By Cydney Posner
Expanding on the concepts discussed in the email below regarding potential proposals to improve audit reports, the following New York Times article discusses a conflict between the views of Ernst &Young, whose audit found the financial statements a Chinese company, Sino-Forest Corporation, to fairly present its financial position, and Muddy Waters Research, whose research showed the same company to have fraudulently overstated the extent of its operations. The market apparently believes Muddy and has tanked the company's shares.
The author, Floyd Norris, uses the conflict over this company as a platform for discussing how a more meaty audit report might help shareholders better evaluate the controversy: "Investors trying to decide whether to believe the Muddy Waters report, with its detailed assertion that the company's claims are contradicted by Chinese records, would love to know just what Ernst did to check. What records did it inspect? Which tree plantations did it visit? Who did the work? Was it people from Ernst's Toronto office, which signed the report, or people from a Chinese affiliate? How many auditors did the work, over what period of time?
"Ernst's audit opinion does not say, which is no surprise. Virtually every audit opinion in the world says almost the same thing, with no details about the company being audited. Auditors are paid millions of dollars to produce a report that no one thinks is worth reading. "
Norris notes that the PCAOB is considering a proposal that would require auditors to say much more in their reports: "One idea the [PCAOB] is expected to consider is requiring auditors to disclose more about what they did, and did not, do…. Ideally, auditors would point to things that they could not audit. Auditors could be called upon to specify where they thought fraud was most likely in a given company or industry, and what they did to confront the risk. Investors could have a chance then of comparing the work of differing audit firms, as one firm disclosed it had checked something other auditors did not mention. If an audit was expected to call attention to possibly critical information that was not available to the auditors, perhaps there might be pressure from investors on companies to make that information available. In any case, investors could better understand what the auditors knew — and did not know — in reaching their conclusions."
Norris also suggests that the PCAOB may propose to "end the ‘one grade fits all' audit model, in which every company is deemed to ‘fairly' present its results. Perhaps a second grade could be added, like ‘presents adequately,' for companies that push the envelope but do not violate the rules.
"In addition, auditors could be called upon to discuss the risks the company was taking. They could also be asked to call attention to some of the most critical disclosures in the footnotes, something that French auditors already do. If much of that happened, audit opinions could become a lot more interesting to read."