The Auditors Report

Call For Research from the SEC

Members of The American Accounting Association have long been instrumental in accounting standards setting and regulation by providing useful perspectives for consideration of evolving issues. A number of important issues that can influence the usefulness and integrity of financial reporting now demand the concerted efforts of our best minds. Proper resolution of these issues can ensure that our capital markets continue to function efficiently and remain the envy of the world.

Therefore, research papers are invited on a number of issues facing the Securities and Exchange Commission. Submitted papers will be considered for recognition at a potential conference that will bring together members of standards-setting groups, regulators, preparers, users, and academics. The conference would permit the various participants in our financial markets to share perspectives on a wide range of topical issues.

Interested parties may submit research on any of the topics listed below, or on topics that are of similar interest. The reviewing committee will provide first consideration to papers received by March 1, 2000. Research on these topics, previously published or not, is welcome at any time. Please send completed papers to: Academic Fellow, Office of the Chief Accountant, Securities and Exchange Commission, Washington, DC 20549-1103. Any questions regarding research may be submitted to Dick Dietrich at 202-942-4400.

Auditing
In the past few years the press has reported numerous cases of misstated financial statements. Investors have lost tens of billions of dollars in these cases. As a result, the Commission staff is interested in research that may provide recommendations that, if implemented, could improve the effectiveness of audits. Potential topics include:

  • The 1999 report of the Committee of Sponsoring Organizations (COSO) entitled Fraudulent Financial Reporting: 1987-1997, An Analysis of U.S. Public Companies, reported that 83% of the cases reviewed involved the CEO or CFO. These cases typically involved an override of controls by senior management. These actions by management and the resulting internal control weaknesses were not detected by the auditors. Yet, audit firms are adopting audit approaches based increasingly on the testing of controls. What is the effectiveness of audit procedures based on (a) testing of controls, (b) testing of account balances, or (c) analytical procedures? What steps could auditors have taken that would improve their ability to detect management’s override of internal accounting controls? Do management’s reports on internal controls provided to investors provide a benefit? What audit committee policies or procedures have a positive influence on the effectiveness of internal controls?
  • What is the relationship between the duration of the auditor/client relationship and audit failures? Do new auditors contribute to discovery of facts that should have been uncovered by predecessor auditors?
  • Is there a pattern of omitted and necessary audit procedures or other characteristics that are associated with audit failures (lawsuits, enforcement actions) which, if corrected, would have prevented the audit failures?
  • What key factors influence an auditor’s decision-making process when confronted with difficult and contentious accounting issues?
  • How do audit partners’ evaluation and compensation arrangements influence their judgments and behavior?
  • How do auditors assess materiality? Is their methodology consistent with the approach markets use to assess materiality?
  • Do accounting standards calling for recognition or measurement of subjective or discretionary events, such as the standards for asset impairments and restructuring charges, give rise to financial data that cannot be audited? What changes in the auditing or accounting standards might provide improvements?
  • What changes to the profession’s current quality control processes, including peer review, could be made to strengthen and enhance its effectiveness?
  • What structural changes to the relationship between auditors, management, shareholders, the board of directors, and other constituencies might enhance the audit process?

Auditor Independence
The business of accounting firms has been evolving at a quickening pace from a provider of audit and attest services to a provider of a wide range of other financial and consulting services (e.g., compensation planning, valuations, business planning, investment advice, strategy development, and information systems consulting, etc.). Audit partners thus become a potential gatekeeper charged with a responsibility for the distribution channel (client) through which the firm provides many services to the client. As a result, potential topics regarding auditor independence include:

  • How does the existence of the partner’s gatekeeper function impact independence and the regulation of auditors?
  • What factors are considered by users of financial statements when assessing whether or not auditors are independent?
  • Do users of financial statements consider nonaudit services provided by auditors to impair auditor independence? How would public filing disclosure of all nonaudit services being provided the client by the accounting firm affect investors’ perceptions regarding auditor independence?
  • What is the relationship between factors that investors perceive to impair independence and factors that auditors believe actually impair independence?
  • How does the “materiality” of a financial or family relationship affect investors’ views about auditor independence?
  • What relationships with a member, including the partner, of an engagement team, or audit firm, would impair the independence of that member (e.g., the existence of a business relationship between a sibling, cousin, or more distant family member and an employee or officer of an audit client)?
  • Financial service firms are acquiring CPA firms. Under some arrangements, partners and staff of the CPA firm become employees of the acquirer and are then “rented” back to the CPA firm for audit engagements. What business relationships between the audit client and the acquiring firm, its officers, and employees, will impair independence?
  • Some have argued that mandatory auditor rotation could provide benefits by having a new set of “eyes” look at the financial reporting periodically. Others have argued that mandatory rotation results in initial audits with audit personnel who are less experienced on the registrant’s issues. What effect would mandatory rotation of auditors have on actual or perceived auditor independence?

Accounting and Financial Disclosure
The foundation of the U.S. capital markets is high quality transparent financial reporting and disclosures. This provides investors information necessary to assess market risks and make efficient capital allocation decisions. Yet, chairman Levitt’s 1998 Numbers Game speech raised concerns about trends in financial reporting that, if left unchecked, could impact the quality of financial reporting. Accordingly, financial reporting topics include:

  • The U.S. capital markets use a quarterly financial reporting model to provide timely reporting of information to investors. Many foreign countries use a semiannual model. Some people advocate a “continuous” reporting approach. Yet others believe a continuous approach would result in greater pressure on management to “make the numbers.” What are the cost/benefits of these different approaches to investors and management and what are the implications for corporate governance? Are there currently processes built into the financial reporting system that could be changed without reducing transparency? If so, what are they and how should they be changed?
  • What financial data do investors and analysts use that is currently not provided in filings with the SEC?
  • The FASB is currently examining the use of non-GAAP performance measures. How do investors and analysts currently use such measures?
  • What economic effects (e.g., on managers, shareholders, sellers) are related to the accounting method used to account for a business combination? Why do managers prefer one method over another?
  • How do sell-side and buy-side analysts adjust their earnings forecasts, models, and stock recommendations for acquired intangibles and subsequent amortization expense? How do they use cash earnings measures and GAAP earnings measures with respect to those adjustments?
  • How do analysts adjust their models for goodwill or for the accounting method (purchase vs. pooling) used to account for a business combination?
  • What information regarding intangible assets do investors and analysts believe is useful and necessary for making informed investments decisions? What data and disclosures are used by analysts that are not currently included in the financial statements or other required disclosures?
  • How do initially reported amounts and disclosures vary from subsequent actual results when accounting is based on discretionary triggers (e.g., management plans for restructurings or impairment of assets)?
  • How do financial analysts and investors use market risk disclosures? Are market risk disclosures priced? Are there disclosures being made that are not used, or are additional disclosures required? Do the market risk disclosures alter a firm’s approach to risk or cause competitive harm?
  • The market risk disclosure requirements provide choices as to presenting risk exposure. Which of the methods, including assumptions, provides users with the most useful information?

International
The Commission staff is currently assessing the quality of international accounting standards. The need for improvements in the worldwide financial reporting structure that will be needed for a rigorous implementation and enforcement of these accounting guidelines, including the quality of auditing, auditing standards and quality control procedures is also being studied. Research on the following topics would benefit the staff:

International Accounting

  • What factors should be considered to determine whether a standard is “high quality”?
  • When companies using IASC standards trade on non-US exchanges, is their cost of capital different from companies using domestic GAAP on those exchanges? Do those markets assess a premium for information prepared on the basis of IASC standards?
  • What factors impede a non-US company’s access to US capital markets?
  • How do analysts respond to and use reconciliation data in Form 20-F?
  • How comparable is financial reporting between public non-US companies currently using IASC standards both in US and non-US markets?
  • What are typical footnote disclosures by companies currently using IASC filings (a) in non-US countries, (b) in US filings using reconciliation and (c) similar US GAAP filings?
  • What information that is not included in the statements or footnotes do buy-side analysts request from non-US firms who prepare financial statements using IASC standards?
  • What firm characteristics (e.g., size, industry, location, capital structure) are associated with choices among existing alternatives permitted by IASC standards? Are some alternatives chosen more frequently than others?
  • Is the information provided by the IASC’s allowed revaluation alternative for accounting for fixed assets value relevant?
  • What disclosures regarding significant risks and uncertainties precede significant events reported in the financial statements prepared with IASC standards?
  • How rigorously applied is the existing IASC standard on business combinations? What is the quality and implementation comparability of the existing IASC standard on business combinations?
  • How do IASC standards compare with US standards on dimensions of comparability, transparency, quality, and full disclosure? International Auditing
  • What significant differences exist between US and international auditing standards?
  • Does the application of non-US GAAS affect market valuation?
  • How do auditor independence regulations vary among major countries?
  • What quality control standards, including internal and external inspection, exist for auditors in major countries?
  • What method(s) are used to enforce international audit standards and how do these methods impact compliance with international auditing standards in comparison to the methods impact on enforcing U.S. auditing standards?

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