Auditors help to ensure investors have accurate information to make informed investment decisions. Now, however, the body that oversees the practices of public auditors, the Public Company Accounting Oversight Board (PCAOB), is proposing to completely alter financial reporting. Through proposed changes to auditing standards known as NOCLAR (Noncompliance with Laws and Regulations), the PCAOB would degrade audit quality, harm investor protection, make the audit process considerably more complex, and increase the cost and scope – without a clear benefit to investors. The Proposal outlines a series of complex duties, without adequate justification, that are not encompassed within the audit and therefore are beyond the remit of the PCAOB.
Transforming auditors into law enforcement officials
The current PCAOB standard distinguishes between laws and regulations that have a direct and material effect on the determination of financial statement amounts (e.g., tax laws that affect tax accruals and tax expense) and those that have an indirect financial statement effect (e.g., laws related to securities trading, occupational safety and health, environmental protection, etc.).
The new PCAOB proposed standards would drastically expand the scope of the auditor’s responsibility to matters well outside the auditor’s traditional role. Specifically, the new standards from the PCAOB would require auditors to:
- Identify all laws and regulations “with which noncompliance could reasonably have a material effect on the financial statements” globally;
- Require auditors to then evaluate whether noncompliance with those identified laws and regulations “may” have occurred and “could reasonably” have a material impact on financial statements;
- Insert auditors into company legal and management decisions that are not part of the traditional audit process.
In effect, these standards will transform the public company audit, moving its purpose away from the integrity of financial statements and into an investigation that requires auditors to evaluate whether client companies are out of compliance with all laws across all jurisdictions in which the company operates.
Negative impact on investors and companies
Public companies work with their auditors to ensure financial statement information is accurate. If the PCAOB expands the scope of auditors’ work and increases auditing responsibilities, it would harm investors by diverting auditors’ time, attention, and resources away from auditing financial statements and would divert company management, employees, and resources away from financial reporting to focus on noncompliance.
By the Chamber’s estimate, the financial cost of the PCAOB’s proposal could triple annual auditing costs for public companies, from $18.2 billion to $54.6 billion – a net increase of $36.4 billion. It’s clear that the costs of the proposal, both in time and money, do not exceed the benefits, especially considering that companies are already under stringent review for compliance with laws and regulations from other parts of government.
The PCAOB should not confuse auditors for lawyers and should not undermine the audit process by expanding the scope of NOCLAR requirements as proposed. Given the estimated costs of these proposed standards, the PCAOB must weigh heavily whether the proposed standards are fit for purpose.