Issue 1 | January 2014

Audit Reports to Identify Engagement Partner?

PCAOB issues proposal that follows IIASB’s lead

The PCAOB has been considering the requirement of disclosing the engagement partner’s name on the auditor’s report since 2005. A reproposal released in December raises the controversial issue once again, modifying a previously stalled 2011 effort. This latest attempt follows other auditor report changes proposed in August, as covered in the October Audit & Accounting Alert. These initiatives are responses to the objective to “improve the relevance and usefulness of the audit report for the investing public,” as stated in the PCAOB’s newly issued five year strategic plan.

The rest of the world appears to be further along in considering audit partner identification. The International Auditing and Assurance Standards Board included the disclosure in a July Exposure Draft (ED) that revamps audit report standards. A reading of comment letters to that ED reveals that most major audit authorities around the world already require audit partner identification, or are in favor of the requirement.

The Board members of the PCAOB unanimously approved the reproposal for consideration. Also included in the reproposal was a requirement to disclose the location of other participants that provided over 5% of the audit hours for an engagement, including the names of other audit firms involved. Currently, only the name of the primary audit firm is disclosed.

A number of expected benefits from the reproposal were voiced: 1) Transparency and accountability for the audit would be enhanced. 2) A sense of immediacy would be placed on the engagement partner, as a current reminder of responsibility for the quality of the audit (similar to the requirement of CEOs and CFOs to sign certifications of company financials). 3) Over time, investors would be able to accumulate data on auditors that would be useful in evaluating and comparing the level of quality between auditors. 4) Cost of capital would be reduced where auditors with higher perceived quality ratings are utilized. 5) There would be closer alignment with other jurisdictions globally.

 Some Board members expressed reservations that could prevent them from supporting the final standard: 1) Evidence was lacking that audit quality or auditor accountability would be enhanced. 2) Potentially greater legal liability could be placed on the engagement partner. In the original 2011 proposal, the partner’s signature was called for. By changing that requirement to only identifying the partner without an actual signature, the liability exposure was considered to be lessened. 3) Additional costs would be incurred on the audit. But that may infer that the audit work had been inadequate to start with. 4) Auditors would be deterred from taking “high-risk” audits. However, if a company is deemed “high risk,” there may be other more pressing issues that should be addressed, in any event.

The Board has provided a 60 day comment period that ends on February 3, 2014. Given the subjective nature of some of the expected benefits and concerns, this short time frame may not allow for much more clarity to come forth, than has been observed in the two years since the original proposal was presented.

Three other recent developments that respond to the objectives of the PCAOB’s strategic plan cover audit engagement quality reviews, consulting services, and worldwide audit inspections. A PCAOB report issued on December 6 indicates that while firms generally have engagement quality review methodologies that are consistent with the standards, the execution of the reviews does not always implement the standards called for in the methodologies. Also, the renewed focus on nonauditing consulting services by registered firms has given rise to concerns about the impact on independence and appropriate attention to the primary audit function. The PCAOB will take a closer look at this area in 2014. Finally, indications are that China has started to respond to the PCAOB’s call for inspection of Chinese audit workpapers. This past month, audit documents from several Chinese companies have been turned over to US regulators.

For further information, see PCAOB Proposes Engagement Partner Disclosure

Integrated Reporting Framework Released

Momentum continues for broader perspective in corporate reports

We first reported on sustainability accounting in the September 2012 Audit & Accounting Alert, where the history of the initiative up until that point was summarized. Then this past May, the worldwide publication of the International Integrated Reporting Council’s (IIRC) reporting framework Consultation Draft was covered, followed in October by the American Sustainability Accounting Standards Board’s (SASB) first effort at specific industry standards. 

Now, after considering 359 letters of comment over the past several months, the International Integrated Reporting (<IR>) Framework has been issued right on schedule in December. The 35 page document is accompanied by an 11 page Basis for Conclusions and 50 page Summary of Significant Issues.

As stated in the Framework, “The primary purpose of an integrated report is to explain to providers of financial capital how an organization creates value over time. An integrated report benefits all stakeholders interested in an organization’s ability to create value over time, including employees, customers, suppliers, business partners, local communities, legislators, regulators and policy-makers.” Taking a global approach, the Framework is principles-based and flexible, in that, depending on jurisdiction, the prescribed information can be presented in a standalone report, as a “distinguishable, prominent and accessible part of another report,” or as called for in compliance with local requirements.

A goal of this reporting approach is to foster a longer term and broader perspective, as opposed to the shortsighted, quarterly focus on results that currently prevails. The portrayal of value created or dissipated is designed to consider financial, manufactured, intellectual, human, social and relationship, and natural capital.

Describing the formation of the report, the Framework sets out guiding principles and content elements. The guiding principles are: 1) Strategic focus and future orientation, 2) Connectivity of information, 3) Stakeholder relationships, 4) Materiality, 5) Conciseness, 6) Reliability and completeness, and 7) Consistency and comparability.

The content elements that an integrated report should have are:

• Organizational overview and external environment: What does the organization do and what are the circumstances under which it operates?
• Governance: How does the organization’s governance structure support its ability to create value in the short, medium and long term?
• Business model: What is the organization’s business model?
• Risks and opportunities: What are the specific risks and opportunities that affect the organization’s ability to create value over the short, medium and long term, and how is the organization dealing with them?
• Strategy and resource allocation: Where does the organization want to go and how does it intend to get there?
• Performance: To what extent has the organization achieved its strategic objectives for the period and what are its outcomes in terms of effects on the capitals?
• Outlook: What challenges and uncertainties is the organization likely to encounter in pursuing its strategy, and what are the potential implications for its business model and future performance?
• Basis of presentation: How does the organization determine what matters to include in the integrated report and how are such matters quantified or evaluated?

A supportive Investor Network of 35 firms is providing an ongoing critique of the IR development process. In the 2013 Yearbook, their recommendations for improving disclosures included:

1. Providing a clear overview of the business model
2. Addressing industry-specific factors, including trends, risks and opportunities, over the long term
3. Indicating timeframes for key strategies, milestones and targets, looking beyond the short and medium term to longer term horizons
4. Aligning integrated reports and other key disclosures, including financial statements, management discussion and analysis or management commentary, sustainability reports, codes of conduct and policy statements.

Asked about the main barrier to investors calling for integrated reports, one of the Investor Network representatives pointed out the need for more consistency and assurance with the reporting.

 While the development of the Framework and related guidance have come together relatively quickly, the broad application will take time. As indicated by the pilot project which includes over 100 companies from around the world, some have gotten the message and are paying attention to future trends and their impact. However, many others are still bound by the pressures of creating profits on a quarterly basis. Eventually that mentality may limit their long term prosperity unless they find a means of moving toward the broader perspective called for in integrated reporting.

For further information, see The International <IR> Framework released with Business and Investor support.

Additional A&A News

The following links provide a selection of current articles devoted to highlighting other A&A topics currently making news.

1. PCC Standards for Goodwill: What Valuation Specialists Need to Know
2. CAQ suggests streamlining proposed auditor reporting duties
3. FASB, IASB to Tackle Lease Issues in January
4. Islamic Accounting Needs Broader Adoption, Says AAOIFI Chief
5. FRC to simplify small company accounting
6. Compliance Mountains to Climb