17(d). Frequency of Auditing
Auditor Involvement
The shorter the period of time covered by financial statements, the lower is the need for auditor involvement. The need for timeliness is inversely related to the length of the reporting period and short-period measurements, which are relatively imprecise, are difficult to verify. With periods as short as three months, there seems to be little value to be added from auditor involvement with the financial reporting process. In fact, such involvement is likely to diminish timeliness, a primary attribute of interim reports. If external auditors are to be involved, their role should be to assist enterprises to establish procedures and routines that minimize the time taken to get reports prepared and lessen the probability of material errors or misstatements. [Also included in 11(c)] [AIMR/FAPC92, p. 38-39]
In fact, there may be instances in which the auditor's role in annual reporting could be reduced. In companies with strong financial management, effective financial and managerial controls, supplemented by competent internal auditing, a full annual external audit might not be necessary. In those cases, the external auditor would do more systems testing and evaluation than financial statement verification. What might result would be negative assurance on the financial statements in the format referred to in the professional literature as a "limited review." The review work would largely be composed of assessing the effectiveness of financial and managerial control systems and relying on a high-quality internal audit function. [Also included in 11(c)] [AIMR/FAPC92, p. 39]
For enterprises that were to discontinue full annual audits, a time would come when a full external examination of the financial statements would be necessary. This might take place quinquennially. The purpose of that examination would be to provide positive assurance by performing a full audit with emphasis on: (a) complete evaluation of control systems, and (b) a retrospective view of annual income for the five-year period by disclosure of all components of income that make one year not comparable with another. Here is another instance where standards implementing the notion of comprehensive income would be indispensable. We suggest that if and when they are promulgated, the SEC authorize a few selected enterprises to experiment with the changed auditor responsibilities that we suggest. [Also included in 11(c)] [AIMR/FAPC92, p. 39]
__________
[Context] Meeting of the Investor Discussion Group on March 17, 1993. Part of the meeting was devoted to the topic of auditor involvement.
Committee/Staff/Observer
We note that some users of external financial reports have suggested that certain companies need not obtain annual audits. They suggest that companies with strong financial management, effective financial and managerial controls, and competent internal auditing could obtain audits less frequently, such as every five years. Our question is: do you agree that some companies should obtain audits less frequently than annually? If so, which companies and why? [TI 3/17, p. 8]
Participant I-11
Absolutely not. [TI 3/17, p. 8]
Participant I-7
I second that. [TI 3/17, p. 8]
Participant I-12
I was thinking the same thing; absolutely not. [TI 3/17, p. 9]
Participant I-11
The fact that a company has all these strong managerial controls today doesn't mean they're going to have them 5 years from now, or 4, or 3, or tomorrow. In 5 years, a company can go through 5 CFOs. I think that the annual review of what's going on by the independent auditor is essential. [TI 3/17, p. 9]
__________
Participant I-11
A central issue to these discussions is what the role of the auditor is or should be. I think that we may be looking at auditors to do more than they should be doing, using that as an excuse not to do it ourselves. The broad issue is that the financial statements of a company are supposed to accurately reflect the operating performance of that company. The proper role of the auditor is to provide independent judgement that the financial statements do provide an accurate reflection of the operating results. If you think of the role of the auditor in those terms, then expecting of the auditor to get involved in things like the MD&A or the company's forecasts are not appropriate functions for the auditor. On the other hand, issues relating to uncertainty of estimates are related to the auditor's role. To the extent that it is economically feasible, we ought to have a lot more information in that area. There is some limit based on cost-effectiveness. For example, I'm not sure that it is cost-effective to have a quarterly audit. [Also included in 9 and 17(b)] [TI 3/17, p. 11]
Participant I-12
I would agree with that. I know that a lot of companies that I cover have their statements audited not only quarterly but before they report, which I find astounding for companies who report 10 days after the end of the quarter. I don't see any need to have an audit done more than annually. I also think that there are areas where the auditor might become involved; measurement uncertainties, for example. Another area for auditors would be looking at transactions with related parties (including major suppliers and major customers). In close relationships like that, that's where a company has the greatest potential for trying to cook the books. An auditor could look at those transactions and determine whether they're being accounted for on an arm's length basis. [Also included in 9 and 17(b)] [TI 3/17, p. 11-12]
Committee/Staff/Observer
Should there be any auditor involvement with quarterly reports or once a year is enough? [Also included in 11(d) and 17(b)] [TI 3/17, p. 12]
Participant I-16
I think the quarterly issue has to be deferred towards the later discussion of what you want quarterly reports to be, in terms of whether they should be like annual reports, that is, discrete periods, or whether they should be an integral part of the whole year (thus, with some smoothing). You need to decide that before deciding whether they should be audited or not. [Also included in 11(d) and 17(b)] [TI 3/17, p. 12]
[Context] Meeting of the Creditor Discussion Group on March 11, 1993. Part of the meeting was devoted to the topic of auditor involvement.
Committee/Staff/Observer
Question number 3. It has been proposed by some that in some cases users might be better served if auditors only did what we now consider a full-scope audit say once every five years, with the years in between involving reviews of internal control and limited assurance reports that might be in the form of something similar to a review report. Would you prefer to migrate to that kind of a world? [TC 3/11, p. 17]
Participant C-10
Absolutely not, and I think that's a silly question. I think we should move on to the next question. [TC 3/11, p. 18]
Participant C-13
I'm not sure that I'm as dogmatic as I think I heard him say. I think it's an idea that's worth exploring, and not one we should simply reject out of hand. The suggestion that we hear a great deal from the preparer community is that the costs of what we are asking them to provide are excessive. And there can be an argument that the cost of a full scope audit for certain corporations -- now how you define what those corporations might be is a very difficult question -- is not necessary on an annual basis if a sufficient amount of review is done in the interim. [TC 3/11, p. 18]
Participant C-5
I agree with [participant C-10] completely and maybe would reverse the question and say: "Who should we do audits for more frequently?" I think that the horizon of all the strategic issues that go into and that have to be a part of the financial presentation is just shortening compared to a few years ago. [TC 3/11, p. 18]
Participant C-13
[Participant C-5], you've got an internal auditor with a substantial internal audit staff that reports independently to the board of directors. [TC 3/11, p. 18]
Participant C-5
Most internal audit firms are making reports on controls and process as opposed to the representations of financial statements. I would argue that internal auditors are not doing enough on the financial side. The accountants can easily use the internal auditor as a resource to cut cost but there's no reason why they can't still do the same full-scope audit with a company. I don't believe you have to extend time between audits to cut cost. [TC 3/11, p. 18-19]
Participant C-1
From a creditor's standpoint, audits should be done quarterly. We'd love to have everything that we've asked for done every quarter. But there is a cost to that. And my guess is that if you switched around and what you had on here was issuers, they would all be telling me audits are done too frequently and they don't need them done. I don't think you're ever going to get an answer from us that says an audit shouldn't be done annually. Maybe in effect what we need is an audit that has more detail than is done now, that's done every other year, but you still have a normal audit that is done now. Middle sized companies generally don't have large internal audit staffs that can run around and make sure that everything else is going on correctly. I think that's something a large company has and I'm not sure how valuable an internal audit staff is and most companies that we're dealing with don't have it. [TC 3/11, p. 19]
Participant C-4
I would think that the objective of this question is to try and find a way for borrowers to reduce their overall costs and I think that providers of credit would be more willing to reduce their costs if they are getting annual audits. A possible solution for borrowers would be to allow us to engage auditors. And then we provide the credit to them and, in essence combine their auditing costs with their credit costs. And we would be much more willing to provide a competitive price to them if we were selecting the auditor. So it's a possible alternative to this question. That would be an ideal situation for us. We could select the auditor we want. [Also included in 17(f)] [TC 3/11, p. 19]
Participant C-15
Did you have some criteria in mind in terms of which companies would be audited every five years, as opposed to which ones every year? It would seem to me that would be a difficult decision to make. And just by making that decision, you are making a statement about the quality of the companies that you are going to have to audit every year. [TC 3/11, p. 19]
Participant C-13
The SEC has a concept, something called a world-class company, but we never discovered exactly what it was. [TC 3/11, p. 20]
Participant C-2
My concern about the question is what do you drop back to then, because we see a wide range of quality of reviews, where some are just a notch below an audit and some have absolutely no disclosures. So what protection do you have then if you have to wait five years to get audited numbers? [Also included in 17(e)] [TC 3/11, p. 20]
Participant C-11
I know the genesis of this question. It goes back to the previous discussion we've had. There's something wrong with many audits and so we need to find ways to get this subject out in the open. Whether this is an appropriate framework is not the point. It's about how we can improve the qualitative aspects of audits. [Also included in 17(a)] [TC 3/11, p. 20]
Committee/Staff/Observer
Let me make sure I understand your point. What the people who recommended this had in mind is: "Let's use this recommendation as a way to initiate discussions about quality of audits?" [Also included in 17(a)] [TC 3/11, p. 20]
Participant C-11
Yes. [Also included in 17(a)] [TC 3/11, p. 20]
Participant C-8
This is already happening at the lower end. Many of our smaller clients are pushing us to accept reviews in lieu of audits or audits every other year, or some combination of a reduction in the quality of the statements, and it's happening quite a bit. And in our industry, it's becoming kind of a competitive issue as well, whether you'll do it or lose the business. So it's already occurring. [Also included in 17(e)] [TC 3/11, p. 20]
Committee/Staff/Observer
So you're saying in terms of your ability to write bonds that that's used as a competitive factor in terms of people down the street being willing to accept fewer numbers of audits? [Also included in 17(e)] [TC 3/11, p. 21]
Participant C-8
If we've been writing a company's bonds for a number of years, and we've been getting an audit, and then we get a phone call that says ABC company has agreed to write my bonds at the same level with a review. What are you going to do? Then you have to make a decision. So it's already occurring, and more frequently. [Also included in 17(e)] [TC 3/11, p. 21]
Participant C-10
I think that the FASB and the auditors in general are under a lot of pressure from the business roundtable and the large corporations on cost issues like that. I think they should stand up to that pressure. The large corporations are trying to control the whole accounting presentation situation in this country in my view. [TC 3/11, p. 21]
Participant C-12
I work for a large firm, and I think in general a well regarded firm, but having external auditors come in and look at our files and review our process on an ongoing basis, is a very good and even a necessary discipline for us. And if I think it's good and necessary for me to do it, there's no way I want somebody else to go five years without that. [TC 3/11, p. 21]
__________
Participant C-10
. . . I also would vote in favor of as much as you could do quarterly. Again, I think that depends on the size of the companies and costs. [Also included in 17(b)] [TC 3/11, p. 22]
[Context] Responses to the postmeeting questionnaire to the March 17, 1993 Investor Discussion Group meeting.
QUESTION 3
Some users of external financial reports have suggested that companies with strong financial management, effective financial and managerial controls, and competent internal auditing, need not obtain annual audits of their financial statements. They suggest that those companies obtain audits less frequently, such as every five years.
The meeting participants seemed generally to disagree with this suggestion. Please indicate your degree of agreement or disagreement with each observation below:
SA - Strongly Agree
A - Agree
N - Neutral
D - Disagree
SD - Strongly Disagree
Strongly Agree Neutral Disagree Strongly
Agree Disagree
a. Annual audits create a 5
necessary "discipline" in
financial processes and
systems that encourages
people to follow the "rules".
b. Current business 4 1
strategies change quickly, so
it is difficult to keep up
with changes even on an
annual basis. Longer times
between audits would make
understanding of the business
even more difficult.
c. The value of internal 1 4
audit participation in the
financial statement auditing
process is through cost
control, rather than as a
substitute of external
auditing.
d. Current alternatives, if 4 1
an annual audit is not
performed, are not adequate
to provide the disclosures
and assurances investors need
annually.
Strongly Agree Neutral Disagree Strongly
Agree Disagree
e. Annual audits should 2 1 2
continue, but periodically an
even more exhaustive audit
should be performed.
Participant I-11: This is a
new thought to me -
intriguing, but I haven't
thought it through.
f. Something else. Please
describe:
[PMQI 3/17, p. 5-6]
[Context] Responses to the postmeeting questionnaire of the March 11, 1993 Creditor Discussion Group meeting.
QUESTION 3
Some users of external financial reports have suggested that companies with strong financial management, effective financial and managerial controls, and competent internal auditing, need not obtain annual audits of their financial statements. They suggest that those companies obtain audits less frequently, such as every five years.
The meeting participants seemed generally to disagree with this suggestion. Several observations were made during the discussion. Please indicate your agreement or disagreement with each observation below:
SA - Strongly Agree
A - Agree
N - Neutral
D - Disagree
SD - Strongly Disagree
SA-6,A-7
a. Annual audits create a necessary "discipline" in financial processes and systems that encourages people to follow the "rules".
SA-5,A-3,N-2,D-2
b. Current business strategies change quickly, so it is difficult to keep up with changes even on an annual basis. Longer times between audits would make understanding of the business even more difficult.
Participant C-14: True but not the reason for annual audits.
A-4,N-3,D-5
c. The value of internal audit participation in the financial statement auditing process is through cost control, rather than as a substitute of external auditing.
SA-6,A-4,N-2,D-1
d. Current alternatives, if an annual audit is not performed, are not adequate to provide the disclosures and assurances creditors need annually.
SA-4,A-3,N-2,D-4
e. Current competition in credit markets is such that if a substitute for annual auditing were sanctioned, creditors would find it difficult to require borrowers to incur the costs of annual audits.
Participant C-14: The size of investment banker fees indicates that companies will do anything to raise funds.
A-5,N-1,D-5,SD-1,F-1
f. Annual audits should continue, but, periodically, an even more exhaustive audit should be performed.
Participant C-12: e.g., acquisitions, discontinued operations, major revaluations of receivables/loans, etc.
SA-1,A-1
g. Something else. Please describe:
Participant C-13: Extensive periodic audit, more extensive than current practice at longer intervals than annually, (? 3 years), with annual assurance from management that controls, procedures and operating conditions have not materially changed.
Participant C-14: The annual audit works - this issue is not worth the time we have devoted to it.
Participant C-11: The focus should shift to periodic, in-depth audits of critical aspects, including systems controls or asset impairment, that are not necessarily done annually. The annual audit seems to focus on everything to a mechanical and shallow review in a time pressure framework, rather than forcing the auditor to see the broader picture of where problems may exist.
Participant C-17: D) Except possibly in the case of public companies through SEC disclosure requirements. I doubt the SEC would permit anything less than annual audits in any event.
[PMQC 3/11, p. 4-5]
__________
To improve financial reporting, from an analyst's point of view, [one analyst] recommended . . . the following. . . : [Also included in 1(b), 2(c), 3(a), 8(d), and 15] [BEAR STEARNS, p. 2]
Require that audits be performed on quarterly reports. [BEAR STEARNS, p. 2]