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孙小美
American Institute of Certified Public Accountants
Oral Testimony Presented to the Panel on Audit Effectiveness
July 11, 2000
Participants: Mr. Barry C. Melancon, President and CEO of the AICPA
Mr. James S. Gerson, Vice-Chair – Auditing Standards Board
Mr. Daniel W. Jones – SEC Practice Section Representative
Mr. Melancon: Thank you Mr. O'Malley and distinguished members of the Panel for the opportunity to express our thoughts to you on your draft report. I am Barry Melancon, president and CEO of the AICPA. Before we begin our formal comments, please allow me to introduce the gentlemen with me. Jim Gerson is here representing the AICPA's Auditing Standards Board. Jim currently serves as the vice-chair of the ASB and assumes the chairmanship in October of 2000. Jim is a partner with PricewaterhouseCoopers and is National Director of Audit Policy of his firm. Dan Jones is attending as the AICPA's SEC Practice Section's representative. Dan is a partner with Deloitte & Touche and is the Senior Partner in charge of the Audit and Attest Practice of his firm. During our testimony, I will be asking Jim and Dan to speak on certain aspects of the Panel's draft report especially concerning the recommendations as they relate to auditing standards, governance, and disciplinary matters.
This report has validated our belief that the profession and the quality of audits are fundamentally sound. We know you and your staff have worked long and hard to harness all the information collected over the last year and a half and we congratulate you on your significant accomplishment. The issues you have struggled with are extremely complex, and the profession recognizes and appreciates your boundless dedication to improving the overall quality of audits of publicly held companies.
We also want to thank the profession's eight largest firms for their continuous support of the Panel's project, especially their cooperation in the quasi-peer reviews and the significant resources that each of these firms have devoted in the past eighteen months to your study. The Panel is to be commended that despite the focus on the large firms, and the auditors of SEC registrants, that its draft report included many helpful recommendations that were designed specifically to assist small firms.
We would be remiss if we did not mention that the investing public is fortunate to be served by a profession and a Securities and Exchange Commission that are equally committed to protection of the public interest.
If there is one overriding message that we want you to understand and take with you today, it is that a core value of the AICPA's mission is its commitment to a self-regulatory program that focuses on protecting the public interest, enhances the credibility of financial reporting through the audit, monitors firm performance, and disciplines those who violate the rules. A profession has a unique responsibility in its ability to have an effective self-regulatory program. It has been the auditing profession's commitment and dedication to preserving the integrity of financial reporting that has made our self-regulation program so successful over the years and will continue to make it successful in the future. Without question, our self-regulatory system has greatly contributed to creating the best and strongest financial reporting system and financial markets in the world. The auditing profession would not do anything to jeopardize this public trust.
The investing public can be reassured by the Panel's findings and conclusions, based on their own independent and in-depth review of audits, that audits are being conducted in an effective manner and the Panel is satisfied that the model underpinning financial statement audits generally is appropriate.
When I first appeared before this Panel in October 1999, I reminded you that the auditor does not work in a static environment. With the dynamic markets, globalization of the economy, rapid changes in technology and virtually driven world, to name a few, the auditor must be able to readily adapt to his or her environment. We, at the AICPA, are committed to assisting our members with that adaptation process. In our efforts to meet that goal, we will evaluate all of the Panel's recommendations. It is our obligation at the AICPA to be cautious so that we do not anchor the audit so that it becomes static.
In our comments today, we will be addressing three major issues in your report that we believe are vitally important to protecting the public interest and enhancing the credibility of financial reporting. Those issues are the ability of audit firms to provide non-audit services in the New Economy and the positive effect those services may have on the effectiveness of the audit, reliance on sound professional judgment rather than mandating prescriptive approaches to auditing, and an effective due process structure for standards setting. The AICPA will also be submitting detailed written comments that address some of the specific issues contained in the draft report.
Our commitment to self-regulation is extremely important in today's business environment. We must also look to the future in assisting audit firms to meet with the rapid changing needs occurring in the business marketplace. The new economy has caused all of us to reevaluate long recognized business models on which business success was predicated. The New Economy requires new and different skills for those in the audit profession for example, understanding rapidly evolving information technology, understanding how "new" businesses are run, and evaluating soft information. We must bring these new and broader skills and strong professional judgment with us to the audit to enable us to understand these new forms of business, including all aspects of their operations. The profession of today must also interact internationally and not be confined strictly to domestic issues. Our efforts have always focused on continuous improvement of the audit process. We are always looking at and reevaluating what we do in all aspects of the self-regulatory program as the business environment changes.
Our profession welcomes this independent in-depth review of our standard-setting and self-regulatory activities. The recommendations you have made will assist us in studying changes helpful to our profession now and in the future. This profession has thrived because of its willingness to have transparency in its standard-setting and self-regulatory activities, subject itself to outside reviews, and to make changes, if required, that enhance protection of the public interest.
In fact, the profession has always demonstrated a willingness to consider the results of independent reviews of its activities. A 1996 report of the General Accounting Office entitled, The Accounting Profession — Major Issues: Progress and Concerns, found that the profession has been responsive in making changes to improve financial reporting and auditing of public companies to major issues raised by the many studies from 1972 through 1995. We shall be equally responsive to your study.
To start our comments, we would like to address the issue of auditor independence, specifically with respect to non-audit services. We were pleased to see that the Panel did not identify any instances in which providing non-audit services had a negative effect on audit effectiveness or resulted in an actual loss of auditor independence. In your report you have identified two opposing views on the various services that an accounting firm may offer to audit clients and whether those services may be perceived as a weakening of the independent auditor's relationship with a client. We were pleased to see that the Panel did not detect any instances of non-audit services having had a negative effect on audit effectiveness. We understand that a majority of the Panel members hold the view that an exclusionary rule is not warranted and would not best serve the public interest, and that audit firms should be allowed to provide these services, if the audit firm has appropriate safeguards in place to assure independence from the attest function. We agree with this view held by the majority of the Panel members.
Over the years, various studies have been performed regarding non-audit services and no empirical evidence exists to suggest that providing non-audit services impairs or causes an ineffective audit or concluded that an exclusionary rule on non-audit services is necessary. This is consistent with the profession's findings. We believe that, with the appropriate safeguards in place, the provision of many non-audit services may enhance the audit by broadening the firm's understanding of a company's business, operating environment, and other factors that lead to a more effective audit. This more effective audit clearly is in the public interest. Another positive factor is the importance of non-audit services that affects our ability to attract and retain qualified specialists.
We ask, that in your final report, you clearly state a majority of the Panel members found that an exclusionary rule is not warranted. We believe that the Panel's findings lend crucial objective evidence that providing non-audit services to audit clients does not impair the effectiveness of the audit and if non-audit services are also performed, may result in a more effective audit in many situations. We also believe the Panel's majority view opposing an exclusionary ban on non-audit service does not support regulatory action to ban non-audit services to audit clients. We believe that important issue should be dealt with by the Independence Standards Board and through effective audit committees. Our position is perhaps best articulated by the SEC Chief Accountant himself in a January 19, 2000 memorandum to SEC Chairman Arthur Levitt and I quote "...taken together, the ISB standard and the Commission's audit committee disclosure requirement should bring independence issues to audit committees' attention and stimulate their participation in identifying and resolving independence issues."
As both the Panel and the profession consider the complex issues of independence, we want to state our support for the ISB and the Independence Issues Committee. We believe that the ISB is the appropriate public forum in which independence issues should be thoughtfully considered and debated. The ISB was created jointly by the SEC and the profession. The SEC's support of the ISB is imperative and needed for the ISB to properly fulfill its mission. At no time since its creation have the public and non-public members on the ISB been divided on a decision. It is our belief that the ISB is the body that should issue independence standards for auditors of publicly held companies.
Moving on to another subject of great importance to the audit profession, we would like to spend a few minutes talking about an issue that is implicit in many of the recommendations that you have made to the profession. That issue is one of professional judgment. Throughout your report, especially in Chapters 2 and 3, you have made recommendations that appear to negate or minimize both the importance and ability of auditors to use professional judgment.
Numerous recommendations call for more "specific and definitive" requirements in the auditing standards. We believe that increasing reliance on specific and definitive requirements in the audit of financial statements leads to a "cookbook" audit approach, which is driven by checklists, and limits the role of professional judgment by the auditor.
We believe that, as the role of professional judgment is minimized, the quality and effectiveness of audits will decline. We believe that the most important component of a high-quality and effective audit is the professional judgment of the auditor. No amount of specificity in the auditing standards will replace good, sound professional judgment.
Sound professional judgment is organic. It is dependent on the competencies and skills that the auditor brings to bear. It is capable of assessing and reacting to the infinite number of situations that an auditor may encounter. A cookbook audit approach could never be as rich and complete as sound professional judgment. An auditor is able to exercise this professional judgment because of an extensive education, years of experience in similar situations, comprehensive professional education requirements, and adherence to a professional code of ethics, and high quality, comprehensive auditing standards.
Greater professional judgment by an auditor is the key to protecting the public today and in a future that is ever changing and complex. Although we understand that specific and definitive auditing procedures make it easier for a regulator to determine whether the procedures have been followed, we believe that a static checklist will never be able to keep pace with the complexity and rapidly changing nature and risks associated with the new economy. Understanding the nature of these risks requires sound professional judgment and it is unlikely that more specificity within auditing standards will create an environment that encourages professional judgment.
This reminds us of the current debate in the medical profession. When a physician makes a diagnosis of an illness, the physician uses his or her professional judgment in making a decision on the best way to treat the illness. However, if the patient is a member of an HMO, then the HMO goes through a checklist oriented procedure on whether to allow the costs attributable to the treatment. In many cases, as we are sure you are aware, the HMO disallows or refuses to cover many of the treatment costs. This in effect, overrides the physician's professional judgment in treating that illness. We fear that prescribing required auditing procedures, like the HMO following a checklist of prescribed treatment procedures for various illnesses, would lead to an eroding of the professional judgment that is needed to conduct a more effective audit.
Auditing is a profession. The fact that we are professionals and can bring our expertise and professional judgment to bear is the reason that we have been so successful in protecting the public interest and in maintaining public confidence in financial reporting. Its specialized body of knowledge that is applied by all of its members whether it is the legal, medical or auditing profession defines a profession. Without professional judgment, auditing will cease to be a profession. Those protecting the public interest will cease to be professionals. We believe that the public interest will be at risk.
In your report, you acknowledge an issue that we long tried to influence. That is, the future of the accounting profession is dependent on attracting the best and brightest students. If professional judgment gives way to checklists of required audit procedures, the best and brightest students will chose more challenging and interesting professions. The profession will spiral downward. We also fear that the recent rulemaking proposal by the SEC to restrict audit firms from providing non-audit services to its clients will also contribute in making the profession less attractive to the best and brightest.
Further, auditing firms have different strengths and competencies, which allow them to specialize in clients of different industries, types, sizes, and complexities. This specialization is important because one size does not fit all when it comes to auditing. We are concerned that an increased reliance on specific and definitive standards will lead to a homogenization of the audit, contributing further to the downward spiral of the profession. To maintain the value of the audit in the eyes of the public, and the auditing firms, we believe that it is very important to prevent the perception that the audit is a commodity. We believe that allowing the firms to differentiate themselves according to their specialties, strengths, and competencies will maintain the value of the audit. Auditors will be encouraged to maintain their competencies, and clients will be able to choose from auditing firms based on their specialized skills.
You recommend that peer reviewers should exercise more professional judgment during the conduct of peer reviews. In certain circumstances, we have seen the results of peer reviews that are checklist driven. This method results in an ineffective peer review. Many of your recommendations regarding specificity of audit procedures may lead to the same result in the audit arena.
We urge you, in your final report, to consider the importance that professional judgment has in the performance of audits. We will consider this skill as we review your recommendations. Professional judgment should constantly be nourished thus protecting the public today and in the future. We ask that you reconsider your recommendations as to whether they inhibit the attractiveness of the profession to the best and brightest individuals.
We recognize that meeting the needs of practitioners while establishing minimum standards for the profession to ensure the continuation of high-quality audits is not an easy task. Too many standards can hamper the exercise of professional judgment and can never cover all the circumstances an auditor may face. The ASB recognizes the fine line between too little and too much guidance. The ASB's goal in setting standards is not to eliminate professional judgment, but to focus it.
Over these two days of hearings, you are implementing a process that is as important as any recommendation contained in your report. By this statement, we mean a due process by which interested parties can testify or comment on the conclusions and recommendations that you have reached. The AICPA firmly believes in due process. Every standards-setting function of the AICPA is open to public comment. I am now going to ask Jim Gerson to speak specifically about the ASB's standards-setting due process.
Mr. Gerson: Thank you Barry and I thank the Panel members for the opportunity to testify on behalf of the AICPA and the Auditing Standards Board.
Barry has discussed the importance of due process in any standards-setting environment. The protection of the public interest is the foundation of our standards-setting procedures. The ASB uses the same general due process procedures as the Administrative Procedures Act prescribes for government agencies in enacting regulation.
Protecting the public interest as a standards setter requires maintaining a challenging balance between the needs of the public, preparers of financial statements, auditors of SEC registrants, auditors of private companies, and government regulators. The ASB achieves this balance through its due process. Our due process protects the public and allows us to issue new auditing standards within a reasonable timeframe.
The standard-setting processes of the ASB are conducted under true public oversight. That is, our meetings are open to any member of the public, and our standards are subject to public scrutiny and comment before the ASB issues an auditing standard in its final form. We follow the same procedures with respect to the quality control standards.
Within the framework of our due process, the ASB pledges to consider the Panel's recommendations. All of our auditing standards are a result of the ASB's due process. First, the need for a project may be identified through comments from practitioners, regulatory pressure, litigation, or actions of other groups that affect the profession. Then, research is performed to analyze the issues, gather data on current practice, review existing literature, and develop alternative approaches. The AICPA's Audit and Attest Standards Team and a small task force do this. A proposed pronouncement is then submitted to the ASB, which considers it and evaluates alternatives.
An important part of the process is that we bring knowledge and experience to the table to develop the auditing standards in a public forum. This knowledge and experience is not limited to the 15 members of the board. Experts on various topics are invited to sit on the appropriate task forces to contribute to the deliberation of the standards. Even before the exposure of proposal, the ASB seeks input from representatives of its constituencies, including the SEC.
The recommendations resulting from the ASB's public deliberative process will be subject to public scrutiny in the form of exposure drafts of proposed auditing standards. Exposure drafts are posted on our website, with notices sent electronically to all the offices of audit firms with AICPA members, regulators, and similar interested parties, and anyone else who requests them. Ordinarily, ninety days are allowed for comments from the public. Through our exposure draft process, the ASB will obtain views of interested parties in the public and private sector. Finally, the ASB will carefully consider the comments from all parties, especially those comments on issues that it had not previously considered, before issuing a new standard or revising an existing standard. We believe that our procedures will result in new or revised standards that address the underlying findings contained in your recommendations an appropriate and timely fashion.
It is clear to the ASB that the omission of any one of the steps in our due process is not in the public interest. It is also clear to us that if the ASB were to ignore or override the comments that may be received during the public comment period merely because they may vary from certain of the Panel's recommendations, it would result in a denial of due process to all constituencies.
The ASB should consider the opinions of all of our constituencies, whether it is auditors, users or preparers of financial statements, or government regulators.
Having said this, I want to assure the Panel that we work closely with the SEC, and meet regularly with them. We take their suggestions very seriously but, even with the SEC, we must consider their views in the context of our overall deliberations and the views of others.
As such, we ask that the Panel acknowledge in its final report that its recommendations and priority of its recommendations be subject to the ASB's due process procedures, which is in the public interest.
Furthermore, we suggest that the Panel make a recommendation to the SEC that the SEC encourage and support the ASB in carrying out its planning and standards-setting mission in the public interest and subject to full due process.
That concludes my comments on the due process aspect of the report and I will give the floor back to Barry.
Mr. Melancon: We would like to take a few minutes to comment about the earnings management and fraud chapter of your draft report. We, as a profession, are very concerned about fraud. We recognize the impact that misstated financial statements have, not only on U.S. capital markets, but also on other international exchanges, and other users of financial statements. The purpose of the audit is the issuance of an opinion on whether the financial statements are free from material misstatements, whether caused by error or by fraud. However, we fear that your use of the term, "zero defects", conveys an unreasonable expectation to users of financial statements. Terms or representations such as "zero defects" contribute to the continued expectation gap between what audits are and what the public believes an audit is.
The AICPA suggests that you revise your report to recommend a "zero-tolerance" for unacceptable behavior by auditors. We believe that this is consistent with your conclusion that reasonable, not absolute, assurance that financial statements are materially misstated is a sufficiently high standard of responsibility for auditors to protect the public interest, and will not create unrealistic expectations for the audit.
I am now going to ask Jim to comment more thoroughly on the earnings management and fraud issues contained in your report.
Mr. Gerson: Thank you, Barry.
Many of your findings concerning earnings management and fraud confirm the ASB's desire to issue additional guidance that helps auditors exercise professional judgment. For example, your recommendations related to non-standard journal entries and the relationship between the risk assessment and the auditing procedures are issues where I would predict that the ASB would consider issuing additional guidance.
Most of Chapter 3 seems to focus on the Panel's desire for stronger and more definitive auditing standards in various areas including planning and supervision, forensic-type fieldwork phases, and the performance of specific substantive procedures in various areas. The ASB and Panel share a common goal – the performance of effective audits. We believe that the auditing standards should enable auditors to provide reasonable assurance that the financial statements are not materially misstated. In keeping with that goal, the AICPA Board of Directors issued a policy statement in 1993, in which it stated as one of its five principal goals, the improvement of the prevention and detection of fraud. In 1997, the ASB issued SAS No. 82, Consideration of Fraud in a Financial Statement Audit. At that time, the ASB developed a strategic plan to commission several academic research projects to study the efficacy of the standard. These research projects are underway now. The ASB will consider the conclusions of these research projects and the recommendations of the Panel's report, within the context of its due process in its deliberations concerning possible amendments to the auditing standard.
Since SAS No. 82 was issued, we have completed several projects to assist auditors in this area. First, when SAS No. 82 it was accompanied by a considerable amount of additional guidance to assist auditors in implementing the standard. In 1999, the ASB issued guidance on revenue recognition. We are following this project up with the development of an Audit Guide on Auditing Revenue. The ASB is also currently working on guidance on auditing reserves. In addition, the SEC Practice Section has issued Practice Alerts in 1998 and 1999 on revenue recognition and non-standard journal entries.
It is our understanding that the Panel's recommendations are based, at least in large measure, on conclusions drawn from audits performed before the effective date of SAS No. 82. We caution the Panel against making recommendations based primarily upon research that was conducted before the effective date of SAS No. 82 and we suggest that the Panel recommend to the ASB that it consider its own research when evaluating the efficacy of the fraud standard.
We further suggest that the Panel's recommendations to the Auditing Standards Board related to earnings management and fraud focus on areas where auditors could use additional guidance in exercising professional judgment. As we discussed earlier, we caution the Panel about the dangers of recommendations that would limit or inhibit the professional judgment of the auditor.
Mr. Melancon: Thanks, Jim.
We now want to spend a few minutes discussing the issues and recommendations that you have made concerning the governance of the auditing profession.
Self-regulation over the auditing processes works because of the strong commitment of the profession, and the existence of a strong, independent oversight board. To that end, each party has supported the other individually and collectively to protect the best interest of the public investor.
The AICPA supports a strong oversight board that is independent of both the profession and the SEC. The Public Oversight Board has served the public and the profession well for almost 25 years. The AICPA has always supported the POB's efforts and initiatives, monetarily and in the mutuality of interests in protecting the public interest.
We understand that the Public Oversight Board is currently proposing to develop a formal charter to depict explicitly the extent and scope of the POB's activities and perhaps to incorporate recommendations made by the Panel concerning expanded oversight responsibilities. We are confident that the Public Oversight Board and the AICPA will produce a charter that will support and preserve an independent oversight board.
In your report, you raise issues and make recommendations regarding the peer review process and enhanced disciplinary procedures. I want to ask Dan Jones to comment on these aspects of your report.
Mr. Jones: Thank you, Barry. I thank the distinguished Panel members for allowing me to testify today on behalf of the SEC Practice Section.
Barry has asked me to convey comments to you on certain issues and recommendations contained in your report. First, we want to thank you for accepting our assistance in certain areas of the report especially those that dealt with disciplinary and peer review issues.
We want to start with the disciplinary area of your report. We are pleased to see that you have incorporated into your recommendations, many of the suggestions that the profession presented to you earlier this year. You recognize that many aspects of the current disciplinary processes work well and that the profession should be a driver of suggested reforms to our disciplinary processes. What became apparent from your report is that more transparency is required in our current processes so that the investing public fully understands the commitment that the auditing profession has in disciplining its own members.
As you have aptly described in your report, the profession's disciplinary procedures center on the AICPA's Professional Ethics Division and the SEC Practice Section. Many of the Panel's concerns revolve around timeliness of disciplinary actions by the profession. You have rightly discerned the reasons for the delay in certain disciplinary matters. That is, the lack of protection or the right of privilege over its disciplinary activities.
We are pleased to report to you today that the SEC Practice Section is implementing many of the Panel's recommendations. The SEC Practice Section expects to issue a new membership requirement regarding its disciplinary processes in September 2000. This membership requirement will offer transparency to the current process and provide timelier disposition of disciplinary matters. To ensure that the profession meets its commitment to these enhanced disciplinary requirements, the largest accounting firms have pledged significant additional funding. This additional funding is to provide resources to ensure that disciplinary matters are conducted in a more timely and effective manner.
We are pleased to report to you today that the SEC Practice Section is implementing many of the Panel's recommendations. The SEC Practice Section expects to issue a new membership requirement regarding its disciplinary processes in September 2000. This membership requirement will offer transparency to the current process and provide timelier disposition of disciplinary matters. To ensure that the profession meets its commitment to these enhanced disciplinary requirements, the largest accounting firms have pledged significant additional funding. This additional funding is to provide resources to ensure that disciplinary matters are conducted in a more timely and effective manner.
However, we must caution the Panel that any recommendations that may result in additional or unnecessary litigation risk to or actions against auditors are unacceptable. Some of the Panel's embellishments to our original proposal risk upsetting the delicate balance that we have achieved with the additional transparency and restrictions imposed on the process. These embellishments may not be possible to implement or accept and may upset the proposal in its entirety. As we are sure you are aware, any modifications to the original proposal must be completed in a way that is not prejudicial to the firms or their members or that would in any way add additional, unacceptable risk of legal exposure.
Next, we would like to spend a few minutes discussing the Panel's report and recommendations concerning the peer review process. As you know the SEC Practice Section, in March 1999, began to research and consider methods on how the peer review process could be improved and enhanced. The SEC Practice Section completed and issued a report on its research in January 2000. For example, the report contained recommendations on continuous peer review for larger audit firms and recommended more involvement by the POB staff in those reviews. We are pleased that you have included the SEC Practice Section's report and recommendations as an exhibit to your report and that you encourage us to implement the recommendations contained in that report.
We are pleased to inform you that the SEC Practice Section Peer Review Committee is implementing as many of those recommendations as possible by the end of this year. The Peer Review Committee is evaluating the effectiveness of the other recommendations that the Panel has made to determine if the recommendations are within its expertise to implement. Several of these recommendations are contained in Chapter 2 of your draft report. As we understand it, the purpose of recommendations to the SEC Practice Section Peer Review Committee was to "close the loop" on new or existing auditing standards to determine if the auditing standards or a firm's audit methodology is effective. At first glance, many of the Panel's recommendations appear to be appropriate and fall within the peer review purview. However, concern exists that some of your recommendations may be more relevant to the business aspect of the firm's practice, and thus should not be part of the peer review process. Our written response to the draft report will discuss these issues in more detail.
Thank you for your attention and I will be pleased to answer any questions after we complete our oral testimony.
Thank you for your attention and I will be pleased to answer any questions after we complete our oral testimony.
Mr. Melancon: Thank you, Dan.
During Dan's testimony, he mentioned several initiatives that the SEC Practice Section has or will implement to improve its self-regulatory activities. I know that the Auditing Standards Board also has begun several projects that are focused on several aspects of the Panel's report. I would like to ask Jim to report on those initiatives.
Mr. Gerson: As Barry mentioned, the ASB has several new projects that are pertinent to the Panel's report. One initiative by the ASB concerns audit documentation. The purpose of this new project is to develop clear, concise, and consistent guidance regarding the objective, nature and extent of audit documentation required for compliance with generally accepted auditing standards.
Earlier, I discussed research activities concerning SAS No. 82. The fraud standard has been effective for about a year and a half. The ASB has formed a new fraud task force chaired by David Landsittel, a past chair of the ASB. This group will consider the research and other activities of the ASB, as well as the Panel's recommendations, in preparation for the retrospective review of SAS No. 82.
Last year, the ASB responded very quickly to the Blue Ribbon Panel on Audit Committee Effectiveness report and recommendations by issuing SAS No. 90, Audit Committee Communications. We believe that this document addresses many of the recommendations in the Panel's report in the section on Communications with Audit Committees.
The ASB has begun a project on inherent risk that is seeking to provide strengthened guidance to auditors in making inherent risk assessments, and determining the nature, timing, and extent of audit tests because of those assessments.
The ASB also is has begun a project that will provide a formal GAAS hierarchy that establishes the authoritative status of auditing pronouncements.
In order to ensure that we have a comprehensive response to all matters affecting audit, attest, and quality control standards, we will hold a special two-day meeting in September to fully develop our work plan for the next few years. We planned this meeting in anticipation of your report that is obviously is a key input into that process. A number of constituencies will be represented at this meeting, including international representatives.
Mr. Melancon: In our closing remarks, we would like to discuss protecting the public in the future and what the AICPA is doing to achieve that objective.
When this Panel was formed in 1998, the Panel's mission was to assess whether audits that are being performed today are effective. We now have your draft report on the results of that study. The AICPA's mission is not only to ensure that audits are effective today, but also in the future. We are moving forward in the areas on continuous auditing and continuous peer review to ensure that effectiveness.
The advance of the digital economy has created, among other things, a demand for more timely assurance on a broader range of information than that previously provided by the annual audit of historical financial statements. If decision makers need continuous information on which to base their decisions, it is also highly likely these decision makers will need independent assurance on the reliability of such information. We believe that the relevance of financial statement information may be significantly enhanced by the provision of timelier assurance.
We suggest that the Panel reconsider their recommendations in light of the possibility of continuous auditing because we believe that continuous auditing will be an integral component of the financial statement audit in the future. As such, many of the recommendations that you make concerning specific audit procedures may quickly become outdated or inefficient in the new economy of today or the future.
The AICPA will continue to research and develop new services that provide protection for the public in situations where the public receives information. WebTrust and SysTrust are examples of such services. For example, WebTrust is a comprehensive e-commerce service designed to build trust and confidence among consumers and businesses purchasing goods and services over the Internet. SysTrust is an innovative service that responds to the critical need for assurance on the reliable operations of computer systems. Both services meet increasing demands in the marketplace for independent third-party verifications of business operations and cover important aspects of today's New Economy, such as privacy and confidentiality.
The AICPA is keeping its eyes on the international auditing arena. We are involved in shaping international auditing standards. The ASB is committed to significantly strengthening its leadership role in developing international auditing standards and quality control processes that meet the need of a global market place. The AICPA has a representative on the International Auditing Practices Committee, and the ASB has a subcommittee that monitors the work of the IAPC and provides input into the IAPC's progress.
In May 2000, a joint working group consisting of representatives from Canada, the United Kingdom, and the United States published a report making recommendations to the IAPC arising from a study of recent developments in the audit methodologies of the largest accounting firms. Based on this experience, IAPC will begin a project to identify areas where significant changes are necessary in international auditing standards.
The auditing profession has many issues facing it from the global economy, to the increasing complexity of business, to the demand for more timely information, and the expansion of the type of information demanded by investors. The AICPA is committed to assisting our members to adapting to this ever-changing environment, but with the public interest always foremost in our minds.
On behalf of the profession, we thank you again for assisting us in the maintaining our profession's role as guardians of the public trust.
That concludes our testimony. We will be glad to answer any questions you may have for us.
AICPA Testimony
Panel on Audit Effectiveness
Final
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©2000 AICPA
Oral Testimony Presented to the Panel on Audit Effectiveness
July 11, 2000
Participants: Mr. Barry C. Melancon, President and CEO of the AICPA
Mr. James S. Gerson, Vice-Chair – Auditing Standards Board
Mr. Daniel W. Jones – SEC Practice Section Representative
Mr. Melancon: Thank you Mr. O'Malley and distinguished members of the Panel for the opportunity to express our thoughts to you on your draft report. I am Barry Melancon, president and CEO of the AICPA. Before we begin our formal comments, please allow me to introduce the gentlemen with me. Jim Gerson is here representing the AICPA's Auditing Standards Board. Jim currently serves as the vice-chair of the ASB and assumes the chairmanship in October of 2000. Jim is a partner with PricewaterhouseCoopers and is National Director of Audit Policy of his firm. Dan Jones is attending as the AICPA's SEC Practice Section's representative. Dan is a partner with Deloitte & Touche and is the Senior Partner in charge of the Audit and Attest Practice of his firm. During our testimony, I will be asking Jim and Dan to speak on certain aspects of the Panel's draft report especially concerning the recommendations as they relate to auditing standards, governance, and disciplinary matters.
This report has validated our belief that the profession and the quality of audits are fundamentally sound. We know you and your staff have worked long and hard to harness all the information collected over the last year and a half and we congratulate you on your significant accomplishment. The issues you have struggled with are extremely complex, and the profession recognizes and appreciates your boundless dedication to improving the overall quality of audits of publicly held companies.
We also want to thank the profession's eight largest firms for their continuous support of the Panel's project, especially their cooperation in the quasi-peer reviews and the significant resources that each of these firms have devoted in the past eighteen months to your study. The Panel is to be commended that despite the focus on the large firms, and the auditors of SEC registrants, that its draft report included many helpful recommendations that were designed specifically to assist small firms.
We would be remiss if we did not mention that the investing public is fortunate to be served by a profession and a Securities and Exchange Commission that are equally committed to protection of the public interest.
If there is one overriding message that we want you to understand and take with you today, it is that a core value of the AICPA's mission is its commitment to a self-regulatory program that focuses on protecting the public interest, enhances the credibility of financial reporting through the audit, monitors firm performance, and disciplines those who violate the rules. A profession has a unique responsibility in its ability to have an effective self-regulatory program. It has been the auditing profession's commitment and dedication to preserving the integrity of financial reporting that has made our self-regulation program so successful over the years and will continue to make it successful in the future. Without question, our self-regulatory system has greatly contributed to creating the best and strongest financial reporting system and financial markets in the world. The auditing profession would not do anything to jeopardize this public trust.
The investing public can be reassured by the Panel's findings and conclusions, based on their own independent and in-depth review of audits, that audits are being conducted in an effective manner and the Panel is satisfied that the model underpinning financial statement audits generally is appropriate.
When I first appeared before this Panel in October 1999, I reminded you that the auditor does not work in a static environment. With the dynamic markets, globalization of the economy, rapid changes in technology and virtually driven world, to name a few, the auditor must be able to readily adapt to his or her environment. We, at the AICPA, are committed to assisting our members with that adaptation process. In our efforts to meet that goal, we will evaluate all of the Panel's recommendations. It is our obligation at the AICPA to be cautious so that we do not anchor the audit so that it becomes static.
In our comments today, we will be addressing three major issues in your report that we believe are vitally important to protecting the public interest and enhancing the credibility of financial reporting. Those issues are the ability of audit firms to provide non-audit services in the New Economy and the positive effect those services may have on the effectiveness of the audit, reliance on sound professional judgment rather than mandating prescriptive approaches to auditing, and an effective due process structure for standards setting. The AICPA will also be submitting detailed written comments that address some of the specific issues contained in the draft report.
Our commitment to self-regulation is extremely important in today's business environment. We must also look to the future in assisting audit firms to meet with the rapid changing needs occurring in the business marketplace. The new economy has caused all of us to reevaluate long recognized business models on which business success was predicated. The New Economy requires new and different skills for those in the audit profession for example, understanding rapidly evolving information technology, understanding how "new" businesses are run, and evaluating soft information. We must bring these new and broader skills and strong professional judgment with us to the audit to enable us to understand these new forms of business, including all aspects of their operations. The profession of today must also interact internationally and not be confined strictly to domestic issues. Our efforts have always focused on continuous improvement of the audit process. We are always looking at and reevaluating what we do in all aspects of the self-regulatory program as the business environment changes.
Our profession welcomes this independent in-depth review of our standard-setting and self-regulatory activities. The recommendations you have made will assist us in studying changes helpful to our profession now and in the future. This profession has thrived because of its willingness to have transparency in its standard-setting and self-regulatory activities, subject itself to outside reviews, and to make changes, if required, that enhance protection of the public interest.
In fact, the profession has always demonstrated a willingness to consider the results of independent reviews of its activities. A 1996 report of the General Accounting Office entitled, The Accounting Profession — Major Issues: Progress and Concerns, found that the profession has been responsive in making changes to improve financial reporting and auditing of public companies to major issues raised by the many studies from 1972 through 1995. We shall be equally responsive to your study.
To start our comments, we would like to address the issue of auditor independence, specifically with respect to non-audit services. We were pleased to see that the Panel did not identify any instances in which providing non-audit services had a negative effect on audit effectiveness or resulted in an actual loss of auditor independence. In your report you have identified two opposing views on the various services that an accounting firm may offer to audit clients and whether those services may be perceived as a weakening of the independent auditor's relationship with a client. We were pleased to see that the Panel did not detect any instances of non-audit services having had a negative effect on audit effectiveness. We understand that a majority of the Panel members hold the view that an exclusionary rule is not warranted and would not best serve the public interest, and that audit firms should be allowed to provide these services, if the audit firm has appropriate safeguards in place to assure independence from the attest function. We agree with this view held by the majority of the Panel members.
Over the years, various studies have been performed regarding non-audit services and no empirical evidence exists to suggest that providing non-audit services impairs or causes an ineffective audit or concluded that an exclusionary rule on non-audit services is necessary. This is consistent with the profession's findings. We believe that, with the appropriate safeguards in place, the provision of many non-audit services may enhance the audit by broadening the firm's understanding of a company's business, operating environment, and other factors that lead to a more effective audit. This more effective audit clearly is in the public interest. Another positive factor is the importance of non-audit services that affects our ability to attract and retain qualified specialists.
We ask, that in your final report, you clearly state a majority of the Panel members found that an exclusionary rule is not warranted. We believe that the Panel's findings lend crucial objective evidence that providing non-audit services to audit clients does not impair the effectiveness of the audit and if non-audit services are also performed, may result in a more effective audit in many situations. We also believe the Panel's majority view opposing an exclusionary ban on non-audit service does not support regulatory action to ban non-audit services to audit clients. We believe that important issue should be dealt with by the Independence Standards Board and through effective audit committees. Our position is perhaps best articulated by the SEC Chief Accountant himself in a January 19, 2000 memorandum to SEC Chairman Arthur Levitt and I quote "...taken together, the ISB standard and the Commission's audit committee disclosure requirement should bring independence issues to audit committees' attention and stimulate their participation in identifying and resolving independence issues."
As both the Panel and the profession consider the complex issues of independence, we want to state our support for the ISB and the Independence Issues Committee. We believe that the ISB is the appropriate public forum in which independence issues should be thoughtfully considered and debated. The ISB was created jointly by the SEC and the profession. The SEC's support of the ISB is imperative and needed for the ISB to properly fulfill its mission. At no time since its creation have the public and non-public members on the ISB been divided on a decision. It is our belief that the ISB is the body that should issue independence standards for auditors of publicly held companies.
Moving on to another subject of great importance to the audit profession, we would like to spend a few minutes talking about an issue that is implicit in many of the recommendations that you have made to the profession. That issue is one of professional judgment. Throughout your report, especially in Chapters 2 and 3, you have made recommendations that appear to negate or minimize both the importance and ability of auditors to use professional judgment.
Numerous recommendations call for more "specific and definitive" requirements in the auditing standards. We believe that increasing reliance on specific and definitive requirements in the audit of financial statements leads to a "cookbook" audit approach, which is driven by checklists, and limits the role of professional judgment by the auditor.
We believe that, as the role of professional judgment is minimized, the quality and effectiveness of audits will decline. We believe that the most important component of a high-quality and effective audit is the professional judgment of the auditor. No amount of specificity in the auditing standards will replace good, sound professional judgment.
Sound professional judgment is organic. It is dependent on the competencies and skills that the auditor brings to bear. It is capable of assessing and reacting to the infinite number of situations that an auditor may encounter. A cookbook audit approach could never be as rich and complete as sound professional judgment. An auditor is able to exercise this professional judgment because of an extensive education, years of experience in similar situations, comprehensive professional education requirements, and adherence to a professional code of ethics, and high quality, comprehensive auditing standards.
Greater professional judgment by an auditor is the key to protecting the public today and in a future that is ever changing and complex. Although we understand that specific and definitive auditing procedures make it easier for a regulator to determine whether the procedures have been followed, we believe that a static checklist will never be able to keep pace with the complexity and rapidly changing nature and risks associated with the new economy. Understanding the nature of these risks requires sound professional judgment and it is unlikely that more specificity within auditing standards will create an environment that encourages professional judgment.
This reminds us of the current debate in the medical profession. When a physician makes a diagnosis of an illness, the physician uses his or her professional judgment in making a decision on the best way to treat the illness. However, if the patient is a member of an HMO, then the HMO goes through a checklist oriented procedure on whether to allow the costs attributable to the treatment. In many cases, as we are sure you are aware, the HMO disallows or refuses to cover many of the treatment costs. This in effect, overrides the physician's professional judgment in treating that illness. We fear that prescribing required auditing procedures, like the HMO following a checklist of prescribed treatment procedures for various illnesses, would lead to an eroding of the professional judgment that is needed to conduct a more effective audit.
Auditing is a profession. The fact that we are professionals and can bring our expertise and professional judgment to bear is the reason that we have been so successful in protecting the public interest and in maintaining public confidence in financial reporting. Its specialized body of knowledge that is applied by all of its members whether it is the legal, medical or auditing profession defines a profession. Without professional judgment, auditing will cease to be a profession. Those protecting the public interest will cease to be professionals. We believe that the public interest will be at risk.
In your report, you acknowledge an issue that we long tried to influence. That is, the future of the accounting profession is dependent on attracting the best and brightest students. If professional judgment gives way to checklists of required audit procedures, the best and brightest students will chose more challenging and interesting professions. The profession will spiral downward. We also fear that the recent rulemaking proposal by the SEC to restrict audit firms from providing non-audit services to its clients will also contribute in making the profession less attractive to the best and brightest.
Further, auditing firms have different strengths and competencies, which allow them to specialize in clients of different industries, types, sizes, and complexities. This specialization is important because one size does not fit all when it comes to auditing. We are concerned that an increased reliance on specific and definitive standards will lead to a homogenization of the audit, contributing further to the downward spiral of the profession. To maintain the value of the audit in the eyes of the public, and the auditing firms, we believe that it is very important to prevent the perception that the audit is a commodity. We believe that allowing the firms to differentiate themselves according to their specialties, strengths, and competencies will maintain the value of the audit. Auditors will be encouraged to maintain their competencies, and clients will be able to choose from auditing firms based on their specialized skills.
You recommend that peer reviewers should exercise more professional judgment during the conduct of peer reviews. In certain circumstances, we have seen the results of peer reviews that are checklist driven. This method results in an ineffective peer review. Many of your recommendations regarding specificity of audit procedures may lead to the same result in the audit arena.
We urge you, in your final report, to consider the importance that professional judgment has in the performance of audits. We will consider this skill as we review your recommendations. Professional judgment should constantly be nourished thus protecting the public today and in the future. We ask that you reconsider your recommendations as to whether they inhibit the attractiveness of the profession to the best and brightest individuals.
We recognize that meeting the needs of practitioners while establishing minimum standards for the profession to ensure the continuation of high-quality audits is not an easy task. Too many standards can hamper the exercise of professional judgment and can never cover all the circumstances an auditor may face. The ASB recognizes the fine line between too little and too much guidance. The ASB's goal in setting standards is not to eliminate professional judgment, but to focus it.
Over these two days of hearings, you are implementing a process that is as important as any recommendation contained in your report. By this statement, we mean a due process by which interested parties can testify or comment on the conclusions and recommendations that you have reached. The AICPA firmly believes in due process. Every standards-setting function of the AICPA is open to public comment. I am now going to ask Jim Gerson to speak specifically about the ASB's standards-setting due process.
Mr. Gerson: Thank you Barry and I thank the Panel members for the opportunity to testify on behalf of the AICPA and the Auditing Standards Board.
Barry has discussed the importance of due process in any standards-setting environment. The protection of the public interest is the foundation of our standards-setting procedures. The ASB uses the same general due process procedures as the Administrative Procedures Act prescribes for government agencies in enacting regulation.
Protecting the public interest as a standards setter requires maintaining a challenging balance between the needs of the public, preparers of financial statements, auditors of SEC registrants, auditors of private companies, and government regulators. The ASB achieves this balance through its due process. Our due process protects the public and allows us to issue new auditing standards within a reasonable timeframe.
The standard-setting processes of the ASB are conducted under true public oversight. That is, our meetings are open to any member of the public, and our standards are subject to public scrutiny and comment before the ASB issues an auditing standard in its final form. We follow the same procedures with respect to the quality control standards.
Within the framework of our due process, the ASB pledges to consider the Panel's recommendations. All of our auditing standards are a result of the ASB's due process. First, the need for a project may be identified through comments from practitioners, regulatory pressure, litigation, or actions of other groups that affect the profession. Then, research is performed to analyze the issues, gather data on current practice, review existing literature, and develop alternative approaches. The AICPA's Audit and Attest Standards Team and a small task force do this. A proposed pronouncement is then submitted to the ASB, which considers it and evaluates alternatives.
An important part of the process is that we bring knowledge and experience to the table to develop the auditing standards in a public forum. This knowledge and experience is not limited to the 15 members of the board. Experts on various topics are invited to sit on the appropriate task forces to contribute to the deliberation of the standards. Even before the exposure of proposal, the ASB seeks input from representatives of its constituencies, including the SEC.
The recommendations resulting from the ASB's public deliberative process will be subject to public scrutiny in the form of exposure drafts of proposed auditing standards. Exposure drafts are posted on our website, with notices sent electronically to all the offices of audit firms with AICPA members, regulators, and similar interested parties, and anyone else who requests them. Ordinarily, ninety days are allowed for comments from the public. Through our exposure draft process, the ASB will obtain views of interested parties in the public and private sector. Finally, the ASB will carefully consider the comments from all parties, especially those comments on issues that it had not previously considered, before issuing a new standard or revising an existing standard. We believe that our procedures will result in new or revised standards that address the underlying findings contained in your recommendations an appropriate and timely fashion.
It is clear to the ASB that the omission of any one of the steps in our due process is not in the public interest. It is also clear to us that if the ASB were to ignore or override the comments that may be received during the public comment period merely because they may vary from certain of the Panel's recommendations, it would result in a denial of due process to all constituencies.
The ASB should consider the opinions of all of our constituencies, whether it is auditors, users or preparers of financial statements, or government regulators.
Having said this, I want to assure the Panel that we work closely with the SEC, and meet regularly with them. We take their suggestions very seriously but, even with the SEC, we must consider their views in the context of our overall deliberations and the views of others.
As such, we ask that the Panel acknowledge in its final report that its recommendations and priority of its recommendations be subject to the ASB's due process procedures, which is in the public interest.
Furthermore, we suggest that the Panel make a recommendation to the SEC that the SEC encourage and support the ASB in carrying out its planning and standards-setting mission in the public interest and subject to full due process.
That concludes my comments on the due process aspect of the report and I will give the floor back to Barry.
Mr. Melancon: We would like to take a few minutes to comment about the earnings management and fraud chapter of your draft report. We, as a profession, are very concerned about fraud. We recognize the impact that misstated financial statements have, not only on U.S. capital markets, but also on other international exchanges, and other users of financial statements. The purpose of the audit is the issuance of an opinion on whether the financial statements are free from material misstatements, whether caused by error or by fraud. However, we fear that your use of the term, "zero defects", conveys an unreasonable expectation to users of financial statements. Terms or representations such as "zero defects" contribute to the continued expectation gap between what audits are and what the public believes an audit is.
The AICPA suggests that you revise your report to recommend a "zero-tolerance" for unacceptable behavior by auditors. We believe that this is consistent with your conclusion that reasonable, not absolute, assurance that financial statements are materially misstated is a sufficiently high standard of responsibility for auditors to protect the public interest, and will not create unrealistic expectations for the audit.
I am now going to ask Jim to comment more thoroughly on the earnings management and fraud issues contained in your report.
Mr. Gerson: Thank you, Barry.
Many of your findings concerning earnings management and fraud confirm the ASB's desire to issue additional guidance that helps auditors exercise professional judgment. For example, your recommendations related to non-standard journal entries and the relationship between the risk assessment and the auditing procedures are issues where I would predict that the ASB would consider issuing additional guidance.
Most of Chapter 3 seems to focus on the Panel's desire for stronger and more definitive auditing standards in various areas including planning and supervision, forensic-type fieldwork phases, and the performance of specific substantive procedures in various areas. The ASB and Panel share a common goal – the performance of effective audits. We believe that the auditing standards should enable auditors to provide reasonable assurance that the financial statements are not materially misstated. In keeping with that goal, the AICPA Board of Directors issued a policy statement in 1993, in which it stated as one of its five principal goals, the improvement of the prevention and detection of fraud. In 1997, the ASB issued SAS No. 82, Consideration of Fraud in a Financial Statement Audit. At that time, the ASB developed a strategic plan to commission several academic research projects to study the efficacy of the standard. These research projects are underway now. The ASB will consider the conclusions of these research projects and the recommendations of the Panel's report, within the context of its due process in its deliberations concerning possible amendments to the auditing standard.
Since SAS No. 82 was issued, we have completed several projects to assist auditors in this area. First, when SAS No. 82 it was accompanied by a considerable amount of additional guidance to assist auditors in implementing the standard. In 1999, the ASB issued guidance on revenue recognition. We are following this project up with the development of an Audit Guide on Auditing Revenue. The ASB is also currently working on guidance on auditing reserves. In addition, the SEC Practice Section has issued Practice Alerts in 1998 and 1999 on revenue recognition and non-standard journal entries.
It is our understanding that the Panel's recommendations are based, at least in large measure, on conclusions drawn from audits performed before the effective date of SAS No. 82. We caution the Panel against making recommendations based primarily upon research that was conducted before the effective date of SAS No. 82 and we suggest that the Panel recommend to the ASB that it consider its own research when evaluating the efficacy of the fraud standard.
We further suggest that the Panel's recommendations to the Auditing Standards Board related to earnings management and fraud focus on areas where auditors could use additional guidance in exercising professional judgment. As we discussed earlier, we caution the Panel about the dangers of recommendations that would limit or inhibit the professional judgment of the auditor.
Mr. Melancon: Thanks, Jim.
We now want to spend a few minutes discussing the issues and recommendations that you have made concerning the governance of the auditing profession.
Self-regulation over the auditing processes works because of the strong commitment of the profession, and the existence of a strong, independent oversight board. To that end, each party has supported the other individually and collectively to protect the best interest of the public investor.
The AICPA supports a strong oversight board that is independent of both the profession and the SEC. The Public Oversight Board has served the public and the profession well for almost 25 years. The AICPA has always supported the POB's efforts and initiatives, monetarily and in the mutuality of interests in protecting the public interest.
We understand that the Public Oversight Board is currently proposing to develop a formal charter to depict explicitly the extent and scope of the POB's activities and perhaps to incorporate recommendations made by the Panel concerning expanded oversight responsibilities. We are confident that the Public Oversight Board and the AICPA will produce a charter that will support and preserve an independent oversight board.
In your report, you raise issues and make recommendations regarding the peer review process and enhanced disciplinary procedures. I want to ask Dan Jones to comment on these aspects of your report.
Mr. Jones: Thank you, Barry. I thank the distinguished Panel members for allowing me to testify today on behalf of the SEC Practice Section.
Barry has asked me to convey comments to you on certain issues and recommendations contained in your report. First, we want to thank you for accepting our assistance in certain areas of the report especially those that dealt with disciplinary and peer review issues.
We want to start with the disciplinary area of your report. We are pleased to see that you have incorporated into your recommendations, many of the suggestions that the profession presented to you earlier this year. You recognize that many aspects of the current disciplinary processes work well and that the profession should be a driver of suggested reforms to our disciplinary processes. What became apparent from your report is that more transparency is required in our current processes so that the investing public fully understands the commitment that the auditing profession has in disciplining its own members.
As you have aptly described in your report, the profession's disciplinary procedures center on the AICPA's Professional Ethics Division and the SEC Practice Section. Many of the Panel's concerns revolve around timeliness of disciplinary actions by the profession. You have rightly discerned the reasons for the delay in certain disciplinary matters. That is, the lack of protection or the right of privilege over its disciplinary activities.
We are pleased to report to you today that the SEC Practice Section is implementing many of the Panel's recommendations. The SEC Practice Section expects to issue a new membership requirement regarding its disciplinary processes in September 2000. This membership requirement will offer transparency to the current process and provide timelier disposition of disciplinary matters. To ensure that the profession meets its commitment to these enhanced disciplinary requirements, the largest accounting firms have pledged significant additional funding. This additional funding is to provide resources to ensure that disciplinary matters are conducted in a more timely and effective manner.
We are pleased to report to you today that the SEC Practice Section is implementing many of the Panel's recommendations. The SEC Practice Section expects to issue a new membership requirement regarding its disciplinary processes in September 2000. This membership requirement will offer transparency to the current process and provide timelier disposition of disciplinary matters. To ensure that the profession meets its commitment to these enhanced disciplinary requirements, the largest accounting firms have pledged significant additional funding. This additional funding is to provide resources to ensure that disciplinary matters are conducted in a more timely and effective manner.
However, we must caution the Panel that any recommendations that may result in additional or unnecessary litigation risk to or actions against auditors are unacceptable. Some of the Panel's embellishments to our original proposal risk upsetting the delicate balance that we have achieved with the additional transparency and restrictions imposed on the process. These embellishments may not be possible to implement or accept and may upset the proposal in its entirety. As we are sure you are aware, any modifications to the original proposal must be completed in a way that is not prejudicial to the firms or their members or that would in any way add additional, unacceptable risk of legal exposure.
Next, we would like to spend a few minutes discussing the Panel's report and recommendations concerning the peer review process. As you know the SEC Practice Section, in March 1999, began to research and consider methods on how the peer review process could be improved and enhanced. The SEC Practice Section completed and issued a report on its research in January 2000. For example, the report contained recommendations on continuous peer review for larger audit firms and recommended more involvement by the POB staff in those reviews. We are pleased that you have included the SEC Practice Section's report and recommendations as an exhibit to your report and that you encourage us to implement the recommendations contained in that report.
We are pleased to inform you that the SEC Practice Section Peer Review Committee is implementing as many of those recommendations as possible by the end of this year. The Peer Review Committee is evaluating the effectiveness of the other recommendations that the Panel has made to determine if the recommendations are within its expertise to implement. Several of these recommendations are contained in Chapter 2 of your draft report. As we understand it, the purpose of recommendations to the SEC Practice Section Peer Review Committee was to "close the loop" on new or existing auditing standards to determine if the auditing standards or a firm's audit methodology is effective. At first glance, many of the Panel's recommendations appear to be appropriate and fall within the peer review purview. However, concern exists that some of your recommendations may be more relevant to the business aspect of the firm's practice, and thus should not be part of the peer review process. Our written response to the draft report will discuss these issues in more detail.
Thank you for your attention and I will be pleased to answer any questions after we complete our oral testimony.
Thank you for your attention and I will be pleased to answer any questions after we complete our oral testimony.
Mr. Melancon: Thank you, Dan.
During Dan's testimony, he mentioned several initiatives that the SEC Practice Section has or will implement to improve its self-regulatory activities. I know that the Auditing Standards Board also has begun several projects that are focused on several aspects of the Panel's report. I would like to ask Jim to report on those initiatives.
Mr. Gerson: As Barry mentioned, the ASB has several new projects that are pertinent to the Panel's report. One initiative by the ASB concerns audit documentation. The purpose of this new project is to develop clear, concise, and consistent guidance regarding the objective, nature and extent of audit documentation required for compliance with generally accepted auditing standards.
Earlier, I discussed research activities concerning SAS No. 82. The fraud standard has been effective for about a year and a half. The ASB has formed a new fraud task force chaired by David Landsittel, a past chair of the ASB. This group will consider the research and other activities of the ASB, as well as the Panel's recommendations, in preparation for the retrospective review of SAS No. 82.
Last year, the ASB responded very quickly to the Blue Ribbon Panel on Audit Committee Effectiveness report and recommendations by issuing SAS No. 90, Audit Committee Communications. We believe that this document addresses many of the recommendations in the Panel's report in the section on Communications with Audit Committees.
The ASB has begun a project on inherent risk that is seeking to provide strengthened guidance to auditors in making inherent risk assessments, and determining the nature, timing, and extent of audit tests because of those assessments.
The ASB also is has begun a project that will provide a formal GAAS hierarchy that establishes the authoritative status of auditing pronouncements.
In order to ensure that we have a comprehensive response to all matters affecting audit, attest, and quality control standards, we will hold a special two-day meeting in September to fully develop our work plan for the next few years. We planned this meeting in anticipation of your report that is obviously is a key input into that process. A number of constituencies will be represented at this meeting, including international representatives.
Mr. Melancon: In our closing remarks, we would like to discuss protecting the public in the future and what the AICPA is doing to achieve that objective.
When this Panel was formed in 1998, the Panel's mission was to assess whether audits that are being performed today are effective. We now have your draft report on the results of that study. The AICPA's mission is not only to ensure that audits are effective today, but also in the future. We are moving forward in the areas on continuous auditing and continuous peer review to ensure that effectiveness.
The advance of the digital economy has created, among other things, a demand for more timely assurance on a broader range of information than that previously provided by the annual audit of historical financial statements. If decision makers need continuous information on which to base their decisions, it is also highly likely these decision makers will need independent assurance on the reliability of such information. We believe that the relevance of financial statement information may be significantly enhanced by the provision of timelier assurance.
We suggest that the Panel reconsider their recommendations in light of the possibility of continuous auditing because we believe that continuous auditing will be an integral component of the financial statement audit in the future. As such, many of the recommendations that you make concerning specific audit procedures may quickly become outdated or inefficient in the new economy of today or the future.
The AICPA will continue to research and develop new services that provide protection for the public in situations where the public receives information. WebTrust and SysTrust are examples of such services. For example, WebTrust is a comprehensive e-commerce service designed to build trust and confidence among consumers and businesses purchasing goods and services over the Internet. SysTrust is an innovative service that responds to the critical need for assurance on the reliable operations of computer systems. Both services meet increasing demands in the marketplace for independent third-party verifications of business operations and cover important aspects of today's New Economy, such as privacy and confidentiality.
The AICPA is keeping its eyes on the international auditing arena. We are involved in shaping international auditing standards. The ASB is committed to significantly strengthening its leadership role in developing international auditing standards and quality control processes that meet the need of a global market place. The AICPA has a representative on the International Auditing Practices Committee, and the ASB has a subcommittee that monitors the work of the IAPC and provides input into the IAPC's progress.
In May 2000, a joint working group consisting of representatives from Canada, the United Kingdom, and the United States published a report making recommendations to the IAPC arising from a study of recent developments in the audit methodologies of the largest accounting firms. Based on this experience, IAPC will begin a project to identify areas where significant changes are necessary in international auditing standards.
The auditing profession has many issues facing it from the global economy, to the increasing complexity of business, to the demand for more timely information, and the expansion of the type of information demanded by investors. The AICPA is committed to assisting our members to adapting to this ever-changing environment, but with the public interest always foremost in our minds.
On behalf of the profession, we thank you again for assisting us in the maintaining our profession's role as guardians of the public trust.
That concludes our testimony. We will be glad to answer any questions you may have for us.
AICPA Testimony
Panel on Audit Effectiveness
Final
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