Category: Accounting and Auditing

SEC issues public statement on impact of coronavirus on financial reporting and audit quality

In a public statement issued today, SEC Chair Jay Clayton, Corp Fin Director Bill Hinman, SEC Chief Accountant Sagar Teotia and PCAOB Chairman William D. Duhnke III provided guidance regarding the impact of the coronavirus on financial reporting and audit quality, as well as the potential availability of regulatory relief.  The statement arose out of the recent continuing dialogue between these officials and the senior leaders of the largest U.S. audit firms regarding difficulties in connection with conducting audits in emerging markets.

Audit committee chairs identify effective practices for audit quality improvement

In December, the PCAOB posted a report on the results of its 2019 conversations with almost 400 audit committee chairs, focused on audit committee perspectives on audit quality assessment and improvement, auditor communications, new auditing and accounting standards, and technology and innovation. Valuably, the report identifies practices—not necessarily endorsed by the PCAOB—that the committee chairs found to be most effective for improving audit quality across these categories. The report also includes a few PCAOB staff responses to FAQs raised during the conversations.

New Statement on Key Reminders for Audit Committees

Yesterday, SEC Chair Jay Clayton, SEC Chief Accountant Sagar Teotia and Corp Fin Director William Hinman posted a “Statement on Role of Audit Committees in Financial Reporting and Key Reminders Regarding Oversight Responsibilities.”  As the year draws to a close, given the vital role of audit committees in the financial reporting system, the Statement is intended to provide “observations and reminders on a number of potential areas of focus for audit committees.  Issuers and independent auditors also should be mindful of these considerations with an eye toward ensuring that audit committees have the resources and support they need to fulfill their obligations.”

Happy New Year Everyone!

SEC proposes to amend auditor independence rules

Recently, SEC Chief Accountant Sagar Teotia hinted at possible forthcoming changes to the auditor independence rules, remarking that, in connection with the recent changes related to lending relationships, the SEC “also received comments on other aspects of auditor independence rules.  In conjunction with that feedback, the Chairman directed the staff to formulate recommendations to the Commission for possible additional changes to the auditor independence rules for potential rulemaking.” However, the nature of the potential changes remained something of a mystery. The proposal to amend the auditor independence rules has now been released.  According to the press release issued today, the proposal is intended to modernize aspects of the independence rules to minimize the potential for “relationships and services that would not pose threats to an auditor’s objectivity and impartiality [to] trigger non-substantive rule breaches or potentially time consuming audit committee review of non-substantive matters.”  It is important to keep in mind that violations of the auditor independence rules can have serious consequences not only for the audit firm, but also for the audit client.  For example, an independence violation may cause the auditor to withdraw its audit report, requiring the audit client to have a re-audit by another audit firm.  As a result, in most cases, inquiry into the topic of auditor independence should be a menu item on the audit committee’s plate. The comment period will be open for 60 days.

Should CFOs serve on outside boards?

When a company’s CFO serves on another company’s board, does it help or hurt the financial reporting of the CFO’s company? It’s easy to imagine that the time commitment associated with outside board service would be a distraction from the CFO’s primary job and ultimately impair the CFO’s performance—especially since, as reported in CFO.com, a majority of finance chiefs on outside boards are appointed to the time-consuming audit committee. But, according to an academic study, “CFO Outside Directorship and Financial Misstatements,” just published in Accounting Horizons, a peer-reviewed journal of the American Accounting Association (link is to a version on SSRN), that’s not the case. In fact, the study demonstrated that outside board service can actually enhance the quality of the financial reporting of the CFO’s company.

Does appointment of a former partner of the client’s audit firm to the client’s audit committee impair audit quality?

Studies of former partners of audit firms that have assumed management positions at audit clients have raised concerns, at least pre-SOX, about potentially lower audit quality, perhaps reflecting hesitation by the audit firm to “challenge aggressive accounting decisions” made by former partners of their firms. But what happens when a former partner joins the audit client’s audit committee? Does the former partner feel pressured not to question the audit firm’s decisions or lose objectivity about the quality of the work of the audit firm? Does the audit firm feel pressured to accept the company’s more aggressive accounting decisions when a former partner sits on the audit committee? In this study, published in Auditing: a Journal of Practice & Theory, a group of academics looked at that question.  Their conclusion was that affiliated former partners on audit committees actually led to improved audit processes and outcomes. Why? Applying psychology’s “social identity theory,” the authors posit that the former partners continued to identify with their former firms, but instead of losing their objectivity, the former audit partners “use their knowledge of, and identification with, the audit firm to improve the audit process and the communication between the two parties,” leading to improvement in audit quality.

What is going on at the PCAOB?

Yikes! What is going on at the PCAOB? You may recall that, back in 2018, former staffers at the PCAOB and former partners of KPMG were charged by the SEC in connection with  “their participation in a scheme to misappropriate and use confidential information relating to the PCAOB’s planned inspections of KPMG.” You know, that case where the former PCAOB staffers were accused of leaking to KPMG the plans for PCAOB inspections of KPMG—“literally stealing the exam.” (See this PubCo post.) The same scheme led the U.S. Attorney’s Office for the SDNY to file criminal charges against the former staffers, and some have actually been sentenced to prison.  But that’s not even the half of it.