Will Naming the Audit Partner in Reports Improve Quality?

A splintered panel of audit regulators has tweaked its plan to require audit firms to identify engagement partners in audit reports and is trying one last time to gain consensus that the move ultimately will improve audit quality.

The Public Company Accounting Oversight Board's newest proposal retains the notion of naming the engagement partner in the audit report, but drops an earlier requirement to also name engagement partners in other filings with the PCAOB. Two of the board's five members are openly skeptical that there's any link between identifying partners and improving audit quality. The proposal also raises the bar slightly on a requirement for audit firms to identify those from outside the principal audit firm who assisted in performing the audit, such as specialists or firms in other countries that might be engaged to help with overseas audit work.

Although the package is not significantly different from the board's first formal rule proposal on the topic in 2011, which followed a 2009 concept release that initially suggested requiring auditors to sign audit reports, the PCAOB is asking for a new round of public comment for a variety of reasons, said member Lewis Ferguson. It's fair for people to wonder, he said during an open meeting, “Can't you people make up your mind about this project?” But much has changed since the 2011 proposal, he said. “The law on liability is developing, the academic literature is developing, and other countries are beginning to adopt engagement partner disclosure requirements,” he said. “That gives us more information.” In addition, the Jobs Act, finalized after the 2011 PCAOB proposal, requires the PCAOB to study the consequences of its rule proposals on emerging growth companies.

PCAOB Chairman James Doty called the proposal an “accountability reform,” much like the requirement for CEOs and CFOs to certify financial statements under the Sarbanes-Oxley Act. “It holds the promise of improving audit quality by sharpening the mind and reminding auditors of their responsibility to the public,” he said. Armed with more information about partner history and the involvement of other firms with their own track records, “the market could react by appropriately pricing the cost of capital,” he said. The board's inspection process has demonstrated that audit quality varies by engagement, and firms often outsource much of the work for overseas audits to other firms, none of which is visible to investors, he said. Doty added that he thinks investors are willing to pay more for better audits.

PCAOB member Jeanette Franzel said there are still many unanswered questions about how identifying engagement partners might affect audits. She doesn't believe the academic research cited in the board's proposal release makes a link between identifying engagement partners and making them more accountable. In fact, she notes the board's objective over the course of the project has changed from holding auditors more accountable to simply being more transparent, and the release doesn't explain why. “Many of the conclusions reached in the release are based on speculative beliefs, and therefore I cannot agree with them,” she said.

“Many of the conclusions reached in the release are based on speculative beliefs, and therefore I cannot agree with them.”

—Jeanette Franzel,

Member,

PCAOB

Franzel and PCAOB member Jay Hanson both objected to naming engagement partners in the audit report over concerns about increased legal liability for auditors. “The extent to which this would spark additional litigation against engagement partners or other named firms or would affect their ultimate liability remains unclear,” Hanson said. He also worries about the “disincentive for the best and the brightest young accountants to becoming auditors at a time when financial statements are more complicated than ever,” not to mention the potential for “defensive auditing,” leading to unnecessary audit work that would add to cost, but not necessarily quality. Franzel and Hanson both called for continued consideration of whether a disclosure for the sake of added transparency could be required somewhere other than in the audit report.

Call for More Evidence

After the PCAOB's open meeting to publish the new proposal, Hanson said the board's latest proposal is a targeted call not just for opinions, but for evidence. Comments on earlier releases have already demonstrated that views vary widely, even within professional groups that typically are more like-minded. “Can you provide us with evidence that we can look at to support the position you are taking?” he said. “If we can get evidence, it might tip us one way or the other. If we can see something on how investors will use this information, personally I would be very interested to see that.”

DISCLOSURE INFORMATION

Below is an excerpt from the PCAOB's latest proposal on improving audit transparency, explaining what disclosure is needed for certain other participants, besides the engagement partner, in an audit.

The information to be disclosed would be:

With respect to other independent public accounting firms, the name of the firm(s); with respect to persons not employed by the auditor, the phrase “persons not employed by our firm”;

The location of other participants in the audit (the country of headquarters' office location for a firm and the country of residence of a natural person or headquarters' office location of another person that is an entity); and

The percentage of hours attributable to the audits or audit procedures performed by the other participants in the audit in relation to the total hours in the most recent period's audit (“the percentage of the total hours in the most recent period's audit”).

Applicability of the Disclosure

The reproposed amendments would require the auditor to disclose information about independent public accounting firms and other persons not employed by the auditor that took part in the audit under arrangements pursuant to either AU sec. 543 or Auditing Standard No. 10, as applicable …

…Disclosing Names of Certain Other Participants in the Audit

In the 2011 Release, the board proposed that the names of all other participants whose extent of participation exceeded the disclosure threshold would be included in the auditor's report. After considering comments raised regarding the applicability of the proposed disclosure to alternative practice structures and the impact on such structures, the board is proposing to require only the names of other independent public accounting firms participating in the audit to be disclosed. Other persons not employed by the auditor, including persons employed by

other entities in alternative practice structures and persons engaged by the auditor with specialized skill or knowledge in areas other than accounting or auditing, would be listed in the disclosure as “persons not employed by our firm,” rather than identified by their names, including only the location and extent of participation of those persons ...

Source: PCAOB.

Cindy Fornelli, executive director at the Center for Audit Quality, has objected to naming the engagement partner in the audit report, and the new proposal is doing little to sway her. “The CAQ supports the PCAOB's efforts to respond to calls for further transparency into the audit,” she said in a statement. “However, given that we do not see a nexus to audit quality or accountability, we do not believe the auditor's report is the appropriate place to identify the engagement partner.” She said CAQ comment on the proposal will explore other ways to inform investors of the name of the engagement partner.

PwC reacted similarly to the new proposal. “PwC supports the PCAOB's objectives with respect to enhancing the transparency of audits, including the identification of the engagement partner, and we look forward to evaluating the board's most recent proposal,” said Vin Colman, U.S. assurance leader for the firm.

Gaylen Hansen, a partner with regional firm EKS&H and a member of the PCAOB's Standing Advisory Group, says he doesn't see a great deal of difference between the current and prior proposals. “My overall impression is the battle lines seem to be drawn between board members,” he says. “They've been talking about this since 2005 and here we are still fighting over it.”

PCAOB member Steve Harris was openly frustrated during the board's meeting over the time the project has taken, pressing Doty to commit to a final vote as early as March 2014, even after allowing for a 60-day comment period on the latest proposal. Doty agreed the final vote should be taken by mid-year.