The role of auditing in capital markets today is under fire because investors get little insight from auditors about what they do or learn in the course of a normal audit, and the key to fixing the problem is greater transparency. That's the view of James Doty, chairman of the Public Company Accounting Oversight Board, revealed through a recent speech in London.
“The audit market flirts with stagnation,” said Doty at a recent accounting conference in London. In the United States, large audit firms are seeing revenue growth of 15 percent in consulting services while audit revenue is flat, he said. “Audit practices have shrunk in comparison to audit firms' other client service lines. Worldwide, many companies consider the audit an obligatory compliance function, best obtained at the lowest cost.”
Doty believes the challenge before regulators is to “harness the market as an ally in the cause of audit quality.” If regulators like the PCAOB extract more information out of auditors to give investors more insight into the audit, perhaps they will better appreciate what the audit gives them and reward good quality audits with greater investment. Under the current model, investors can't see any difference from one audit to another, he said. “With little information about particular audits, some members of the public seem to echo the clients, with the conventional wisdom that the audit is largely irrelevant to the investment process today,” he said. “Management says that (key performance indicators) and non-GAAP measures threaten to supplant the audit.”
The solution, he said, is to give investors more insight into the audit, along with more independence from auditors, and more reliability. Doty points to three specific projects under way at the PCAOB that are focused on those objectives. First, the board is looking at the auditor's reporting model, and whether a different form of audit report oriented toward the needs of users might flesh out new insights that will help users understand the quality of financial reporting. “The project is not about changing the nature or scope of the auditor's work,” he said. “It's about making the results of that work more relevant. The audit report should speak to the financial statement users, perhaps as it would if the user had personally contracted for the audit.””
Second, the board is looking for more transparency into who performs the audit by having engagement partners and affiliated audit firms listed in the audit report. “If we want the audit profession to compete on quality more than price, we've got to provide markets more information about the audit,” Doty said. “Knowing the name of the engagement partner on an audit, and the various other firms that participate in a global audit, is just a start. But it may help the investing public begin to identify and judge quality, leading to better auditing.” Academic study has determined investors value information about who participates in the audit, Doty said, and the PCAOB recently provided a new page on its website to list the various subsidiaries that operate under the major global accounting networks.
Finally, the board is studying what it can do to drive greater independence into the audit process. The board issued a concept release asking for views on whether mandatory firm rotation would do the job, but it got little support for the idea in the comment and feedback process and hasn't produced any empirical evidence that it would be effective. The board continues to “dig deeper for the most relevant insights and leanring,” Doty said.
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