BoardMatters Quarterly, June 2012

Regulatory activity and possible financial reporting changes

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Questions for the audit committee to consider

  1. What are the audit committee's procedures to monitor auditor independence and audit quality in the current environment?

  2. How would the PCAOB's auditor communication proposals affect the information that the audit committee currently receives from the independent auditors?

  3. Does the audit committee understand the potential changes to the company's financial reporting expected to result from the Boards' joint projects (e.g., revenue recognition, leases)?

Over 90% of responses to the PCAOB's concept release on enhancing auditor independence, objectivity and professional skepticism oppose mandatory audit firm rotation.

Proposals could change the financial reporting process for everyone

Significant standard setting and legislative activity worldwide in recent month affects auditors and, by extension, the audit committee. Audit committees need to monitor these developments closely, share their views and understand the implications.

 Questions for the audit committee to consider                       

Audit committee matters

The Public Company Accounting Oversight Board (PCAOB) issued the concept release on auditor independence (the Concept Release) in August 2011.

The Concept Release sought comments on possible ways to enhance auditor independence, objectivity and professional skepticism, including mandatory audit firm rotation and other alternatives.

In March 2012, more than 40 panelists participated in a two-day public meeting hosted by the PCAOB to discuss the Concept Release. Panelists included institutional investors, former government officials, audit committee chairs of major corporations, senior executives of issuers, representatives from trade associations, academics and senior leaders of audit firms.

Many of the panelists were among the more than 600 people and organizations that submitted comment letters on the Concept Release. More than 90% of those letters opposed mandatory audit firm rotation.

Most roundtable panelists representing issuers, audit committees and audit firms opposed mandatory audit firm rotation. They pointed to the lack of evidence linking audit firm tenure to possible weaknesses in auditor independence, objectivity or professional skepticism.

They also expressed concerns about the increased cost of the audit, including the human capital and audit committee time that would be required to bring a new audit firm up to speed to perform a high-quality audit.

Panelists expressed significant support for retaining audit committee oversight of the independent auditor, with many panelists stating that the audit committee is well-positioned to identify and engage an auditor that best meets the needs of the company.

Several participants noted that alternative ideas could enhance auditor independence, objectivity and skepticism, and that these ideas would be more constructive than the Concept Release's mandatory rotation requirement. The PCAOB staff is analyzing the comments and feedback from the public meetings.

In addition, the PCAOB is reviewing comments on its proposal to enhance the relevance and quality of communications between the auditor and the audit committee. In response to constituents' concerns about its initial March 2010 proposal, the PCAOB tried to better align new communication requirements in the revised proposal with other PCAOB standards.

The proposal would not impose additional performance requirements other than communications.

Accounting changes

Audit committee members should keep an eye on potential changes to the company's accounting policies from the joint projects of the Financial Accounting Standards Board and the International Accounting Standards Board (the Boards) on revenue recognition and leases.

Revenue recognition

Commenter's on the joint revenue recognition proposal generally agree that the Boards have made significant progress on their proposal to replace essentially all existing revenue guidance in US GAAP and IFRS. However, respondents also say that the proposal needs more implementation guidance to prevent diversity in practice.

In particular, respondents want more clarity on accounting for variable consideration and determining when it is appropriate to recognize revenue over time rather than at a point in time. They also expressed concern that the costs of complying with the proposed disclosure requirements would outweigh the benefits, and the disclosures could result in information overload.

In addition, many believe retrospective adoption would be too burdensome. We expect the Boards to re-deliberate certain aspects of the proposal before issuing a final standard.

Recognizing leases on the balance sheet

The Boards remain committed to recognizing leases on the balance sheet but continue to struggle with how to account for related lease revenue and expense. They are now considering ways to mitigate the front-loading of lease expense for certain leases, and they have agreed to perform additional outreach and research.

The Boards also continue to look at the lessor model, which they hope to keep consistent with lessee accounting. The extra work will push back the issuance of an exposure draft until at least the third quarter of 2012.

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