Introduction
Even though auditors sell their services, the profession of auditing – certainly of the financial kind rather than the forensic type – is unlikely to feature in the list of top one hundred most sexy professions in the world. Not because auditors themselves are not attractive or because they live boring lives. I am sure that a thorough research into the profession over the past seventy years will uncover a few auditors who have been involved in interesting activities, vocations and affairs of a non-financial nature. But the first problem is that a researcher is more likely to be attracted to a thesis on the why babies cry than on the life and times of an auditor. The second is that auditors seem to reserve their shenanigans to financial affairs that in extreme circumstances can result in the break-up of more than a domestic family. This was the case with Arthur Andersen LLP, up to 2001 one of the ‘Big Five’ but which in 2002 voluntarily surrendered its licences to practise as auditors after being found guilty of criminal charges relating to the firm’s handling of the auditing of Enron. It was subsequently cleared by the US Supreme Court but by then all its clients had fled to safer havens.
A profession whose major identifiable product – the audit opinion – remains fundamentally unchanged for seventy years has to attract the rare ISTJ type of personality and can hardly be expected to be anything but boring. In fact I recall at an Annual General Meeting a couple of years ago the Chairman, a member of the self-described learned profession no less, proposed that the auditor’s report be “taken as read” since the reading of the report by the Secretary would “turn members off.” Little does he know that that kind of disrespect for our professional output is one of the principal reasons why the audit fee always includes a premium, akin to damages for defamation!
The Americans
If the American audit regulator PCAOB (the Public Company Accounting Oversight Board) – set up under the Sarbanes-Oxley Act of the USA in response to the Enron/Andersen fiasco – has its way, the auditor’s opinion is likely to undergo its first major overhaul in seventy years, probably unique for any profession. But not before the auditor feels compelled to divert from poring over some unfathomable trial balance which s/he is ticking with a green or purple ink pen (the preserve of the profession) to write several letters stoutly defending the status quo. It is easy to imagine the accounting profession inventing the aphorism “if it ain’t broke, don’t fix it”!
So what exactly is the PCAOB recommending? Before addressing the question it may be useful to note that the audit report presented to shareholders is not the only product of the audit. In fact while that is the statutory output, the discussions which the auditor has with the client during the course of the audit, and the advice and recommendations contained in what is referred to as a management letter, are of immense if not greater benefit to the client. In the USA the auditors are required to communicate with the Audit Committee of the Board on several specific, high level issues, such as disagreements with management, consultations with other accountants on auditing and accounting issues, major issues discussed with management prior to retention and difficulties encountered in performing the audit.
They also send to the management a letter, unimaginatively called a management letter, in which they set out the findings arising from the audit, the implications of those findings to the operations and the financial statements and the auditors’ recommendations thereon. These are mainly intended to improve the efficiency and effectiveness of the client’s operations.
Guyana
Guyana subscribes to international rather than US standards, the former of which also have two separate standards on communicating following the audit, one named Communication with Those Charged with Governance and the other Communicating Deficiencies in Internal Control to Those Charged with Governance and Management.
My experience is that the two sets of issues are merged into a single management letter which goes initially as a draft to management for its comments which are incorporated into the final version of the management letter to the directors.
International
Almost simultaneously as the US has begun its initiative, the International Auditing and Assurance Standards Board (IAASB), which is supported by the International Federation of Accountants and whose pronouncements the Institute of Chartered Accountants of Guyana subscribes to, has come out with its own Consultation Paper Enhancing the Value of Auditor Reporting: Exploring Options for Change. This paper once again discusses the age old question of the expectation gap, that is the difference between what users expect from the auditor and the financial statement audit, and the reality of what an audit is.
The current consultation both in the US and internationally goes beyond this expectation gap. There is a perception that there should be more transparency about the entity and its financial statements, particularly key financial reporting risks and how they are being addressed; and how the audit is performed, including key areas of audit risk. One only has to consider the case of Enron in the US and our own Enrons such as Stanford and Clico to appreciate how inadequate a bald audit report and inadequate communications by auditors are to the users of financial information.
The information gap
Serious users of corporate financial information – not the little old ladies and gentlemen for whom attendance at an AGM is a highpoint of their social calendar – point to the existence of an information gap, described by the IAASB as the information users believe they need to make informed investment and fiduciary decisions, and what is available to them through the entity‘s audited financial statements or other publicly available information.
Any deficiency in the existence or presentation of such information could have serious implications for the efficiency of capital markets and the cost of capital – matters which are like oxygen to the capitalist world. For everyone, this information gap increases the challenges of understanding how corporate financial information, including the audited financial statements and related disclosures, reflects the overall picture of the entity‘s financial condition, performance and sustainability of its business.
Bridging the gap
What then do they believe can help? In a concept release the PCAOB has come up with four Approaches to Changing Auditor’s Report. A fact sheet released by the Board of PCAOB states that the four potential changes, which it describes as “alternatives,” are not mutually exclusive, so that any revised auditor’s report could include one or a combination of the alternatives, elements within the alternatives, or alternatives not currently presented in the concept release. The four are:
An Auditor’s discussion and analysis (AD&A) as a supplemental narrative report to the auditor’s report in which the auditor discusses his or her views regarding significant matters, such as audit risks identified in the audit, audit procedures and results, and auditor independence.
Required and expanded use of emphasis paragraphs. This would require inclusion of an expanded emphasis paragraph (currently optional) in all audit reports. The emphasis paragraph would highlight the most significant matters in the financial statements and identify where these matters are disclosed in the financial statements.
Auditor assurance on other information outside the financial statements. This would require auditors to provide assurance on information outside the financial statements, such as management’s discussion and analysis (MD&A) or other information (for example, non-GAAP information or earnings releases).
Clarification of language in the standard auditor’s report. This would involve clarifying what an audit represents and auditor responsibilities. Language and concepts that the PCAOB believes could be clarified include: reasonable assurance, auditor’s responsibility for fraud, auditor’s responsibility for financial statement disclosures, management’s responsibility for the preparation of the financial statements, auditor’s responsibility for information outside of the financial statements, and auditor independence.
The discussion paper put out by the IAASB lists eight issues of which the first is the risk facing the business while others include changes to accounting policies that have a significant impact on the financial statements, the methods and the judgments made in valuing assets and liabilities and significant unusual transactions.
Conclusion
It is early days yet and any decision will be some time in coming since the process has to consider the range of opinions and submissions which the PCAOB and the IAASB will receive, many of them self-serving and representative of vested interests. Both the Americans and the international board have set a time of September 2011 for the submission of comments. I hope that the Guyanese accounting profession that has distinguished itself by its avoidance of any issue of substance or significance will make some contribution to the discussion, even if it does so as part of the regional umbrella body.
Of course no one should draw the wrong inference: the fundamental nature of the audit opinion will remain the same – to report on the truth and fairness of the financial statements. What will change are the contents of the report which should just make auditors a bit more accountable and their product more useful.