Friday, October 24, 2008

Fair Value Concept Release Coming By Year-End, Practice Alert on Current Environment Likely Too, PCAOB Tells SAG

The Public Company Accounting Oversight Board intends to publish a Concept Release on fair value and use of specialists by the end of 2008, PCAOB staff told an advisory group yesterday.

Deputy Chief Auditor Jennifer Rand, presenting PCAOB’s 2008-2009 Accomplishments and Priorities to PCAOB’s Standing Advisory Group (SAG) yesterday said that “The staff has been following the developments in the current credit crisis and evaluating how the current economic environment may affect the development of new auditing standards.” She said PCAOB’s project to update existing auditing standards on fair value and use of specialists is a “high priority” and the first step will be issuance of the Concept Release for public comment, a step that sometimes precedes a formal rule proposal.

Fair Value: “As it relates to fair value,” said Rand, “this project encompasses updating the existing standards on auditing accounting estimates, auditing fair value measurements, and auditing derivatives and financial instruments. These are three separate standards under the Board's interim standards. In the specialists' project, we are evaluating the requirements regarding the auditor's use of specialists in instances where a company engages or employs a specialist and the auditor uses that specialist's work as evidential matter in performing an audit, and where an auditor itself engages a specialist and uses that specialist's work as evidential matter.”

Potential Practice Alert on current issues: Additionally, PCAOB is considering issuing guidance on Audit Considerations in the Current Economic Environment. Based on the SAG’s recommendations, it appears this guidance may be issued in the form of a Practice Alert (PA), likely by year-end. The PA would reference existing guidance in areas such as (but not necessarily limited to): (1) Fair value measurements (2) Other than temporary impairment (aka OTTI) (3) Credit derivatives (4) Going concern (5) Pensions/other postretirement benefits (6) Receivables (7) Inventory (8)Other asset impairments (9) Deferred taxes, and (10) Disclosures.

SAG members agreed the above list of topics was worthwhile, noting the topic of “going concern” should address special considerations under the government rescue program (e.g. TARP, guarantees, etc.). SAG members also asked the PCAOB to be clear whether it is simply reiterating existing guidance – and if so, the guidance could be released in the form of a Practice Alert – or, if the guidance amends existing standards, to release it first in the form of a proposal for public comment.

Elizabeth S. Gantnier, Director of Quality Control at audit firm Stegman & Company explained, “Usually the first question after you read [newly issued] guidance is: is there something new, something that doesn’t exist elsewhere?” She added, “The year-end audits are already under way with regard to interim (quarterly reviews) and planning, (thus) time is of the essence.” She advised the PCAOB to “make sure the guidance is clear that we are either reiterating something that already exists, or emphasizing a current economic condition, and not providing new guidance to address an ambiguity; and if we are creating new guidance, to be sure the reader understands that pretty transparently.”

Audit fees: Two SAG members expressed their views on the impact of the current market turmoil on auditing and related audit fees. Dick Dietrich, Chair of the Department of Accounting & Management Information Systems at The Ohio State University, said, “I have heard there is tremendous downward pressure this year (on audit fees), I think we are talking about (doing more) and restoring integrity, one thing you might want to consider is, how you can have investors and audit committees understand that paying more to auditors to make sure these issues are addressed, may be one of the best uses of stockholders’ funds?” Ernie Baugh, National Director of Professional Standards, Mayer Hoffman McCann P.C., said “I agree with Dick on the comment about audit fees going up, if they don’t go up this year, then somebody is not doing what they ought to be doing, and I think our clients should anticipate that.”

Small Co Guidance on AS5: Additional guidance is set for release by year-end, said staff, in the form of updated Guidance for Auditors of Smaller Public Companies, relating to Auditing Standard No. 5, An Audit of Internal Control over Financial Reporting That is Integrated With an Audit of the Financial Statements (AS5). The small company guidance, initially released last year, will incorporate comments received and will take into account information gleaned from PCAOB’s inspection findings.

Other matters discussed at the two-day SAG meeting (held Oct. 22-23) included PCAOB’s consideration of two recommendations made by the U.S. Treasury Advisory Committee on the Auditing Profession (ACAP) relating to Audit quality indicators, and Engagement partner signature on the audit report.

In brief, although audit committees and investors were interested in seeing audit quality indicators, SAG members noted it may not be easy to define a set of audit quality indicators which would ‘faithfully present’ the audit quality which it purports to represent. Additionally, as pointed out by Bob Tarola, SVP and CFO, W.R. Grace and Company, the metrics could be misinterpreted in reaching conclusions or comparisons among audit firms. For example, one firm may spend higher hours auditing a particular company than a comparable company, but the first company may have a more sophisticated financial reporting group, or the audit firm may apply more automated audit technology which reduces the number of manual hours at the first client.

On the subject of Engagement partner signatures (vs. the current practice of ‘the firm’ signing the audit opinion), investors supported adding such a signature to enhance transparency and accountability, auditors were less in favor of such a change since it is the firm that takes responsibility for the audit opinion, and puts its full resources behind the opinion – and all the partners are at risk (at a minimum, financial risk) in the event of litigation relating to that opinion. Issuers were somewhat in the middle of the two camps.

A guest panelist, Janice Hester Amy, senior portfolio manager at Calsters, indicated that investor requests for audit firm rotation may go down if investors had a way of seeing whether the firms rotated engagement partners in accordance with the Sarbanes-Oxley Act.

Bob Kueppers, Deputy CEO of Deloitte, suggested that if transparency were the objective, a potential solution may be to disclose, but not require ‘signature’ of, the name of the engagement partner.

David Becker of Cleary, Gottlieb, Steen & Hamilton (formerly General Counsel at the SEC under Chairmen Arthur Levitt, Jr. and Harvey Pitt) observed, “There is a difference between signing [an audit opinion] and providing information [e.g. the name of the engagement partner], and even though you can’t precisely trace all the threads of liability, signing is a form of representation or acknowledgement of responsibility for the statement that is made, it is an assertion, and absent something that in effect immunizes you from liability will mean that the person signing is regarded as the speaker for the purpose of the representation.”

“Whether you think [it’s a] good thing or a bad thing,” said Becker of a potential disclosure or signature requirement to name the engagement partner, “I don’t think its realistic to say, an audit committee, having gotten a communication from someone saying, ‘we understand the audit team you are considering hiring has as lead partner involved in a restatement or two restatements,’ to assume that won’t have consequences for the person named, of course it will, the audit committee will say to the firm, you’ve got a fair number of partners… we’d rather take the guy without restatements associated with his name than the one with restatements.” He summed up, “You may think it’s a good or bad thing, but it’s not nothing.” NOTE: In a similar vein, some SAG members said an unintended consequence could be that some engagement partners, if they wish to avoid being associated with restatements in a regime in which their name is publicly disclosed in an SEC filing, may be incented to avoid encouraging their clients to restate in instances where restatement would be the proper course to take, thereby potentially hurting, rather than helping, investors. Observation: This could have broader policy and market ramifications than just for investors or creditors in a particular company(ies).

SAG Members Encourage More Transparent Standard-Setting Process
During the discussion of PCAOB’s standard-setting priorities, a number of SAG members suggested the PCAOB could be more transparent by making its deliberations public during the development of a standard, not only at the meeting where the board votes to release a proposed or final standard. The AICPA’s Auditing Standards Board (ASB) which previously set audit standard for public company audits (prior to PCAOB’s formation) and continues to set audit standards for private company audits, was referenced as a positive example of such transparency.

Ernie Baugh, National Director of Professional Standards, Mayer Hoffman McCann P.C said that in briefly reviewing the PCAOB’s proposed risk assessment standards that were just released, he was “somewhat astounded by something not there,” noting there was a very detailed comparison to IAASB (standards), but the AICPA standards (that have been) effective for a year and implemented by virtually all the (audit) firms [i.e., for their private company clients] are hardly mentioned at all.” He added, “it would be really good if we knew where they (the current AICPA standards and the proposed PCAOB standards) were the same, and where they were different.”

In a related comment, Baugh said, “I’ve been involved with standard-setting bodies over 20 years now… and in all of my previous experience, standard setting has been done in the open, in sunshine, this process can benefit from performing in the same manner, it would be very beneficial if you got input as you are developing standards, as opposed to only after they are developed.”

Lynn Turner, former SEC Chief Accountant, agreed, saying, “I remember when twice I was on the ASB, the AICPA did a phenomenally good job talking about standards in public meetings -- why they were going where they were, rather than just going to a public meeting to vote.” He added, “It would behoove this board to adopt the same type of transparency; the transparency you’ve got is a huge step down from what’s been there in the past, and it well serves investors.”

Vin Colman, PwC’s National Office Professional Practice Leader, said, “I was pleased with what Lynn [Turner] talked about around the standard-setting process, I would also encourage the board to think about the process,” and suggested taking a look at the ASB’s process, and other standard-setting processes as examples. Further, Colman asked, “An overarching question is… what are the guiding principles that set the priorities… is it reactionary or judgments?” One such overarching principle that could be considered, he suggested, could be international convergence; another could be cost-benefit. “If we had some kind of framework, it would be helpful,” he said.

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