PCAOB Releases Potential Changes to Auditor's Report

Last week, the PCAOB issued a concept release presenting four potential changes to the auditor's report on public company financial statements. The changes, open for public comment, include the following:

• Auditor's Discussion and Analysis (AD&A) - Presented as a narrative intended to "facilitate an understanding of the auditor's opinion of the financial statements taken as a whole," according to the PCAOB. This section might include a discussion of audit risks identified, significant management judgments, and critical accounting policies.
• Expanded and requisite use of emphasis paragraphs - While emphasis paragraphs are currently optional, they might be required in a standard auditor's report to point the reader's attention to where significant financial statement items can be found in the financials and related footnotes.
• Auditor assurance on information outside the financial statements - Auditor's may be required to issue an opinion on information such as the management discussion and analysis (MD&A), press releases, or other published financial information.
• Clarification of standard language in the auditor's report - The auditor's report might also clarify the auditor's role and concepts mentioned in a standard auditor's report, such as reasonable assurance, and auditor's responsibilities vs. management's responsibilities.

While each of the above recommendations seem to address the need for investors to have a stronger grasp of the level of assurance provided by an independent audit, I fear any or all of the aforementioned changes could further bury investors in a heap of esoteric language. Studies have shown that few information within the audited financial statements and footnotes is consistently read and understood by analysts and investors, so adding even more audited information and discussion may only add to the current level of confusion.

Given that investors feel they have been duped by public companies, auditors, and hedge funds when so much market capitalization evaporated in the recent recession, I understand the legal concerns of the auditing profession and their regulators. If we audit more and disclose more, how could investors ever be duped again? They would have no excuse for making bad investments, right? The information was all there in front of them. Unfortunately, a clean audit opinion is not equivalent to an analyst's recommendation to buy or hold a security. Perhaps auditors do have it a little too easy only having to issue a pass/fail audit report right now, but I fear that the addition of some of the information suggested by the PCAOB, particularly the AD&A, would confuse investors into thinking that an auditor was making an investment recommendation. We need to be careful not to overwhelm investors. It is not the volume of information, but the relevance of it that investors are in need of.