In 2011, the Public Company Accounting Oversight Board (PCAOB) took action on two projects that could have far-reaching effects on audits of public companies. Last June, the PCAOB issued a concept release on possible revisions to audit reports discussing several alternatives for changing the auditor's reporting model to increase its transparency and relevance to financial statement users. One alternative would require a supplement to the auditor's report providing additional information about audits and companies' financial statements—an auditor's discussion and analysis (AD&A).

Although the alternatives in this release are intended to enhance communication to investors, the board acknowledged that new auditing requirements and coordination with the Securities and Exchange Commission (SEC) likely would be necessary. Certain alternatives may result in increased scope of audit procedures beyond those currently required, bringing about new auditing standards and more costly audits.

The PCAOB also issued a concept release to solicit public comment on ways to enhance auditor independence, objectivity and professional skepticism. Through its inspection process, the board observed instances in which auditors did not demonstrate these required qualities when conducting audits. Mandatory audit firm rotation is being considered as a possible approach to enhance independence.

Proponents of mandatory audit firm rotation believe that: (1) auditors will be freed from management pressure by limiting the audit fees received from one client; and (2) firm rotation provides a fresh look at company financial reporting. Opponents are concerned that changing auditors could impose costs on issuers. They also point to academic research to argue that audit quality may suffer in the early years of an engagement, and rotation could exacerbate this trend.

So why is the PCAOB pursuing these changes now? One answer may be that the board is following advice from its Investor Advisory Group (IAG), which provides high-level advice on matters that may arise in fulfilling its mission to protect investors. In 2011, IAG members indicated that it would be useful to investors to receive additional information from auditors beyond the traditional pass/fail audit report. Some members also urged the board to consider mandatory firm rotation in the context of lessons learned from the financial crisis.

These concept releases are important to issuers of financial statements because they have the potential to significantly change the landscape of auditing for public companies. The PCAOB acknowledged that changing the auditor's reporting model could increase the scope of audits.

For example, if required to prepare an AD&A, an auditor will incur additional time to prepare the analysis, perform firm-required reviews of the document, and reconcile AD&A with management's discussion and analysis (MD&A). The board also acknowledged that mandatory auditor rotation could increase costs and disrupt the audit process because issuer personnel likely will spend more time educating auditors on company policies, procedures and business, and answering questions.

Although the comment periods for these releases have closed or will close soon, the PCAOB will solicit additional comments in the future. Before year-end, the board plans to issue for comment a proposed auditing standard on the auditor's reporting model.

Executives and financial personnel should read the proposal and consider providing comment letters to the PCAOB. The board is interested in the pros and cons of its proposals, and will give due consideration to substantive comments. The PCAOB also held a meeting and plans to hold additional public meetings to solicit comments related to auditor independence and audit firm rotation.

Dee Mirando-Gould serves as a director in the Financial Management practice at MorganFranklin. She has 20 years of experience in accounting and auditing, including extensive expertise in public company reporting such as initial and secondary equity and debt offerings, annual and quarterly reporting, and internal controls over financial reporting. She specializes in complex technical accounting and reporting issues, and previously served as Associate Chief Auditor with the PCAOB.