" We are still in the enquiry stage about the extent to which fundamental change to auditor and audit committee regulation will improve audit quality and investor confidence. It will take some time before the dust settles." -Bill McFarland
It's impossible these days to avoid hearing about new regulatory initiatives responding to the financial crisis. They're coming from all sides – Europe, the U.S. and Canada. Understanding the possible implications for audit committees and auditors is a challenge, even for those with their ears very close to the ground.
In April, we held a special briefing for audit committee members in Toronto to put things into perspective. In a free-wheeling, interactive and forthright session, top PwC experts from around the globe shared their insights into the regulatory environment in their jurisdictions, the local reform proposals and the possible political implications. This summary sets out the highlights of the briefing on the global regulatory initiatives, the results of electronic polling of the 45 directors attending, and our perspectives on those results. The polling revealed the usual healthy diversity of opinion, and perhaps not surprisingly, that directors and regulators may not always see eye to eye.
Raising the audit quality bar
- The Canadian Public Accountability Board (CPAB), overseer of Canadian audit firms, and the Public Company Accounting Oversight Board (PCAOB), the audit standard setter in the U.S., have raised the quality threshold for auditors in practice inspections and other public communications.
- Regulators' views on audit quality will impact audits in ways that management teams and directors may find difficult to understand. For example, regulators now appear to be expecting that we devote more senior time to the examination of significant financial statement balances in situations where internal controls over those balances are strong and the risk of a material misstatement is assessed as low.
- Professional scepticism and objectivity has been a particular focus of regulators recently. While scepticism usually is thought of as an auditor-specific issue, it is also relevant to audit committees. In its 2011 Public Report, for example, CPAB stressed the importance of audit committees exercising appropriate scepticism in their interactions with auditors and management, rather than acting as an advocate for management.
" Because we are affected by both international and U.S. auditing standards, it's important that we in Canada monitor and assess what's going on, and that we make sure global standard setters appreciate the implications to auditor reporting when there are inconsistencies in their approaches." -Bob Muter
- In Canada, CPAB and the Canadian Institute of Chartered Accountants (CICA) have initiated a joint consultative project on a broad range of issues relating to the roles and responsibilities of audit committees and auditors. The objective is to provide useful input to Canadian standard setters and regulators, assist Canadians currently engaged in global processes, and set the context for further research, debate and guidance.
- The project has three separate work streams – the role of audit committees in overseeing auditors, the audit reporting model, and independence. The following are the specific issues being considered for each:
- The first output you can expect is a draft discussion paper on the role of the audit committee, scheduled to be released for comment in the fall of 2012, with a final paper targeted for early in 2013.
" Ultimately, I think the U.S. will stop short of mandatory audit firm rotation and consider other alternatives to improve audit quality." -Michael Gallagher
- In the U.S., the PCAOB is focusing on a number of alternatives to improve audit quality. Two of the more significant and controversial projects currently being debated are whether mandatory audit firm rotation would improve auditor independence, objectivity and professional scepticism; and whether expanded auditor reporting to stakeholders would add to the transparency of financial reporting.
- Feedback from the profession, audit committee members and other participants in the U.S. capital markets on mandatory audit firm rotation has been overwhelmingly negative, as few believe that it would improve auditor independence, objectivity and professional scepticism and instead believe it would be a threat to audit quality and increase costs without any offsetting benefits. Given broad and passionate opposition to a "one size fits all" solution like mandatory audit firm rotation, in the unlikely event the PCAOB were to move forward with this alternative, obtaining required approval from the SEC would be a challenge at best and congressional intervention could also be possible, if not likely.
- With respect to expanded auditor reporting, there has been significant debate on whether reporting for investors would be improved if a company's annual report were to include a separate "Auditors' Discussion and Analysis" (AD&A) section setting out the auditor's perspectives on the company's reporting, including their evaluation of management's critical estimates and judgments. In addition to the significant hurdles as to the practicability of such reporting and whether this would actually undermine quality financial reporting by introducing greater complexity and creating confusion, the profession in the U.S. believes that AD&A reporting would be inconsistent with the role of the auditor, which is to attest to information prepared by others so as to raise its credibility. However, the profession is exploring ideas to accommodate additional information needs by expanding auditor reporting in other ways including alerting investors to the most important aspects of the financial statements, or more directly associating with certain elements of Management's Discussion and Analysis.
- The U.S. decisions with respect to mandatory audit rotation and expanded auditor reporting will be of special significance to Canada because of their relevance to Canadian SEC registrants, and the influence that the U.S. has had on Canadian standards in the past.
"This is a complicated journey that we're on... It starts with consultation, then there's a proposal from the European Commission, then there's debate, then there's a compromise and then an actual decision... I hope the legislators will make significant improvements to the proposals." -David Devlin
- In Europe, the European Commission, led by Commissioner Michel Barnier, is proposing radical reforms to legislation as part of a politically driven initiative to re-regulate European financial markets in response to the European financial crisis and bailouts. The legislation is scheduled for finalization in 2012 and some of the more important proposed audit reforms are set out below.
- The legislative proposals include appropriate reforms in some cases, but these require clarification. Other proposals require reconsideration. As with other European legislation, it can be expected that the proposals will be subject to significant debate and political compromise. Final outcomes might be significantly different.
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