Will We Soon See the Financials Through the Eyes of Auditors?

By Cydney Posner

Following is a link to an article in CFO.com regarding the discussion at a recent PCAOB roundtable (See my article of 6/21/11.)  The roundtable was organized to discuss issues identified in a PCAOB concept release related to alternatives for changing the auditor's reporting model to provide investors with more transparency in the audit process and more insight into the company's financial statements (or other information outside the financial statements).

Apparently, much of the discussion focused on the possibility of requiring an AD&A , an Auditor's Discussion and Analysis, a narrative that, much like an MD&A, would provide a view of the financial statements "through the eyes" of the auditor. As described by the PCAOB, the AD&A would be a supplemental narrative report that would provide a platform for the auditor to discuss his or her views regarding significant matters such as audit risks identified in the audit, audit procedures and results, auditor independence, management's judgments and estimates, accounting policies and practices and difficult or contentious issues and "close calls." An AD&A would not provide separate assurances on any matters discussed, but rather is "intended to facilitate an understanding of the auditor's opinion on the financial statements taken as a whole." The AD&A has generally been viewed as the most controversial of these PCAOB proposals because it could require the auditor to characterize judgments and provide subjective views.

Lynn Turner, a former SEC chief accountant quoted in the article, opined that the AD&A would provide "meaningful context to the mere pass/fail grades" that auditors provide in their reports. The issue arises because companies that have been involved in financial scandals or otherwise played prominent roles in the financial crisis received "the same clean report" as other companies. However, in litigation, auditor testimony often "provides valuable information about what went wrong at those companies." Instead of limiting the information to "board audit committees, which turn it over to corporate lawyers for use in defending the company against lawsuits," the information could also be released to investors in an AD&A. Turner advocated " ‘pull[ing] the attorneys out' of the process of providing auditors' views to the public…."

Others took issue with Turner's view, contending that investor mistrust could instead be assuaged by requiring auditors to attest to portions of MD&As to give investors confidence about the critical accounting estimates that are used in important financial reporting calculations. Still others were concerned that providing the subjective interpretive elements of an AD&A would introduce "an element of bias" into auditor assessments, which should remain objective. Some worried that an AD&A would add too much complexity to the process of understanding financial statements, as investors sought to reconcile any differences with the MD&A. However, other speakers countered that the resulting analysis could lead to more accuracy, possibly raising questions about management's reporting and estimates, which could lead to "much better behavior."