization, and presentation which may impact the auditors’ ability to understand and follow the standards and, of course, inspectors’ ability to monitor compliance.

As a layman, a non CPA, I have wondered how firms large and small go about training and applying different sets of standards. It is my understanding that large firms do so by incorporating required provisions into their own methodologies, using the ISAs as the base, an approach likely to be impractical for smaller firms. My further understanding is that the ASB has embarked on rewriting its standards over a two-year period using the ISAs as the base or template with pluses or minuses to reflect differences when applying ASB rather than international standards. These differences are expected to arise because of specific aspects of our US environment and largely be reflected as guidance in the application of standards rather than significant numbers of additional requirements, an approach followed by many standard setters around the world. In fact, unless PCAOB modifies the format of its standards writing, it may, in two years time, be the only major standards writer not to use international standards as a base.

At times I have thought that I was a voice in the wilderness on convergence of auditing standards, but I find that is not the case.

For example, one of the leaders of the AAA, Zoe-Vonna Palmrose, last December spoke on this subject at the AICPA National Conference here in Washington. She is currently Deputy Chief Accountant for Professional Practice at the SEC and, as you may know, she formerly was Vice President-Research and a member of the AAA’s Executive Committee and was on the Auditing Section’s Executive Committee while serving as Secretary-Treasurer and then Research Director of the Section. In her December speech she said: “To facilitate the Commission’s oversight responsibilities in this area, the staff meets regularly with the PCAOB staff to discuss and provide input on the PCAOB’s standard-setting activities. In this regard, it is also noteworthy that in considering proposed PCAOB standards, a current priority for the Chief Accountant and OCA is how PCAOB standards relate to those of the IAASB and the ASB, where agreements exist for converging the latter two sets of standards.

“Working towards convergence of auditing standards globally is likewise a theme that has emerged from discussions at the PCAOB’s Standing Advisory Group meetings. Further, it is a perspective receiving prominence in the recommendations of other groups. For example, the Bloomberg/Schumer Report suggested that, ‘The PCAOB should take a world leadership role in establishing [the standardization of world-wide auditing standards] as a priority for the relevant national bodies.’ And the GAO noted at the Commission’s April 4, 2007 open meeting, that ‘Everyone will be best served by having standards setters develop consistent core auditing standards.’”

Other voices have been raised both here and abroad on convergence of auditing standards. PCAOB recently put out for comment a Proposed Policy Statement regarding the degree of reliance the PCAOB should place on inspections by non-US accounting oversight bodies. While convergence was not involved in the Proposed Policy, several commentators offered their thoughts on this subject.

KPMG stated: “The focus should be on how to achieve full international convergence of inspection and registration regimes, like in the area of accounting standards and auditing standards.”

The Federal Audit Oversight Authority (FAOA) of the Swiss Confederation commented: “The FAOA welcomes the current convergence process between US GAAP and IFRS standards. This convergence will in the near future also have an impact on the auditing standards. Accordingly, the differences between the auditing of financial statements pursuant to US law and pursuant to Swiss law will be minimal. The FAOA therefore believes that the cooperation between audit oversight authorities should move step by step from a full reliance system to a final system of mutual recognition.”

And finally, Mazars (a large international partnership based in France) commented in connection with the proposed criterion that the non-US oversight inspection staff must have sufficient expertise in the applicable US laws, regulations, and professional standards: “The practical implementation of this criterion might be difficult. Depending on the level of expertise required, it could turn out difficult and costly for non-US authorities to find and hire such experts, who moreover need to be independent of the audit firms inspected. Looking at the reverse reliance of non-US authorities on work performed by the PCAOB, it is rather doubtful whether the PCAOB will have the expertise in about 80 different national laws, regulations and standards. We therefore expect the PCAOB to take a realistic approach when defining the requirements with regard to this criterion. This practical problem shows the importance of accelerating the convergence process towards a single auditing standard such as the International Standards on Auditing (ISA)”

Not everyone will agree, I’m sure, with the direction I think we should head or with the comments from others I just quoted. But it is my view that recognizing the negative impact of multiple auditing standards and moving towards a single, high-quality internationally accepted set of auditing standards would be a positive step towards meeting the objective set out in the Preamble of Sarbanes-Oxley: “To protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws…”