Issues & Trends

Defining Issues
June 2011, No. 11-39

PCAOB Requests Feedback on Auditors Reporting Model

The Public Company Accounting Oversight Board (PCAOB) recently issued a concept release on the auditors reporting model.1 The concept release requests input from stakeholders on alternatives for changing the auditors reporting model that could increase the transparency and relevance of financial statements and the audit process without compromising audit quality. This edition of Defining Issues summarizes the perceived issues with the current auditors reporting model and potential alternatives for changes to that model, as outlined by the PCAOB. Through its concept release, the PCAOB intends to determine whether there are common views among stakeholders about the usefulness of the current auditors reporting model. The PCAOB is soliciting feedback about the potential direction of a proposed standard-setting project on the content and form of auditor reports to provide more relevant and useful information to investors and other financial statement users. Comments are due September 30, 2011. The concept release describes issues with the current auditors reporting model identified by some stakeholders, provides potential alternatives for change, and requests input about whether these alternatives might be effective in enhancing the communication value of the auditors report. Contents Current Auditors Reporting Model 1 Potential Alternatives Request for Input Next Steps 2 4 4 Other standard setters and regulators, such as the International Auditing and Assurance Standards Board, the International Organization of Securities Commissions, the United Kingdom's Financial Reporting Council, and the European Commission have been considering potential ways to enhance auditor communications, including enhancing the auditor's report.

Current Auditors Reporting Model

The PCAOB developed the concept release in response to criticism of certain aspects of the current auditors reporting model by investors and other financial statement users. The current auditor's reporting model identifies the financial statements that were audited, describes the nature of the audit, and presents the auditor's opinion about whether the financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of the company in conformity with the applicable financial reporting framework. The current auditor's reporting model is commonly described as a pass/fail model because the auditor opines on whether the financial statements are fairly presented (pass) or not (fail). From October 2010 through March 2011, PCAOB staff conducted outreach activities with investors, financial statement preparers, auditors, audit committee members, regulators and standard setters, and representatives of academia. There was consensus among investors that auditors have significant insight into the companies they audit and that auditor reports should provide additional information based on
1 PCAOB Release No. 2011-003, Concept Release on Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements, available at www.pcaobus.org.

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that insight to make them more relevant and useful. The PCAOB believes this information might be useful to investors and other financial statement users and could lead to more efficient markets and improved allocation of capital.

Potential Alternatives
The concept release outlines four alternatives for possible changes to the auditors reporting model and is seeking specific comments on these or other alternatives that could provide investors with more transparency into the audit process and more insight into companies' financial statements or possibly other information outside the financial statements. The alternatives would retain the pass/fail opinion of the current auditor's reporting model and are not intended to alter the auditor's responsibility to obtain sufficient and appropriate audit evidence to support the audit opinion. The concept release also states that the alternatives are not intended to qualify or piecemeal the auditor's opinion or to shift the requirement to assess the risk of material misstatement of the financial statements from the auditor to investors or other users of financial statements. The four alternatives presented in the concept release are: Auditor's Discussion and Analysis; Required and Expanded Use of Emphasis Paragraphs; Auditor Assurance on Other Information Outside the Financial Statements; and Clarification of the Standard Auditor's Report.

The alternatives are not intended to be mutually exclusive. A revised auditor's report could include one alternative, a combination, or elements of each one. The PCAOB also is requesting input on other alternatives that it should consider. The alternatives are primarily focused on enhancing communication to investors by improving the content of the auditor's report rather than changing the fundamental role of the auditor in performing an audit of financial statements. However, the PCAOB acknowledges that, depending on the nature and extent of additional information to be communicated in a revised auditor's report, new auditing requirements and coordination with the SEC would likely be necessary. Further, certain alternatives might result in an increase in the scope of audit procedures beyond those currently required, which would require new auditing standards and increase cost. Auditors Discussion and Analysis. Under this alternative, the auditor would provide a supplemental narrative report, which some have described as an Auditor's Discussion and Analysis (AD&A). An AD&A would provide the auditor with the ability to discuss their views about significant matters. The concept release outlines the type of information that could be included in an AD&A, such as information about the audit (e.g., audit risks identified in the audit, audit procedures and results, and auditor independence) and discussion of the auditor's views about the company's financial statements (e.g., management's judgments and estimates, accounting policies and practices, and difficult or contentious issues). The concept release also indicates that the AD&A could provide the auditor with discretion to comment on material matters for which the auditor believes disclosure could be enhanced to improve investor understanding and highlight areas in which the auditor believes management could have applied different accounting or disclosures. An AD&A also could require the
Defining Issues / June 2011 / No. 11-39 2
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auditor to communicate some of the information that the auditor communicates today to the audit committee. An AD&A would not be intended to provide separate assurance on individual balances, disclosures, transactions, or any other matters discussed. Rather, its purpose would be to facilitate an understanding of the auditor's opinion on the financial statements taken as a whole. An AD&A would likely be among the most expansive form of reporting of the four alternatives presented. Required and Expanded Use of Emphasis Paragraphs. This alternative would require inclusion of an expanded emphasis paragraph in all audit reports that would highlight the most significant matters in the financial statements and identify where these matters are disclosed. Under current PCAOB standards, emphasis paragraphs are not required but may be added at the auditor's discretion to emphasize a particular item in the financial statements. Emphasis paragraphs could be required in areas of critical importance to the financial statements, including significant management judgments and estimates, areas with significant measurement uncertainty, and other areas that the auditor determines are important for a better understanding of the financial statement presentation. An auditor also could be required to comment on key audit procedures performed related to the identified matters. Auditor Assurance on Other Information Outside the Financial Statements. This alternative would require an auditor to provide assurance on information outside the financial statements such as managements discussion and analysis (MD&A), a portion of MD&A or other information (e.g., non-GAAP information or earnings releases). The concept release notes that an auditor providing assurance on information outside the financial statements could improve the quality, completeness, and reliability of such information and provide investors and other users of financial statements with a higher level of confidence in that information. Currently an auditor is not required to provide assurance on earnings releases, nonGAAP information, or MD&A, although companies have the ability to retain the auditor to provide some level of assurance under PCAOB standards.2 Implementing this alternative might require the SEC to develop new management reporting requirements and the PCAOB to develop additional professional standards. Clarification of the Standard Auditor's Report. Another potential enhancement of the current auditors reporting model could involve clarifying language about what an audit represents and what the related auditor responsibilities are. Possible language and concepts that could be clarified in the current auditor's reporting model include: reasonable assurance, auditors responsibility for fraud, auditors responsibility for financial statement disclosures, managements responsibility for the preparation of financial statements, auditors responsibility for information outside of the financial statements, and auditor independence.

For example, the existing PCAOB attestation standards provide requirements for the auditor concerning the performance of an attest engagement with respect to MD&A, if the auditor is engaged to attest on MD&A.

Defining Issues / June 2011 / No. 11-39

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Request for Input

The PCAOB is soliciting stakeholders concerns about the current auditor's reporting model, potential alternatives for change to the current auditor's reporting model, the potential direction of a possible standard-setting project, and potential other considerations associated with changes to the current auditor's reporting model. The PCAOB also is seeking feedback on possible effects of each of the alternatives on: Audit effort, including timing and cost; Relationships between the auditor, management, and the audit committee; Audit committee governance; Auditor and issuer liability; and Confidentiality of company information.

During the PCAOBs open meeting to issue the concept release, one Board member noted the importance to the Board of receiving robust comments on the concept release. The Board would like to hear from a broad range of investors of all sizes and types, as well as from investor representatives, audit committee members, financial statement preparers, analysts, and others.

Next Steps
The PCAOB announced plans for a public roundtable to be held in the third quarter of 2011. Once the PCAOB receives the feedback from the concept release and roundtable, it will determine what changes should be made to the current auditors reporting model.

Contact us: This is a publication of KPMGs Department of Professional Practice 212-909-5600 Contributing authors: Thomas J. Ray John McMahon Earlier editions are available at: http://www.kpmginstitutes.com/financial-reporting-network

The descriptive and summary statements in this newsletter are not intended to be a substitute for what might be adopted or for any other potential or applicable PCAOB requirements. Companies applying U.S. GAAP or filing with the SEC should apply the texts of the relevant laws, regulations, and accounting requirements, consider their particular circumstances, and consult their accounting and legal advisors. Defining Issues is a registered trademark of KPMG LLP. 2001-2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative (KPMG International), a Swiss entity.