By Soyoung Ho
As public companies increasingly provide useful information outside the financial statements, PCAOB member Jay Brown said that it is time again to have a serious discussion about the auditor’s role in providing some assurance on that information.
In response to investor demand, public companies have been providing non-GAAP measures, key performance metrics (KPIs), sustainability reports on a voluntary basis. The extra information is not in the financial statements, which means that companies’ outside accountants do not perform rigorous audit procedure to make sure they are accurate and fairly presented. But often investors believe that such information is audited, creating confusion in the market.
Adding to the confusion is the SEC’s June 2018 rule that required companies to directly embed interactive data onto their financial statements using a process called the Inline eXtensible Business Reporting Language (XBRL). XBRL is computer-readable, making it easier for investors to analyze and compare companies’ financial performance. The market regulator did not require the data tags to be audited. But because the tags are on the financial statements, it is easy to assume that they were audited.
Brown wants to know whether investors want auditors to play a bigger role on non-GAAP metrics and other information outside the standardized financial statements. If so, which metrics or other information is appropriate for auditors to review. He also wants input about what level of assurance should be provided, among other things. Brown made his remarks at the Data Amplified 2019 Conference in Shanghai, China, on October 24. The PCAOB posted the speech on November 5.
This debate is not new. The PCAOB in August 2013 proposed a rule that would require auditors to do more work on information outside the financial statements partly in response to the prevalent use of non-GAAP information by companies during quarterly earnings calls. Regulators have been worried that companies use adjusted GAAP numbers that may be misleading to investors. Often, the non-GAAP metrics show better performance, thus companies choose to present them. While the SEC has cracked down on the more egregious practices, they are not verified by a third-party to lend more credibility.
The PCAOB over six years ago proposed changing the existing rules regarding auditor’s responsibility on “other information.” Currently, auditors must “read and consider” the material, and the board proposed a higher standard to “read and evaluate” and included specific procedures for auditors.
Auditors have for years reviewed the nonfinancial information as part of a normal audit procedure to make sure that it’s consistent with the financial statements. If the PCAOB’s more stringent requirement is finalized, they would need to affirmatively say in the audit report that there are no material misstatements or misrepresentations in the filing. Auditors would have to look at the entire filing and not just the management’s discussion and analysis section and make sure the numbers align.
But audit firms balked at the proposal, and the PCAOB put the project aside. Auditors said it would add to their work and increase their liability risks, resulting in higher audit and reporting costs. The board then put the project on its research agenda. Little progress has been made since then, and board member Brown wants to jump start the conversation again.
“In doing so, the conversation could consider whether the role of auditors in connection with Non-GAAP, KPIs, XBRL or sustainability metrics, should go beyond what is currently required under a standard that was issued before the proliferation of many of these measures,” Brown said at the conference in Shanghai. “And in reviewing the information, the conversation would presumably want to include whether the ‘read and consider’ standard currently applicable provides a sufficient level of auditor involvement.”
In his view, the PCAOB could serve as the moderator of any discussion over changes to the standard.
“The PCAOB has played this moderator role before with respect to [audit] relevance,” Brown explained. “Concerns over the relevance of the audit report caused the PCAOB to convene the key constituencies, collect the relevant comments and feedback, and ultimately devise a set of revisions. The process wasn’t easy and took six years from concept release to final rule to complete, but produced a revised standard approved by the SEC that resulted in disclosure of critical audit matters or CAMs and firm tenure, among other things.” The PCAOB’s standards must be approved by the SEC before they become effective.
He was referring to critical audit matters (CAMs) that auditors of large companies have started to disclose in their audit reports this year. CAMs provide more insight to investors about what matters auditors found most challenging.
“The discussion would have limits,” he added. “The ‘Other Information’ standard was not designed to define relevant metrics. That presumably falls to other regulators or the private sector. Still, the conversation may lead to changes in the audit that result in improvements in accuracy, completeness, and consistency of the information and may reduce some of the uncertainties with respect to these measures and metrics.”
This article originally appeared in the November 11, 2019 edition of Accounting & Compliance Alert, available on Checkpoint.
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