Audits: What More Can Be
What is controversial about
requiring audit firm engagement partners to sign audit reports?
controversy is rooted mainly in different views of whether this step is
necessary or sufficient to improve audit quality and/or make auditors
more accountable to investors.
(mostly investors) see the following benefits:
visibility of the engagement partner's name will help investors
assess risks associated with audits, make auditor ratification
decisions, and communicate with auditors (in ways supplemental to
questions raised at annual shareholders meetings). Most notably, it
will enable research on track records of individual partners and
facilitate questions about their past affiliation with clients
having troublesome matters, e.g., restatements.
also help to improve audits. The signature requirement will fix
accountability (similar to the way the Sarbanes Oxley Act
requires that corporate officers certify to the accuracy of
financial statements). In effect, this exposure will force the
individual to take greater ownership of the opinion.
(mostly auditors) argue that:
transparency can be achieved through proxy disclosures (rather than
additional signatures on audit reports).
communications with investors are limited by restrictions on revealing
confidential information or selectively disclosing information to
signatures will not improve audits because the requirement may embolden
practitioners to circumvent consultations and procedures that are
needed to adapt to US liability practices under which the audit opinion
is backed by the assets of the entire firm (not just the individual
Could required signatures by
audit partners have unintended consequences?
This is an
open question in the PCAOB's Concept Release. Concerns about possible
consequences have ranged from increased audit fees to the need for
issuers of financial statements to explain the reasons for any change in
the engagement partner assigned to the company.
standards on supervision of audit work help?
Inspection Division has identified "inadequate supervision and review"
as an important factor that has allowed audit deficiencies to occur in
recent years. Among the areas in which weaknesses were noted are
internal inspection programs and oversight of work performed by audit
firms' foreign affiliates.
of additional information might the PCAOB make available to investors?
The PCAOB may
soon make available more information about:
that fail to remediate deficiencies in their quality control systems.
of firms that the Board has not yet inspected.
The number of
international inspections that have been deferred and the reasons for
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Investor Confidence in Audits:
What More Can be Done?
Last updated: February15, 2010
Seemingly sudden bank failures and massive undetected
investment swindles have fueled fresh criticism of the value of
independent audits as a way to protect investors. Much has been done
since the Enron meltdown and other accounting scandals to preserve the
integrity and effectiveness of audits of public companies. Yet there is
still room for improvement, and regulators are considering a number of
additional steps designed to further strengthen audits and restore
investor confidence. This Special Report
summarizes the basics of auditing, describes the events and trends that are likely to
affect future audits of public companies, and provides links to additional
Current Audit Practices
Public companies listed on
US capital markets must obtain independent audits of their published
historical financial statements. Key points to keep in mind:
The requirements for audited financial statements. The US Securities and Exchange Commission
(SEC) requires that companies that are
listed on US capital markets file certain reports, including an
annual report with audited financial statements.
The objective of an audit of financial statements. The objective of an audit of financial statements is to determine whether the financial statements are
stated in accordance with specified criteria. For US public
companies traded on US capital markets, the criteria are US
generally accepted accounting principles (US GAAP).
Auditors and CPAs. The term "auditor" typically refers to a firm of
certified public accountants (CPAs). The use of the title CPA is
regulated in the US by state laws.
The role of the PCAOB. To perform an audit of the financial statements of a
public company, an independent auditor must be registered with the
US Public Company Accounting Oversight Board (PCAOB). The PCAOB sets
the standards for audits of public companies and inspects audit
firms to determine if their audits comply with the standards.
The auditor's role. The auditor's
role is to gather sufficient evidence to determine
whether the financial statements contain material errors or other
misstatements and to communicate the findings of audits to
shareholders and others in a written audit report that
indicates whether the financial statements are in material
conformity with GAAP.
Under an integrated
approach to auditing, the auditor considers both the risk of
misstatements and the operating controls put in place by a company's
management to prevent misstatements. Where applicable, the auditor
must attest to management's report on the effectiveness of internal
control over financial reporting.
responsibility to investors. The CPA firm that issues an opinion
on the financial statements of a public company is hired and
compensated by the company's audit committee. The firm has a
responsibility to act in the public interest because it owes its
ultimate allegiance to the corporation's creditors and stockholders,
as well as to the investing public.
Improvements and Recommendations
August 2009, the SEC
approved a new set of reporting
requirements for all firms registered with the PCAOB.
The new rules require that these firms file annual reports containing certain required
disclosures and that the firms issue special reports when certain events
The added disclosures are designed to help investors and regulators
better assess the risks associated with audit firms and their audit
addition, the following additional steps were discussed in a report from
a high-level advisory committee:
Require that the partner responsible for the audit sign the audit
report. On July 28, 2009, the PCAOB requested comments on a
controversial Concept Release. The purpose of the release is to
consider the pros and cons of requiring the engagement partner who
oversees the audit work to sign the audit report. Currently,
practice varies around the world. The US practice is that the report
bears the signature of only the CPA firm. In Europe and in the
approach discussed in the Concept Release, the report must contain
the signature of the engagement partner in addition to the firm's
Require that US audit firms provide investors with annual reports.
Another area in which US practice differs from European practice is
in the level of information about audit firms that is made available
directly to investors. For example, UK audit firms are required to
publish audited financial statements, but US firms are not required
to do so. The final report of the US Treasury Advisory Committee
on the Auditing Profession,
also known as the Paulson Committee,
contained several suggestions in this regard. The Committee's
co-chairs suggested that at least the largest firms should be
required to make audited financial statements available to audit
committees and the investing public.
Establish a formal system for monitoring sources of catastrophic
risk to audit firms. Another recommendation in the Paulson
Committee's report is that the PCAOB should monitor sources of
catastrophic risk to audit firms. A key concern is that global
networks of accounting firms could create new areas of risk and gaps
in regulatory oversight. In the new regulatory environment that is
emerging in the wake of the financial crisis of 2008 and 2009, there
is a concern that some accounting firms, like some banks and other
institutions, may be growing too big to fail or may need an
Morph toward an expanded plain-English audit report. Investors
might find audit reports more useful if the reports contained more
explanations of the audit process and more findings. For example,
the report might clarify the auditor's responsibility to detect
fraud. Or it might highlight some of the important judgments and
estimates that a company makes in putting together its financial
Other possible steps. Other steps being discussed now include
creation of a national center for the prevention and detection of
financial fraud, appointment of independent members to serve on
advisory boards to audit firms, and a study to identify ways to
remove barriers to growth by smaller auditing firms.
Importantly, PCAOB board member Steven Harris has said publicly that he
believes all these areas should be given serious consideration by the
SEC and PCAOB.
Other PCAOB Priorities
Additional PCAOB priorities relating to investor protection include a
standard-setting initiative to address supervision of audit work and a
project to provide enhanced reporting of the Board's own activities for
the benefit of investors and other interested parties. Going
forward, Harris expressed strong support for more participation by
investors in discussions about ways to improve audit quality, both at
the PCAOB and at the International Forum of Independent Audit Regulators
(IFIAR), of which the PCAOB is a member.
PCAOB Concept Release on Signatures Required for Audit Reports
PCAOB RuleMaking Docket on Concept Release
Remarks by PCAOB Board member Steven Harris
Sarbanes-Oxley Act of 2002