October 23, 2018

The Ideas in This Revamped Auditor’s Report Are Great Because Audit Firms Will Hate Most (if Not All) of Them

Michael Rapoport at the Wall Street Journal has a great article today that gives us a good idea of what kind of information would be contained in a useful auditor's report since we all know that, in its current form, it's more or less useless.

This is not hyperbole, since a study entitled "Improving the Auditor's Report" from 2011 found that 45% of financial statement users "believe that the current audit report does not provide valuable information" while 18% "believe the auditor report is of no use to them at all." So, yeah, it'd be nice if the auditor's report was relevant and informative for investors rather than just a rubber stamp.

Very soon we will see how the reporting model will actually change since addressing the "The Auditor's Reporting Model" is at the top of the PCAOB's standard-setting agenda for the 3rd quarter, but the Journal stabs at things first, putting together a revamped audit report based on what wild-eyed ideas are out there. Obviously it's not to be taken as a serious proposal but rather as a throw-everything-but-the-kitchen-sink approach to give people an idea of what's possible and that's a good thing. Take a look for yourself but I'll run down some key things here:

1. The opinion of the auditor is the first sentence of the report. — I like this idea a lot because it doesn't bury the lede (I could take a cue, I know). Tell us up front, in the simplest terms possible, what your opinion is. Right now the crux of the biscuit is near the bottom and that makes little sense to me. I have no idea how BIG AUDIT would oppose this idea but I'm sure their respective policy folks are putting their heads together right now. If nothing else, they'll simply fall back on, "This will not improve audit quality."

2. Definitions! — The Journal's hypothetical suggests defining key terms like "reasonable assurance" and "material misstatements" so investors have a better idea of what an audit firm's work entails and what its purpose is. Seems logical enough, although I imagine audit firms would oppose this on the grounds that it's unnecessary information and offer some haughty explanation like, "The vast majority of users of financial statements users are sophisticated and we're concerned this would contribute to information overload" which is bullshit of the highest order. The firms are notorious for complaining about the so-called "expectations gap" and defining some of these operative words would help narrow that gap. 

3. Who's actually working on this thing? — The hypothetical audit report informs users how an international independent network of firms — who market themselves as one international behemoth — pulls these complicated international engagements together by explaining which of the firm's affiliates are actually performing the work. This is great because if something goes terribly, terribly wrong, problems might get pinpointed. The audit firms would oppose this reform because problems would get pinpointed.

4.  How much of this company is actually being audited? — Reporting the scope of an engagement would be of great use to users because it would quantify the auditor's work. The Journal illustrates aptly, writing things like "These 12 locations represent the principal business units within the Company's three reportable segments and account for 72% of the Company's total assets" etc. etc. which is nice except this idea is a total non-starter. OH HOLY GOD if this gets proposed, watch out. It will be like Mortal Kombat with PCAOB spines, hearts, and small intestines strewn all over the battle room. Why? The answer to this and pretty much every proposal that gets made is "legal liability." If this reform were allowed, every lawyer with a second-hand attache case and Hermes tie from the outlet mall will be arguing that the scope did not provide adequate coverage and therefore the auditors were negligent yada yada yada. Mark my words, this will NOT make it into the report. NEVER EVER EVER. That's precisely why it's a good idea.

5.  What parts of the audit were most important? — I think this is one of the more measured aspects of the reformed auditor's report that the firms would have trouble arguing against. The Journal's example labels this "Areas of Audit Emphasis" and writes "we highlight matters that are, in our opinion, likely to be most important to the users' understanding of the audited financial statements."  Sort of a "greatest hits of XYZ audit 2013" or something. Maybe there was a major acquisition; maybe there was a new accounting rule implemented that affects the company to a significant degree (hello, new lease accounting!); maybe one of the company's businesses had a massive fraud and the forensic team came in to make sure everything is cleared up. These areas of emphasis might change from year to year or they may never change. Regardless, it would useful for investors to know just what the auditors considered to be important aspects of their work for the past year's engagement. Audit firms won't like this because it would expose their opinions to criticism, which in turn could expose them to more legal liability. It's such a convenient and plausible argument, why wouldn't they use it for everything?  

There's more we didn't cover — assessment of risks, Auditor's Discussion & Analysis, naming the audit partner — so go take a look and discuss what you like, what you hate, what's reasonable, what's not and whether any of it has a chance in hell of ending up in a future auditor's report.

How to Make an Audit Report Useful [WSJ]

Related articles

Grant Thornton and the Antichrist

al pacino_devil.jpgIt’s rather mysterious that the New York office of Grant Thornton is located at 666 Third Ave. As I’m sure our more pious readers know, the significance of the 666 is commonly known as “The Number of the Beast“. We won’t get into any more specifics than that other than to mention that it is a pretty creepy-ass looking number.
Is G to the T run by a secret group of Al Pacino-esque figures that are working against the forces of good?
Maybe not but the otherwise boring-assness of that particular lobby is def working too hard to not be noticed…