Summary of PCAOB SAG Meeting-PART ONE
Standard Setting Priorities
October 18, 2007
FEI Summary
Unfinished Projects on Priority List; XBRL, Globalization, Advisory Committees May Impact
As described in Chief Auditor Tom Ray’s remarks at the Public Copmany Accounting Standards Board’s (PCAOB’s) Oct. 18, 2007 Standing Advisory Group (SAG) meeting, PCAOB’s focus this year has been on issuing new internal control guidance in the form of Auditing Standards No. 5 (AS5), which replaced AS2, and the related preliminary staff guidance for small public companies, released last week.
Ray said auditors could begin applying the small company guidance immediately, although they will take public comment on the document through December 17 to consider improvements to the guidance. PCAOB invites public comment on it for potential improvements to the guidance by December 17.
In describing priorities for the upcoming year, Ray said following up on implementation of this year’s internal control guidance will remain a priority.
Most of the other standard setting projects on the priorities list were included in previous year’s lists discussed by the SAG, including risk assessment and fraud risk assessment, fair value, use of specialists, related parties, and consideration of updating the ‘interim standards’ or standards originally issued by the AICPA prior to PCAOB’s founding, which PCAOB accepted on an ‘interim’ basis, to potentially update.
Additionally, although not on the priorities list per se, Ray said three other matters could impact its standard-setting agenda this year: XBRL, globalization, and related work of the SEC Advisory Committee on Improvements to Financial Reporting, and Treasury’s Advisory Committee on the audit profession, both of which PCAOB serves as an observer on.
Regarding XBRL, Ray said, “PCAOB staff will be working closely with the SEC to address auditors' responsibilities with regard to XBRL-tagged data.”
On globalization, he said, “I expect that we will seek the SAG's views on whether there is a need for a set of globally accepted auditing standards, how the PCAOB should interact with other auditing standards setters, and how this should fit within the PCAOB's other priorities, including our approach to acting on the Board's interim professional standards.”
SAG Members Debate Priorities, Question if PCAOB Has Resources; Fair Value Guidance Needed
Seeing so many unfinished standard-setting projects from prior years’ remaining on the list, Lynn Turner, former chief accountant of the SEC, said “I’d have to give you a D at best on your performance over the past 5 years.” He added, “The [PCAOB] board started off on the right foot, but the profession has moved forward, and rather than being a leader, the board has become a clear-cut, undeniably, follower at this time.” He said he’d like to see some things crossed off the board’s list this year, and suggested further consideration of how their projects relate to projects where the AICPA Auditing Standards Board (ASB) has moved ahead. Others suggested the PCAOB leverage off work of the ASB or the International Auditing and Assurance Board (IAASB), where those organizations have gotten ahead, or perhaps serve in an oversight role on projects where IAASB is taking the lead, rather than starting from scratch on its own projects in similar areas.
In response, John Morrissey, Managing Director and Controller of Fortress Investments Group, observed, “How quickly we forget the political and operational headwinds this board faced,” adding, “you are to be commended for a job well done,” for completing its new guidance on internal control audits. “Having lived through it from the preparer’s standpoint,” he noted he finds AS5 a very effective standard.
“But, having said that, the honeymoon is over,” he noted. “The list looks familiar; the first one, Fair Value, is very troubling to me in terms of operational issues as people are struggling with implementing this thing,” referencing FAS 157, Fair Value Measurement. (See related story of FASB considering a request of FEI and IMA to delay the effective date of FAS 157 due to implementation issues.) “If there are operational issues,” with fair value measurement, Morrissey noted, “there are going to be auditing issues as well.” He urged the PCAOB, “you need to get guidance out there, otherwise you won’t be proactive but will be in position of bayoneting the wounded, it needs to get attention very quickly.”
Arnie Hanish, Chief Accounting Officer, Eli Lilly and Company, and Chair of FEI’s Committee on Corporate Reporting (CCR), agreed, saying, “If I were to prioritize the priorities, I would hope given the FAS 157 issues debated right now at FASB, I would put fair value - and link that in with use of specialists - at the top of the list, because of the need and urgency to get something out.”
Hanish and other SAG members said they hoped the PCAOB had sufficient resources to accomplish the matters on their priorities list. Some noted the relatively small size of the PCAOB’s standard-setting staff, vs. the ASB which relies heavily on volunteer input. Ray said the PCAOB is still actively recruiting for more staff for its Office of Chief Auditor, and asked for anyone interested to give him a call.
Hanish Suggests: Start with Clean Sheet in Setting Priorities; International Convergence Looms
Recognizing the PCAOB may get caught up in the interim standards they inherited from the AICPA Auditing Standards Board (ASB), now that AS5 was done, it was time to “step back and take a holistic view of audit standards.”
He urged the PCAOB, “Start with a clean sheet of paper, say: what would we have in the way of approaches to auditing, and more flexibility based on company size, to eliminate certain procedures many of us believe are passé at this point.” He noted as examples the voluminous, boilerplate language used by auditors for their communications with audit committees, saying, “I question whether or not it is serving the purpose for what it was intended, maybe take a fresh look, how effective they are.” Similarly, he noted the “representation letters” auditors require clients to sign including various representations or statements “have gotten out of control from length, breadth, and depth, have become untenable.” Once again, he said, it is a question of whether that process is effective.
Howard Johnson, past chairman of the board of the Institute of Internal Auditors (IIA) agreed with Hanish’s suggestion that PCAOB take a clean sheet approach. Johnson said, “Once in a while, it’s good to sit back and look at the blue sky and think about a strategic renewal process.” He added, “Besides tactical projects,” the PCAOB should think about moving to international audit standards, adding it’s “not something you can do yourself, maybe help the international world get that way, something to think about.”
John Kellas, observer from the IAASB, said, “I welcome your remarks about international cooperation, we very much benefit from participation of the PCAOB as observers,” saying “the interaction is extremely positive.”
“The case for a clearer relationship between audit standards in all jurisdictions is a good one,” Kellas added. “If you’re sitting there as auditor for a foreign registrant, it would be much easier to achieve a quality of audit under PCAOB standards if there were a clearer relationship between standards used domestically and PCAOB’s, it would be clear if there were some sort of common base internationally of standards on which others can build; perhaps [PCAOB’s] review of interim standards can be the base for that model.”
He noted, “The European Union (EU) is looking to adopt our standards at present, their model is somewhat complex, an economic entity with 26 member states and Parliament and a mission to consider as well, they do reserve the right and opportunity to add to our standards and even member states can for local jurisdictional issues.”
Hanish suggested the PCAOB offer an education session for the SAG on the major differences in international vs. PCAOB standards. “While I am a chief accounting officer at a multinational company, we talk about convergence, but we don’t talk much about what the different auditing standards are,” he said, adding “a little education [would be helpful] so we can advise you appropriately if there is need for convergence in international audit standards.”
In addition to differences between international and U.S. audit standards, SAG members, other than the representatives from the Big 4 audit firms, indicated they need more education on differences between international and U.S. accounting standards.
Cynthia Richson, President of Richson Governance Advisors, said, “The experts around the table are saying they aren’t even aware of what the major differences in U.S. GAAP vs. IFRS are.”
Impact of XBRL and Technology; Trickle Down Effect to Private Companies; Need to Bring Auditors, Issuers Together in Dialogue
Shifting topics to XBRL, the SAG observer from the U.S. General Accountability Office (GAO), noted the need for PCAOB to focus on the impact of technology generally on auditing. “It’s really the broader issue of where technology is taking us today, whether auditing standards as developed by any standard setter [are keeping up], whether we are converging on the right thing or not.”
He added the PCAOB may need “to rethink the entire paradigm here,” in which auditors need to be much more savvy about technology. Steinhoff urged the PCAOB to be proactive in this area. “You might want to establish something through the board, I would call it R&D, foresight work, thinking ahead 10-15 years, where technology will take us in delivering information, so you won’t just have to converge or update someone else’s standards.”
Steinhoff supported the PCAOB’s plan to address fraud risk. “A lot is not understood about fraud, people have difficulty - even if they want to - in properly assessing fraud risk,” he said.
“I am concerned most auditors have a limit in their ability to conceptualize how fraud can be conducted outside the company electronically,” said Steinhoff, adding, “this is a big issue in our defense establishment today.”
John White, Director of the SEC’s Division of Corporation Finance and Conrad Hewitt, SEC Chief Accountant, in observer roles with the SAG, described the current status of SEC’s XBRL initiative.
White referenced SEC Chairman Christopher Cox’ statement at a September press conference on XBRL, and related discussion during the Q&A session at that press conference, and said the SEC staff has been given a mandate to develop a proposal for the Commission to consider by the spring, that would propose requiring (mandating) XBRL filing, with the goal of issuing a final rule by next fall.
As to implications for auditors, White explained the SEC’s current thinking is, “Going forward, in a fully implemented XBRL world, what would still be coming in would be the ‘paper copy’ and the audit opinion would speak to the ‘paper copy,’ there would be a specific disclaimer as to the underlying XBRL tags or file.” However, he added, “Obviously the XBRL tags would come into the Edgar system, which leads to the extremely important question of reliability of XBRL if there is an auditor disclaimer with respect to that.
“So, we would look at how to get to a level of reliability with respect to that; an attestation standard would be one choice, either on a voluntary basis; we could have variations in liability, we have things like ‘furnished’ and ‘filed,’ [referencing two ways information is provided in SEC fillings, with ‘furnished’ having less liability attached to it than ‘filed’], there are other things we can do, just to frame this, that is one line of thinking we’ve got on the XBRL topic,” said White.
Hewitt added, “The SEC… created a new Office of Interactive Disclosure, because we feel strongly for the investor and the capital markets, XBRL is a very important tool.” He noted David Blazkowski was hired from S&P to be the new director of that office. The office “will eventually have full time staff of 12 people scattered throughout the SEC, to help the user, investor, and preparer move on with [the XBRL] project.” He added this will be an expansion in staff from the 4 full time staff currently dedicated to XBRL.
Switching to the topic of private companies, Ernie Baugh, National Director of Professional Standards for Mayer, Hoffman, McCann P.C., referenced the comparative impact of AICPA audit standards. “I’m getting questions from Private Companies in using PCAOB standards as the low cost alternative.” He also suggested the PCAOB embark on a codification project, similar to that of the Financial Accounting Standards Board (FASB), to bring together standards and practices for public companies into a ‘reasonable, researchable data base.”
Also on the topic of private companies, Gaylen Hansen, Audit Principal at Erhardt Keefe Steiner and Hottman, PC and a member of the Colorado State Board of Accounting, the board of directors of the National Association of State Boards of Accountancy (NASBA) and the AICPA’s Professional Ethics Executive Committee, noted during the IFRS discussion later in the meeting, “Our firm is a local practice, 400 people, we’re doing IFRS work right now, we’re probably unusual, goes to [the issue of] competition.”
“There is a trickle down effect on private companies, government entities, [and nonprofits] which could be substantial impact, especially if FASB is totally absorbed into the IASB,” said Hansen. Noting that private companies and other nonpublic entities are a major part of the economy, he said, “There is a huge concern out there as to who would set their standards going forward, whether it be auditing, ethics, or accounting.”
In a broad recommendation, Hanish urged the PCAOB to continue its dialogue with working groups of auditors, issuers and others. However, he suggested there was more to be gained if the PCAOB would bring those groups together for a shared dialogue, rather than keeping them separate.
“My perspective is,” said Hanish, “the way things have been set up the last four to five years, because of the mandate you have to police the audit profession, you’ve been reluctant to put the groups together, the auditors and preparers, to find a common ground.” He added, “I would encourage more cohesiveness in that area, I think you’d get a better product.”
Summaries of remaining discussion of IFRS, restatements, subprimes
Check back to FEI's website later today for summaries of Parts Two, Three and Four of the October 18 PCAOB SAG meeting, relating to the impact of IFRS filings in the US on auditing standards, PCAOB's restatements study, and issues arising from the subprime crisis.
Prepared Oct. 19, 2007 by Edith Orenstein, Director of Technical Policy Analysis, Financial Executives International (FEI). This summary does not represent FEI opinion unless specifically noted above.