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Public Companies Criticize Proposed Expansion of Auditor’s Report

December 13, 2013

Public companies submitting comment letters in response to the PCAOB’s proposed expansion of the auditor’s report emphatically told the board that they don’t like the plan. The board wants auditors to disclose what they determined to be the critical issues as they reviewed a company’s financial statements. Companies said the lengthier disclosures will add unnecessary costs and give investors very little in the way of valuable information.

Companies writing to the PCAOB widely panned the audit regulator’s plan to improve the usefulness of the audit report, raising the prospect that the board may have to modify the proposed changes before issuing a final standard.

As drafted, the plan “will unnecessarily delay financial reporting, weaken the primary objective of audit reports, and result in increased costs to companies without significant benefits to financial statements users,” wrote Luca Maestri, Apple Inc.’s vice president and corporate controller on December 10, 2013.

The audit regulator started the project to expand the audit report about three years ago, after investors complained that the report’s current pass-fail model is of only modest use. Investors said they wanted to know more about what auditors thought when they scrutinized a company’s financial statements.

The board said it will hold a roundtable in 2014 on the issue.

The PCAOB in June 2011 issued Concept Release No. 2011-003, Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements and Related Amendments to PCAOB Standards, and followed with a proposal in August 2013, Release No. 2013-005, Proposed Auditing Standards on the Auditor’s Report and The Auditor’s Responsibilities Regarding Other Information and Related Amendments.

The PCAOB’s proposed approach retains the pass-fail model, but it also asks auditors to communicate what they determined to be critical audit matters (CAMs), including the issues they believed were the most difficult and complex during the audit.

Companies in industries as diverse as technology, pharmaceuticals, banking, and shipping had little positive to say about Release No. 2013-005. The U.S. Chamber of Commerce said the proposal “may create a Tower of Babel that can sow confusion in a marketplace that SEC Chair Mary Jo White has acknowledged already suffers from ‘disclosure overload.'” The Chamber was referring to a speech White gave in October about the need to make disclosures useful, not just long.

In particular, companies were worried that auditors may reveal matters the company has not disclosed, and they said that’s not the job of auditors but of management.

“The standard should make clear that CAMs… would not be expected to include specific disclosures of trade secrets or other proprietary information that would be harmful to the company’s competitive position, a significant deficiency not required to be disclosed by the company under [Sarbanes-Oxley], or sensitive information that would prejudice the company’s position in respect to potential litigation,” wrote Pfizer Inc. Senior Vice President and Controller Loretta Cangialosi, who is also a member of the PCAOB’s Standing Advisory Group.

Cangialosi said a quick field test found that the auditor’s report grew to six pages. The information matched with management’s critical accounting policies and did not add useful information for investors. The report had items that Pfizer executives “were surprised were considered CAMs” as they had never been a subject of a significant discussion with the audit committee. The report also added useful information regarding additional steps the auditor undertook to audit the critical matters.

“Given that we and our auditor were reading the same document and coming up with different views as to what a CAM was, I believe that the definition of a CAM is too far-reaching and will result in a large number of items considered CAMs without adding significant value,” she said.

FedEx Corp. suggested that if the PCAOB thinks that companies have overall deficiencies in their financial statement disclosures on critical accounting policies and estimates, it should leave the issue to the SEC and FASB to deal with.

Wells Fargo & Co. was most concerned that the critical matters “may be construed as an implicit qualification of the audit creating a perception that there may be weaknesses or deficiencies in management’s judgment, financial statement estimates or internal control environment,” wrote Richard Levy, the bank’s executive vice president and controller.

Levy said the pass-fail model has served investors well precisely because an opinion is expressed on the financial statements taken as a whole.

Auditing groups were not as bluntly critical but had plenty of suggestions for improvement.

The Center for Audit Quality (CAQ), which is funded by the AICPA and the major public accounting firms, said the auditor’s process for determining CAMs can be streamlined by leveraging the auditor’s existing required communications with the audit committee and using that to determine the critical matters.

“We believe matters that are important enough to merit communication with the audit committee represent the appropriate starting point for an auditor’s consideration of CAMs, given the audit committee’s oversight of the audit and role in representing the interests of shareholders,” wrote the CAQ.

Investors who pushed for change were also dissatisfied, but for different reasons.

The AFL-CIO’s acting director of the office of investment, Brandon Rees, said the PCAOB should go further with the CAMs by requiring auditors to disclose their assessment of significant judgments and estimates made by management.

“Some might argue that by doing so, auditors are taking on the role of management,” Rees wrote. “However, when an auditor has substantial doubt about a company’s ability to continue as a going concern, the auditor is required to issue a modified report—and, in so doing, the auditor is providing new information to the market. So it is not inconsistent to require auditors to disclose their assessment of significant judgments and estimates made by management.”