Auditors’ Opinions Split On Issuing Reports

Audit firms seem split on whether they prefer to issue one audit report or two when giving companies opinions on financial statements and on internal control over financial reporting.

A group of KPMG auditors in Germany became curious about how auditors report on the integrated audit that the Public Company Accounting Oversight Board requires under Auditing Standard No. 2, which spells out how accounting firms should audit internal controls over financial reporting as required by Sarbanes-Oxley.

AS2 and subsequent guidance have directed auditors to perform the audits in a single, integrated fashion to eliminate unnecessary redundancy of testing and other audit procedures—a chief complaint from corporate executives exasperated with SOX audits. The rule, however, gives audit firms a choice about whether to issue one audit report covering both audits or two separate audit reports.

“Neither the Board nor staff has indicated a preference for separate or combined reports,” PCAOB spokeswoman Christi Harlan says. “The standard is neutral in permitting either approach.”

According to an analysis by KPMG’s audit group in Germany, audit firms have chosen both approaches. The group studied audit reports for the 30 companies listed on the Dow Jones Industrial Average, and found that 16 had one audit report covering both the financial-statement audit and the audit of internal controls over financial reporting, while the other 14 companies had two reports, addressing the two audits in separate documents.

The preference seems split among audit firms as well. PricewaterhouseCoopers audited 15 of those 30 DJIA companies and issued a single report in all cases. The other three Big 4 firms issued dual reports in all cases except for one audit issued by KPMG as a single report.

Lee

Jim Lee, PwC’s chief auditor, says the firm considered how to issue its reports at the outset of internal control auditing and decided that a single report would reinforce the notion of an integrated audit. “We thought a combined report was more reflective of what the end objective of the standard was, which is to perform an integrated audit,” he says. “We thought one report was more in the spirit of what’s behind Section 404,” the SOX provision that addresses auditing of internal controls.

Lee says that given the criticism the market has heard about excessive audit costs and the inefficiency in SOX Section 404 implementation, the combined report makes even more sense. “It sends the right message to our clients and to our engagement teams that we need to go through these two processes together,” he says.

Melcher

Winfried Melcher, a KPMG audit partner in Germany, says he has no particular theory on why practice might be split. “We have no other insights than what we have compiled from publicly available data,” Melcher says.

Lillian Ceynowa, director of the Center for Public Company Audit Firms, says, in general, audit firms worry that investors are confused by audit reports and might prefer one report or two depending on how they believe the reports are understood by investors.

Ceynowa says CPCAF member firms are concerned that investors still are confused over the two-pronged opinion auditors must give over internal controls, addressing whether management's assessment about the company’s internal control over financial reporting is fairly stated and also whether internal controls are operating effectively.

REGULATION

Text from an AS2 provision discussing separate or combined reports follows.

Separate or Combined Reports. The auditor may choose to issue a combined report (that is, one report containing both an opinion on the financial statements and the opinions on internal control over financial reporting) or separate reports on the company's financial statements and on internal control over financial reporting.

Source

Text Of PCAOB’s Auditing Standard No. 2 (March 9, 2004)

“A lot of our members believe that the two-opinion requirement may be confusing to investors,” she says. “It could be that auditors are choosing one report or two if they see it as a way to reduce the confusion.”

PwC does not have the same concern for reader confusion, Lee says. “Our view is that investors are best served by having the full picture. The report is clearly broken into sections and it’s easy to see what our opinion is on the financial statements separate from our opinion on internal control. We really haven’t had people say to us ‘This isn’t clear to us.’”

Jones

Susan Jones, a partner in charge of auditing standards at accounting firm Grant Thornton, says her firm has a preference for one report, but not based on any significant difference between the outcome of issuing one report or issuing two.

“AS2 clearly allows for either,” she says. “We have a slight preference for separate reports but we haven’t put much more thought into it than that. If a client wants one report, we’ll do one.”

Ten Eyck

Ernie Ten Eyck, a senior managing director at financial consulting firm FTI and a former assistant chief accountant at the Securities and Exchange Commission, says he’s never seen great significance between a single audit report or separate reports, unless perhaps one audit results in bad news.

“If there is a qualified report on internal control, two reports might be of slight help in distinguishing it from the report on the financial statements,” he says.

Orr

Terry Orr, also a senior managing director at FTI, says no meaningful efficiency is to be gained in issuing a single report rather than two separate reports. Instead, he thinks more firms prefer two reports simply because the market began issuing the second audit as a separate report and is now staying the course.

“Once you’ve established something, especially when a company puts its reports out in one format, they want to stay with that format to create less confusion,” he says. “It’s surprising how users of [a] financial statement might see a little change in an opinion and get confused by what it means.”