U.S. regulators will resume a year long quest to get audit firms to tell investors more about the companies they examine

Improving Audit Reports Is Focus of Hearing

MICHAEL RAPOPORT

April 1, 2014 8:28 p.m. ET

U.S. regulators this week will resume a yearslong quest to get audit firms to tell investors more about the companies they examine. It won’t be easy.

The Public Company Accounting Oversight Board will hold a two-day hearing in Washington on Wednesday and Thursday to listen to the clashing perspectives of three-dozen audit-firm partners, investor advocates, academics, corporate officials and others over the issue of so-called auditor’s reports.

Last August, regulators proposed an overhaul of the reports, the boilerplate letters in the annual reports of every company in which an auditor attests that the numbers are accurate, to make them more useful to investors.

But while auditors, investors and companies agree an overhaul is needed, they can’t agree on the details, and many critics have said parts of the proposal would be too burdensome or could lead to unexpected consequences.

The wrangling shows how difficult it can be to change the rules in a way that benefits investors while still being acceptable to both corporations and auditors.

“The profession’s been talking about this for decades,” said Joseph Ucuzoglu, Deloitte & Touche LLP’s national managing partner for regulatory and professional matters. “Every time it comes up, we let all the challenges and disagreements get in the way. We have to be willing to change what we do to make our work product more valuable.”

The board hopes the discussion will bring the parties closer to a pact.

It is advocating new disclosures telling investors about some of the tough calls an auditor makes and whether the auditor thinks a company is telling the truth, even outside the financial statements.

“People want more from the audit, not less—more insight, more independence, more reliability,” said PCAOB Chairman James Doty.

He said he hopes the meeting “will deepen the debate” over potential changes to the auditor’s report.

Some big accounting firms say they recognize the need to give investors more information than just the “pass-fail” approach of the current report, which doesn’t offer investors much substance on what an auditor thinks of a company.

“We are very supportive of the PCAOB’s efforts to refine the model in ways that will improve audit quality and ultimately benefit investors,” said James Liddy, KPMG LLP’s regional head of audit for the Americas.

Accounting firms also are leery of some of the ideas being discussed. “These are big changes, and I think we need to tread cautiously but definitely move forward,” said Cindy Fornelli, executive director of the Center for Audit Quality, representing the accounting industry.

Auditor’s reports currently require only that an auditor assess whether a company’s financial statements are “fairly presented.” They don’t include any further detail about the quality of the company’s information or accounting practices, and no specifics about what the auditor found during its audit.

The PCAOB’s proposal from last year would keep the pass-fail approach but would require auditors to discuss any so-called critical audit matters in each company’s audit report—the parts of the audit that keep auditors up at night, in which they had to make their toughest or most complex judgments or which gave them the most difficulty in forming their opinion. A company’s approach to valuing a portfolio of complex securities could be a critical audit matter, for instance.

Auditors also would have to evaluate other information in a company’s annual report beyond the financial statements, such as its assertions in the Management’s Discussion and Analysis section of the report, to check for any errors or inconsistencies with the company’s reported numbers. They also would have to add disclosures to the audit report about issues like how long the auditor has worked for the company.

Some accounting-firm executives are concerned that the proposals could improperly put the auditor in the position of disclosing more information about the company than the company itself does. “We do need to be careful about making changes without understanding the nature and potential impact of such changes,” said Mr. Liddy.

Others are concerned that lots of issues could qualify as “critical audit matters” under the PCAOB’s definition, and that could prompt auditors to err on the side of caution by designating dozens of issues in that fashion, which would make the auditor’s report unwieldy.

“If you have a hundred of these things, it’s obviously not going to be that helpful to investors,” said Douglas Skinner, a University of Chicago accounting professor.