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Rules Not Meant To Erect Wall Between Auditors, Cos.

Tammy Whitehouse | March 29, 2005

Standard setters never meant to cut contact between auditors and their clients with the recent wave of rules establishing greater independence for auditors, nor did they intend to create excessive accounting costs for smaller companies. That’s according to Daniel Goelzer, a member of the Public Company Accounting Oversight Board, who spoke at the Washington Economic Policy Conference last week.



Goelzer

Addressing the unintended consequences of Sarbanes-Oxley and related regulatory activity, Goelzer said “One of the most common charges is that, as a result of internal control reporting, companies can no longer look to their auditors for advice on difficult accounting issues.”

Goelzer said the board also is hearing from companies that say they’re feeling victimized by their accountants, particularly when it comes to the PCAOB’s Accounting Standard No. 2. [PCAOB AS No. 2 regulates how accounting firms audit a company’s internal control over financial reporting.] “Some companies have charged that auditors are taking advantage of the flexibility AS No. 2 affords and are performing costly but unnecessary tests on the grounds that their efforts are ‘required by the PCAOB,’” Goelzer said. “Statements like this are almost never true. The Board is committed to using its inspection program to ensure that auditing firms are properly applying AS No. 2 and are not using it as an opportunity to generate fees through unnecessary work.”

The objective of auditor independence rules is to assure financial statements are audited by professionals who otherwise have no meaningful interest in a company’s affairs.

The Securities and Exchange Commission rule on auditor independence says an auditor impairs his or her judgment if the auditor audits his or her own work. The PCAOB’s Audit Standard No. 2 says if an auditor identifies a material misstatement in draft financials that management missed, it should be regarded as a strong indicator of a material control weakness.

The rules, Goelzer said, are causing many in management to conclude they should remain at arm's length from, even adversarial with, their auditors. “AS No. 2 is not intended to erect a wall between auditors and clients,” he said.

Wayne A. Kolins, national director of assurance for BDO Seidman, acknowledges it’s a tightrope walk for auditors. “The issue is out there,” he said. “Audit firms have felt constrained about what they can say to their clients.”

Goelzer said the key to enabling communication that doesn’t violate independence rules is twofold. First, management must perform its own control evaluation and not simply delegate it to auditors or rely on the auditor to catch mistakes. Auditors, on the other hand, must reach their own independent judgments and not negotiate these judgments with management.

“Within these limits, auditor-management free and open communications concerning financial reporting and internal control issues are still permissible,” Goelzer said. “Common sense should resolve most issues.”

Kolins says he advocates dialogue between auditor and client. “The worst thing that could come about would be for an auditor to not talk to a client until the client gives a position,” he said. “We certainly discuss issues; we don’t wait until the pencil is down before providing feedback.”

Kolins said he’s glad to see a common-sense attitude. “I have heard PCAOB people talk about judgment,” he said. “I certainly hope at the end of the day that’s the way regulators see it. I hope that’s the view they take when we’re in the inspection process.”

But, he remains cautious. “There are an awful lot of shoulds and musts in AS2, though,” he said.