PCAOB Has Big Plans In '06; FASB Wants Simplicity

Accounting regulators predict big developments for 2006, including a new report on audit quality control, a new approach to inspections based on earlier guidance, and new standards on audit quality and communications.

Bill Gradison, acting chairman of the Public Company Accounting Oversight Board, told a recent gathering of the Tax Council Policy Institute that the Board is preparing a report that will provide an overview of its findings about quality control at registered accounting firms. The document will be similar to the report the PCAOB issued last November on implementation of Auditing Standard No. 2, which governs audits of internal controls over financial reporting.

Gradison

“In the next few months I expect the Board will open the window to our inspection findings with regard to all of the 2004 domestic inspections,” he said. The report would not identify companies or audit firms by name, which is prohibited by PCAOB rules unless firms fail to comply with the Board’s recommendations. Instead, Gradison explained, “these reports will provide a baseline against which future inspection findings can be compared.”

The Board will also change its approach to inspections in 2006, Gradison said: Inspections of audits for financial reporting and of audits for internal controls will be integrated, reflecting its own guidance last year that the PCAOB expected audit firms to integrate the two audits. The agency has issued guidance several times directing firms to audit both areas in tandem, to eliminate unnecessary duplication of activity.

“Our intent is that inspections conducted in 2006 will focus on whether the firms have gained ‘efficiencies’ principally by implementing the guidance in the staff Q&As and the board report,” he added.

Gradison also breezed over the PCAOB’s rulemaking plans, suggesting the board may act this year on a standard governing communications with the audit committee and that a standard on quality control remains yet to come.

The PCAOB charged its Standing Advisory Group last fall to debate existing rules governing quality control and audit committee communications, to determine if new rules were warranted. In its white paper on audit committee communications, the PCAOB questions whether auditors should be required to disclose more to the audit committee about their assessment of the risk that fraud or other factors could lead to material misstatement.

“The Board’s interim auditing standards do not require the auditor to communicate the results of this (required) assessment,” the Board wrote. “The Board is seeking advice as to whether knowledge of this assessment could help audit committees in overseeing the auditor’s work.”

Landes

Chuck Landes, vice president with the American Institute of Certified Public Accountants, said existing rules governing communication between auditor and audit committee leave room for improvement, but the fine line surrounding confidentiality and ethics makes the subject a sensitive one. He said AICPA is reviewing its own communication rules in tandem with the International Auditing and Assurance Standards Board.

In his speech, Gradison also mentioned the board is still considering engagement quality reviews, also called “concurrent” or “second-partner reviews,” as an area of possible standard-setting.

Currently, firms are required to appoint a partner within the audit firm but separate from the audit engagement team to review work papers and challenge the engagement team on all critical audit issues. The PCAOB first tasked its advisor group to review the adequacy of those requirements in June 2004 and again in October 2005. At the October session, PCAOB focused specifically on whether the reviews are workable in small firm environments.

Gradison offered no further hints about where the PCAOB’s rulemaking debates have steered the discussion. A PCAOB spokesman said no further information is available either about the board’s intended direction or when it might act.

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FASB Reaffirms Goal To Cut Financial Reporting Complexity

The Financial Accounting Standards Board has issued a 10-page response to last summer’s report from the Securities and Exchange Commission on off-balance-sheet accounting, lamenting the complexity of existing accounting rules and reaffirming its commitment to do what it can to make things simpler and more transparent.

In its statement, FASB describes a number of forces—structural, institutional, cultural and behavioral—that it believes have perpetuated complexity in the accounting literature, making transparent financial reporting difficult to achieve.

The statement outlines FASB’s activities targeting outdated and overly complex accounting standards, including rules surrounding leases, pensions, consolidations, financial instruments and intangible assets. It also discusses the Board’s efforts to revise conceptual and disclosure frameworks to simplify rules.

Herz

FASB also describes other initiatives to break down complexity, such as its project to organize and codify accounting literature, and its policy to pursue principles-based standards instead of issuing prescriptive rules. “We remain concerned about the root causes and the effects that complexity continues to have on our financial reporting system,” Board Chairman Robert Herz said in a statement. He said the board wants “concerted and coordinated action” by FASB, the SEC, the PCAOB and other parties in the financial reporting system to cut the verbosity.

The SEC issued its report in mid-June 2005, fulfilling a requirement of the Sarbanes-Oxley Act to analyze off-balance-sheet accounting—the web of rules navigated at Enron to achieve the fraud that led to the company’s demise. The report outlines some broad goals not only for standard-setters like FASB, but also preparers, auditors and other advisers to do what they can to reduce complexity in financial reporting.

“It is not an apology for FASB's past, but a proclamation that the board is ready to help produce a new future,” said Paul Miller, a former member of FASB and an accounting professor at the University of Colorado. “I interpret this to be a strong challenging statement of the board's vision. It includes not only its own role but also the parts to be played by many others.”

Survey Shows European Fund Managers Favor IFRS Over GAAP

Fund managers in Europe prefer International Financial Reporting Standards over U.S. Generally Accepted Accounting Principles, according to a recent survey by PricewaterhouseCoopers and Ipsos MORI.

The survey polled 187 fund managers in seven countries where IFRS became mandatory at the start of 2005; nearly half of respondents found IFRS more helpful than GAAP in assessing a company’s performance. One-fifth said they preferred GAAP over IFRS, and about one-fourth said it depended on the circumstances.

More than half said they believe IFRS makes companies’ historical financial performance fairly clear, and 60 percent said IFRS makes the financial risk that companies assume fairly clear.

“The landscape is clearly shifting,” PwC wrote in a summary of its survey. “IFRS will have a greater impact on the U.S. capital markets through its use as a global accounting language, but also through its influence on the development of U.S. accounting standards.”