Announcing PCAOB’s new auditor’s reporting model

In June 2017,  the United States Public Company Accounting Oversight Board (PCAOB ) issued a new standard and related amendments called “The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion and Related Amendments to PCAOB Standards”. The new standard creates the first significant change to the standard form auditor’s report in 70 years. Reports prepared by public company auditors will contain more information for investors and other financial statement users as a result of new rules.

Under the new standard, the auditor's report will retain the pass/fail opinion of the existing auditor’s report but will also include a new description of “critical audit matters,” providing financial statement users with information about complex aspects of the audit. Critical audit matters are any matters arising from the current period's audit of the financial statements that were communicated or required to be communicated to the audit committee, and that (1) Relate to accounts or disclosures that are material to the financial statements, and (2) Involved especially challenging, subjective or complex auditor judgment.

The US Center for Audit Quality (CAQ), affiliated with the AICPA, views the new standard as a positive step toward continuous improvement of the audit to better serve investors and capital markets. The CAQ welcomes the enhanced auditor’s reporting model to provide additional information to investors and other stakeholders in an increasingly complex and global business environment. It noted the PCAOB’s responsiveness to the auditing profession’s concerns and recommendations throughout the proposal process, including observations from the CAQ’s field-testing.

In October 2017, the US Securities and Exchange Commission (SEC) unanimously approved the PCAOB’s new auditor’s reporting standard, supporting the communication of “critical audit matters” as a way for auditors to provide more information to investors and the public.

For more information on the work of the PCAOB with regards to professional judgment and the auditor, review previous blog postings.

Ethical Lapses Force More CEOs Out of Office

The share of CEOs forced out of office for ethical lapses has been on the rise, according to the 2016 CEO Success study by Strategy&, PwC’s strategy consulting business. The study, which analysed CEO successions at the world’s largest 2,500 public companies over the past 10 years, reports that forced turnovers due to ethical lapses rose from 3.9% of all successions in 2007–2011, to 5.3% in 2012–2016. The 36% increase was due in large part to increased public scrutiny and accountability of executives.

The increase was more dramatic at companies in the US and Canada, where forced turnovers for ethical lapses increased from 1.6% of all successions in 2007–2011 to 3.3% in 2012–2016, or a 102% jump. In Western Europe, the share of CEOs forced out for ethical lapses increased to 5.9% from 4.2%, and in the BRIC countries, to 8.8% from 3.6%.

It is noteworthy that there were 12 women globally appointed to the role of CEO in 2016 – 3.6% of the incoming class. This marks a return of the slow trend toward greater diversity that had been in place over the last several years, and a recovery from the previous year’s low point of 2.8%. The share of incoming female CEOs was highest in the US and Canada, rebounding to 5.7% after falling for the previous three years. Five industries – healthcare, industrials, information technology, consumer staples, and telecom services – did not have a single incoming female CEO in 2016.

Read the full story “More CEOs forced out of office for ethical lapses” at Chartered Accountants Worldwide online. This article was originally published by the Institute of Singapore Chartered Accountants (ISCA) in the June 2017 edition of ISCA Journal. 

Critical success factors for tomorrow’s business leaders: Perspectives from the UK

The latest report from Chartered Accountants Worldwide has called for business to instill a culture of ‘moral courage’ from the boardroom downwards. In Critical Success Factors for Tomorrow’s Business Leaders: Perspectives from the UK, the international body states that social media and the 24-hr scrutiny of the digital age mean that there is a direct link between ethics and value creation that business needs to acknowledge.

The report follows the latest Chartered Accountants Worldwide Critical Success Factors Summit in London. The summits gather senior CEOs, CFOs and executives, together with the heads of global Chartered Accountancy bodies, to discuss key issues facing future finance professionals. The report covers issues ranging from geopolitical tensions to the need for tax simplification and also draws on research surveying chartered accountants leading UK businesses.

According to Pat Costello, Chairman of Chartered Accountants Worldwide: “The digital age means that everyone is under scrutiny, all of the time, and issues can escalate through social media like wildfire. The right decisions need to be taken in real time – it’s no longer enough to rely on the traditional hierarchies. This means we need to foster a culture where people are trained to know what the right thing to do is when a challenge presents itself. A culture of ethics certainly starts in the boardroom, but it can’t stop there.”

Professional Scepticism of Auditors: A Cross-Cultural Experiment

 In light of the growth in multinational business operations and the greater use of international sources of finance, there has been a global trend to increased uniformity in accounting and auditing standards. The research suggests that uniformity in auditing also requires uniformity in the application of those standards. One study attempts to determine whether there are differences in the application of auditing standards due to the influence of cultural differences on decision-making by auditors. In this regard, the study examines the effect of culture, the risk of fraud and errors, and accountability on auditors’ professional scepticism, which is necessary to assess the risk of material misstatements.

Data from a sample of auditors from the Big 4 audit firms in Egypt and Australia were collected. The subjects evaluated the risk of fraud and error at the planning stage. The findings provide evidence as to whether auditors from different cultural backgrounds react differently to audit evidence. The results show that there are significant differences between the two countries with respect to some audit decisions.

This paper makes an original contribution to the literature by providing evidence about whether auditor judgments, decisions and professional scepticism are consistent across cultures. The findings indicate that the exercise of professional judgment differs between cultures. Therefore, the researchers recommend that international auditing standards should consider these differences.

For more information, read the research paper (and the related Doctoral Thesis), Professional Scepticism of Auditors: A Cross-Cultural Experiment by Medhat Endrawes, Department of Accounting and Corporate Governance, Macquarie University and Gary S. Monroe, School of Accounting, University of New South Wales.

Enhancing Audit Quality: Canadian Perspectives - Conclusions and Recommendations 2013

The Enhancing Audit Quality (EAQ) initiative, headed by the Chartered Professional Accountants of Canada (CPA Canada) and the Canadian Public Accountability Board (CPAB), has been completed. This initiative arose following the audit symposium organized by CPAB in December 2011. Work commenced in February 2012 and the final report, Enhancing Audit Quality: Canadian Perspectives - Conclusions and Recommendations, was published in May 2013.

The conclusions in the report will be reviewed and appropriate action will be taken by the pertinent competent bodies in Canada. Reforms introduced in other jurisdictions, such as Europe and the United States, will have to be carefully monitored to ensure that Canadian reforms are not in direct conflict with those proposed elsewhere, frustrating attempts to harmonize the solutions ultimately implemented. Recommendations on how best to maintain auditor independence and support professional skepticism are among the key findings aimed at adding value to financial reporting.

The EAQ initiative gained stakeholder input on developments taking place in jurisdictions  hardest hit by the financial crisis, such as Europe and the United States, where  regulators have suggested a number of remedies such as subjecting  audit firms to term limits and calling for mandatory re-tendering of audits. The EAQ initiative concluded that the preferred approach is having audit committees perform a periodic review of their audit firm at least every five years, resulting in a recommendation to retain or replace the audit firm. A report summarizing the results of the comprehensive review should then be included in an entity’s public disclosures, which would strengthen transparency.

CPAB is Canada’s audit regulator, dedicated to protecting the investing public’s interests and to delivering value to its various stakeholders through world class audit regulation. It regulates the auditors of Canadian public companies through its national inspection program. CPAB delivers value by promoting high-quality, independent auditing. As a champion of audit quality, CPAB contributes to public confidence in the integrity of financial reporting, which supports Canada’s capital markets.

CPA Canada is the national organization representing the Chartered Professional Accountants (CPA) profession in Canada. The Canadian Institute of Chartered Accountants (CICA) and The Society of Management Accountants of Canada (CMA Canada) created the organization on January 1, 2013, to support unification of the Canadian accounting profession under the CPA banner.

OECD unveils plan for cross-border tax reporting

Cross-border portfolio investments are greater than $35 trillion globally, but the intended tax benefits are so difficult to claim that they often do not reach their intended targets. In response, the Organisation for Economic Cooperation and Development (OECD) has developed and approved a standardized system of relief meant to streamline processes, reduce costs and assure investors their rights, while also improving tax compliance.

The electronic system allows tax authorities to exchange information and financial institutions to report information to tax authorities. The new “Treaty Relief and Compliance Enhancement” system is based on eXtensible Markup Language (XML) technology. The United States and Canada are among the 34 countries in North and South America, Europe, Asia, Australia and New Zealand that participate in the OECD.

The135-page “Trace Implementation Package” adopted on January 23, 2013 by the OECD committee that developed it would allow authorized intermediaries to claim exemptions or reduced rates of withholding taxes on a pooled basis on behalf of their portfolio investor customers.  The package contains a complete set of tools and documents for intermediaries to begin using the system, although OECD acknowledges there are still some technology issues to resolve and, in some cases, participating countries may need to change certain domestic laws to enable intermediaries to participate. Learn more about this system at the OECD website and read the article “OECD Offers Plan for Cross-Border Investment Tax Woes” at Compliance Week online

Professional Ethics for CPAs in Business

“The AICPA Code of Conduct applies to all CPAs and the aftermath of accounting scandals has created new expectations and federal compliance issues. Those working in business face unique problems and are sometimes faced with ethical decisions that affect their only source of income.”

“The goal of this course is to promote ethical behavior and ethical reasoning and to give CPAs working in business the tools they need to resolve ethical dilemmas in compliance with the AICPA and government regulations. Case studies are the primary learning tool to allow participants to practice their ethical decision-making skills and their knowledge of AICPA rules.”

The AICPA course Professional Ethics for CPAs in Business is available for online access and as a CD-ROM. Choose the best format that best meets your self-study/on-site group study needs. In addition, review other available professional ethics research and guidance.

Sarbanes-Oxley and the Accounting Profession: Public Interest Implications

A recent research article notes that “The US accounting profession was caught up in, and some say responsible for, the whirlwind of accounting and business scandals that rocked the US markets in 2002. To restore investor confidence in financial information, the Sarbanes-Oxley Act created a new Public Company Accounting Oversight Board [PCAOB] with the authority to set standards for auditors of publicly-traded companies, thus ending a century of professional regulation of auditing.”

The research uses sociological theories of professionalism to help understand the implications of the Sarbanes-Oxley legislation for the accounting profession and for the public interest. It explains why professional self-regulation is important for retaining valuable economic franchises. It also explains why the public interest orientation of the profession is important and how government take-over of auditing standards potentially erodes the public accounting profession’s commitment to the public interest.

According to the article, self-control over professional work, a key characteristic of professional status, is pre-empted by the newly created government oversight body PCAOB. With government takeover of oversight of auditing practice, claims to professional status are weakened and professional commitment to, and involvement with, vital work standards may suffer. In addition, the profession may no longer have incentives to promote the public interest or to innovate and change in response to changing conditions.

The authors trace events leading up to Sarbanes-Oxley legislation and conclude that underlying problems arising from internal work differentiation as consulting work became more profitable and glamorous, and development of a commercially-oriented work culture may continue to threaten the profession in the future.

They speculate that the greatest costs may be opportunity costs as the profession no longer has the incentives or ability to innovate and embrace new forms of accountability. Learn more by reading the research article “Sarbanes-Oxley and the Accounting Profession: Public Interest Implications” by Sara Ann Reiter (1Binghamton University, Binghamton, USA) and Paul F. Williams (North Carolina State University, Raleigh, USA) in Open Journal of Accounting, 2013, Vol. 2, pages 8-15.

A Template for Integrated Reporting

In an era in which news spreads as it happens over the Internet and social media networks, investors, society and governments are increasingly demanding that organizations be accountable to stakeholders, not merely shareholders, and be transparent about their activities. A forthcoming research paper outlines the concept of integrated reporting and proposes a template for integrated reporting. The model is based on the concepts in the King Report on Governance for South Africa (King III), and the International Integrated Reporting Council in the United Kingdom.

According to the author, an integrated report should explain the story of reaching the organization’s vision, underpinned by its values, enacted by management, monitored by governance and using facets of resources relating to financial capital, intellectual capital, social capital and environmental capital. The paper proposes an integrated reporting framework and provides an example of a template to use. Apparently, this is the first academic paper that provides a coherent framework on integrated reporting, along with a template.

The author supports a concise report that informs significant performance implications on the organizational vision during the reporting period. The paper does not define significance as it is an outcome of inquiry into reporting, rather than a rule, and instead leaves it up to preparers to use their professional judgment. Learn more by reading the online 48-page research article “A template for integrated reporting” by I. Abeysekera to be published in the Journal of Intellectual Capital, 14 (2), in May 2013.

Promoting Professionalism: Lessons from the Medical and Legal Professions

Recent research has observed that: “The accounting, medical and legal professions share characteristics common to peer-reviewed professions. These professions also share challenges to professionalism. All three have been criticized for declining professionalism and for choosing commercial success over serving the public interest. Although the medical and legal professions have taken steps to promote a higher level of professional conduct by their members, the accounting profession has not launched initiatives to promote professionalism.”

 

That research discusses the initiatives instigated by the legal and medical professions using the five elements of a professionalism framework. Specifically, the framework highlights the importance of growth in personal conscience, demands compliance with the ethics of duty, inspires realization of aspirational goals, requires accountability of peer professionals, and emphasizes devotion to serving the public good. It recommends that members of the accounting profession use the five elements of the professionalism framework to define, demonstrate and assess professionalism. In addition, it concludes that promoting professionalism is a means for restoring professional identity for individual accountants as well as a means for fulfilling the accounting profession's contract with society.

 

For more information, refer to Promoting Professionalism: Lessons from the Medical and Legal Professions by Laurie Swinney and Bruce Elder in Research on Professional Responsibility and Ethics in Accounting, Emerald Group Publishing Limited, Volume 16, 2012, pp. 93-128. Also, see previous postings on the accounting profession and professionalism.

Developing a framework for “Professionalism”

Australia was the first country outside of the United States to adopt the Certified Financial Planner (CFP) certification model for practitioner excellence. In 2007, the Financial Planning Association of Australia introduced a structured professionalism framework to demonstrate the profession’s commitment to best practice. The publication, A framework for financial planning professionalism, states that professionalism is based on three pillars: professional membership, professional conduct and professional accountability.

The three pillars are illustrated in the following professional framework exhibit. Professional membership is about ensuring that only the right people can become members. Professional conduct is about ensuring members adhere to the high standards set for the profession and that they are supported in following professional ideals. Professional accountability is about protecting the reputation of all members by putting in place an independent, peer-driven disciplinary mechanism.

The framework publication also states: “Our community comprises of our clients, the media, consumer groups and advocates as well as the broader community in which we all live. As a profession, we have obligations and responsibilities to build good relations with the whole community – to be productive and contributing members who make a positive difference to society.”

Furthermore, “A quality professional framework that is supported by the profession and the regulators will underpin these vital goals. Trust will flow on from a robust framework that is supported by members and regulators and shown to have ‘teeth’. The profession’s disciplinary process must be transparent, fair and deliver penalties that match the expectations of the regulators and the community and reinforce best practice behaviours within the profession.”

“The bottom line is that increased community respect will drive the profession’s ‘value proposition’ which will translate into a number of positive outcomes for your business and for you. Some of these outcomes will include increased client stability, growth and profitability.” For more information, also refer to the FPA Code of Professional Practice issued in July 2011.

Principles-based standards and the consequent role of professional judgment enhance the quality of Canadian financial reporting

The academic research provides preliminary confirmation of Ross Skinner’s (1995) hypothesis that Canada’s relatively principles-based GAAP yield higher accrual quality than the US’s relatively rules-based GAAP. These results stem from a comparison of the Dechow-Dichev (2002) measure of accrual quality for cross-listed Canadian firms reporting under both Canadian and US GAAP. However, the research documents lower accrual quality for Canadian firms reporting under US GAAP than for US firms, which are subject to stronger US oversight and greater litigation risk, reporting under US GAAP.

The latter results are consistent with stronger US oversight compensating for inferior accrual quality associated with rules-based GAAP. Consistent with the positive effect of Canada’s principles-based GAAP and the offsetting negative effect of Canada’s weaker oversight, the research found no overall difference in accrual quality between Canadian firms reporting under Canadian GAAP and US firms reporting under US GAAP.

Consistent with Skinner’s writings, the results imply that it is fallacious to attribute perceived deficiencies in Canadian financial reporting to the leeway allowed by principles-based GAAP without allowing for Canada’s oversight, which is relatively weak due largely to the absence of a national securities regulator. If anything, over the 1990-2002 sample period, principles-based standards and the consequent role of professional judgment enhance the quality of Canadian firms’ financial reporting.

To learn more, read the June 2004 article “Earnings Quality under Rules- vs. Principles-Based Accounting Standards: A Test of the Skinner Hypothesis” by Erin Webster and Daniel B. Thornton, Ph.D, FCA, (pictured here). Both are at Queen’s University School of Business in Kingston, Ontario, Canada.

Professional Judgment: Are Auditors Being Held to a Higher Standard Than Other Professionals?

This discussion paper on Professional Judgment was commissioned by the Institute of Chartered Accountants in Australia and written by Professor Ken Trotman, PhD, FCA, Centre for Accounting and Assurance Services Research, University of New South Wales. The September 2006 paper forms part of the Institute’s objective to deliver effective and visionary thought leadership initiatives that profoundly and positively impact business and the accounting profession.

According to the Executive Summary of this paper, “Auditors today are subject to increased expectations from regulators and the investing public. At the same time, corporations are expanding, transactions have become more complex and there are requirements on auditors to provide much greater levels of assurance related to financial fraud.”

The paper further notes that “judgment is the ‘cornerstone’ of auditing and describes some of the 40 years of research that has considered judgment and expertise. While the literature recognises that ‘of course experts make mistakes’, there appears to be a growing presumption that this should not be the case for auditors.”

“In many professions, the difficulty of making judgments is recognised. This paper discusses the role of judgment in medicine, the legal system, police investigations and marketing. It is recognised that errors of judgment do sometimes occur in these professions. The question that arises is whether auditors are being held to a higher level of accountability than other professions. This is particularly important where the scope of audits is constrained by the price society is willing to pay for such services. It is suggested that even a well-conducted audit, following all appropriate audit standards, can fail to detect a material fraud in the financial statements, particularly where management has gone to great lengths to cover up the fraud. These considerations are important in an environment where audit standards have the force of law.”

“The concept of cumulative evidence is discussed by reference to the Public Company Accounting Oversight Board (PCAOB) reviews of the Big 4 in the US. It is concluded that any inspection process should be concerned with whether sufficient cumulative evidence has been obtained rather than specific aspects of particular audit tests. The paper suggests that Australian inspection agencies have an opportunity to more fully inform investors than has been the case with the PCAOB, by providing a more even-handed assessment that describes both the good and the bad. The market needs to be aware of not only problems but also enhancements in independence procedures and quality controls and whether the enhanced policies are continuing to work effectively.”

(Read the discussion paper Professional judgment: are auditors being held to a higher standard than other professionals?)