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Thomson Reuters: Robert Rostan “PCAOB Continues Push for Disclosure Rule About Audit Firm Tenure”

by Soyoung Ho

August 15, 2016, will be an important date for the PCAOB because the comments are due on a proposal that includes a requirement for audit firms to disclose their length of service with public company clients.

If the PCAOB can meet its schedule, the board may be able to finish a rule in early 2017 based on the changes in Release No. 2016-003, Proposed Auditing Standard—the Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion and Related Amendments to PCAOB Standards.

The ultimate location of an auditor’s tenure remains a contentious issue, in part because audit firms do not agree with the PCAOB’s proposed location of the disclosure. The audit regulatory board proposed that the tenure be in the auditor’s report section of an SEC filing. But some firms would prefer that it wind up in the new PCAOB Form AP. If that happens, the disclosure will be in the same form as the requirement for naming the lead partner on an audit engagement, and Release No. 2016-003 asked for comments about whether Form AP would be more appropriate.

Putting it in the audit report detracts from the quality of the audit report,” said Robert Rostan, CFO of Training The Street, which provides training in accounting and corporate finance. “We don’t want to detract from the audit opinion, [which] is very, very important. We’ve already got other things in there that can be distractions, such as the city and the place of origin of the audit report. For Wal-Mart [Stores Inc.], it’s Rogers, Arkansas. But half of the world doesn’t know where Rogers, Arkansas, even is. Why is that in there?”

Some investors believe that a long tenure makes auditors complacent and weakens the quality of their work. Audit firms and companies counter that a long relationship means auditors understand the company’s business and transactions, which in a changing global economy are becoming increasingly complex. It takes a while for an auditor to fully understand a new client’s business, they say.

In the view of former FASB Chairman Dennis Beresford, who has also been a member of the PCAOB’s Standing Advisory Group, tenure may be useful in the context of the shareholder vote on selecting the outside audit firm. But he felt that locating the tenure in the auditor’s report will not give investors the appropriate context to evaluate the information.

“[Form AP] strikes me as a least bad solution,” Beresford said. “Putting it in Form AP at least avoids further muddying up the auditor’s report with irrelevant information.”

In December 2015, the PCAOB approved the final rule in Release No. 2015-008, Improving the Transparency of Audits, which requires audit firms to identify the engagement partner and other participating firms in an audit starting from 2017 in Form AP Auditor Reporting of Certain Audit Participants. The PCAOB previously wanted engagement partners to sign or disclose their names on the auditor’s report. But auditors said that doing so would increase their risks of being sued. As a compromise, the board, with the support of the firms, ultimately settled on Form AP.

Some investors and corporate governance advocates are willing to accept the tenure disclosure in Form AP as a suitable compromise.

“I’m not sure if investors will care that much where they get the info,” said Joseph Carcello, a professor of accounting at the University of Tennessee and a member of the PCAOB’s Investor Advisory Group.

The disclosure of an audit firm’s tenure with a client has been one of the chief issues PCAOB Chairman James Doty has pursued since assuming his post in 2011. Shortly after he joined the audit regulatory board, it published Concept Release No. 2011-006, Auditor Independence and Audit Firm Rotation. The August 2011 document largely focused on a plan to force companies to switch audit firms every several years.

Some investor advocates said forcibly limiting the close relationship between auditor and client would reduce the likelihood that audit firms will go easy in scrutinizing their client’s financials to keep earning large fees. However, companies and audit firms said term limits will do little to improve audit quality and instead increase costs and disrupt business.

In 2013, the House of Representatives wanted to enact legislation that would block the PCAOB from passing a rule that could limit an audit firm’s length of service, but the Senate never agreed. Still, the threat of legislative action contributed to the PCAOB’s decision to back away from a term limit rule and instead require a disclosure of the firm’s length of service. The audit regulator proposed a disclosure of a firm’s tenure in Release No. 2013-005, Proposed Auditing Standards on the Auditor’s Report and the Auditor’s Responsibilities Regarding Other Information and Related Amendments. The disclosure was part of a package to expand the auditor’s report and make it more useful for investors. Auditors would also be required to disclose the most challenging and complex matters that arose during an audit, or what the board called critical audit matters (CAMs).

Some investors called the disclosure of an audit firm’s tenure a reasonable compromise. But the audit firms said there was no clear link between tenure and audit quality and opposed adding the disclosure requirement. The AICPA-affiliated Center for Audit Quality and the U.S. Chamber of Commerce said putting tenure in the auditor’s report would create a false impression that a link between audit quality and tenure exists and give undue influence to the information.

Despite strong opposition by audit firms and companies, the board retained the tenure disclosure in the auditor’s report in the recently revised proposal, which was issued to narrow the scope of the CAMs following concerns raised by audit firms that some of the issues in the CAM disclosures could publicize information that management was not required to release and wanted kept confidential.

During a recent interview, Doty acknowledged the different views about the importance of disclosing an audit firm’s tenure, but he felt it was important to continue with the project.

“People will be able to make their own judgment” of the information’s importance if tenure is disclosed, Doty said.

Some investors will think it is good if a company has been with an audit firm for 10 or 15 years because the auditor will understand the company’s business. Other investors may want to know why the board of directors has not sought another auditor after 50 years.

“But to say the public is not interested in that, doesn’t want that info, or that there could never be a connection to conclude the notion there will not be some relationship between the two, I think simply ignores the tangible evidence we have,” Doty said.