Instead, we would much rather refocus attention on the real issue: audit quality. While auditor rotation offers one potential means by which to improve audit quality, we want to offer up our own proposed solution to the audit quality dilemma. Our solution is based on one important assumption: the major international accounting firms will continue to abandon to their “gatekeeper” responsibilities to the investing public, and continue to operate in their own self-interest, as well as that of their bill-paying “clients.” The result? Investors will continue to receive more of the same: unqualified “audit” opinions on seemingly GAAP-compliant financial statements of companies with dubious financial health and performance. Ask yourself a couple questions. When was the last time you actually saw a “qualified” opinion for a publicly traded company? Or even an “adverse” or “disclaimer” opinion? Been awhile, huh? And if you had, would you even have recognized it as something other than a “clean” opinion? And does it trouble you in the least, that auditors continually manage to issue “clean” opinions, even when companies report material weaknesses in financial reporting? In the old days, material weaknesses almost certainly triggered at least a “qualified” report…not any more!
Okay, so what do we propose? We think that any auditor’s report (the current or improved version) should be supplemented with a detailed “audit engagement” report that will allow investors to make up their own minds about the quality of a company’s audit. Our “audit engagement” report would provide detailed information about the auditor-client relationship (auditor independence), the auditor’s administration of the engagement (supervision, etc.), as well as the qualifications and experience level of the audit team. Here are some specifics.
Audit Relationship Schedule
This report section would provide readers with insights into relationship issues that potentially could negatively affect auditor independence.
Most of the above information can easily be found in publicly available information so a summary disclosure should not be a problem. Only item 3 as it relates to client personnel may not be disclosed in securities filings ad could be considered “new” information.
Audit Administration Schedule
Unlike the first section, this portion of our “audit engagement” report addresses potential audit quality issues associated with how the audit is staffed and executed. Since virtually all of this information is NOT publicly available, we expect Big 4 firm resistance to these disclosures to be quite stiff.
While audit firms will argue that the above information is proprietary in nature and potentially could destroy competition, let’s get real. There is little competition in the large firm audit industry, and their audit product is undifferentiated and homogeneous. All of the Big 4 essentially audit the same way. If you need proof, just review the PCAOB’s audit deficiency reports. By the way, these same reports seem to beg for the information we are suggesting to monitor audit quality.
We believe that the above information will give investors a much better idea of what exactly the auditors looked at and how much effort they expended doing so. Additionally, if auditors knew that their audit approaches were going to be scrutinized, maybe just maybe, they might begin to evaluate the adequacy of their audit model and detailed procedures. At a minimum, this information will prove useful to audit committees of the boards of directors, who may not even have thought of asking such questions of their independent auditors.
Audit Education and Experience Schedule
The final piece to our evaluation of audit quality is assessing the engagement team’s education and experience levels. Hence, the following disclosures.
So, that’s it! Oh, naysayers will comment that our proposal won’t fly either…probably not. But we can and do hope that the PCAOB might consider some of our suggestions in their ongoing audit report project. Also, we would like to encourage our academic colleagues not to dismiss it so quickly…give it a second look, after all, think of the great research data sets our proposal would generate.
But if you just can’t seem to buy into our proposal to address audit quality, here is one last suggestion that virtually retains the status quo. Let’s just rename what we are calling “independent audits.” Let’s simply call them “GAAP compliance certifications” and drop any pretense of independence or an audit. Now wouldn’t that save everyone time and money!This essay reflects the opinion of the authors and not necessarily the opinions of SmartPros, The Pennsylvania State University, The American College, or Villanova University.