July 2003

Standards Setting At The Crossroads

In my recent conversations with NYSSCPA members and other CPAs, I’ve noticed that many people don’t yet recognize the potential for massive changes to how auditing standards are set—and by whom. To assume that the Public Company Accounting Oversight Board (PCAOB)—formed last year by the passage of the Sarbanes-Oxley Act—can, should, or will set standards for all types of auditing, for all types of entities, is to misunderstand and oversimplify matters. It would be just as naïve to assume that the profession can ever return to the standards-setting environment that existed before the passage of the Sarbanes-Oxley Act.

The Tangled Evolution of Auditing Standards Setting

Our existing auditing standards weren’t created out of whole cloth as the result of a consensus-based master plan. For decades, generally accepted auditing standards (GAAS), which the AICPA developed and maintained, have been what all other standards setters or regulators looked to first. In fact, the PCAOB itself has adopted GAAS until it formulates and approves its own rules.

We’re fortunate that people as excellent as its chair, William McDonough, and its chief auditor, Douglas Carmichael, are being appointed to the PCAOB and its staff, because they bring broad knowledge and experience in both business and auditing. We should hope that the PCAOB will continue to welcome input from the accounting profession’s organizations, including some that used to set certain standards. Nevertheless, we must remember that the PCAOB is charged only with setting and enforcing standards for audits of publicly held companies. Even though some people and groups might want or expect wider application of the PCAOB’s rules, the PCAOB does not possess that authority, and the board’s resources will probably likewise limit its ability to engage in discussions that could pull it off course.

Reevaluating the entire standards-setting process is important because the PCAOB’s new regulations and standards will affect only publicly owned companies. Many privately owned companies of all sizes must conduct audits to satisfy the requirements of their lending or investment arrangements. These audits have generally been conducted in accordance with GAAS as set by the AICPA. Governments and government agencies—federal, state, and local—as well as many nonprofit organizations, are required by law to conduct regular audits. The auditing standards for such audits, set by the General Accounting Office (GAO), are commonly known as the Yellow Book. Many organizations that aren’t bound by the Yellow Book regulations follow them voluntarily because they recognize the need for reasonable standards of some kind. Any changes made by the PCAOB will not directly affect the practices followed by these entities; nevertheless, the impetus for change will reach every level of auditing standards.

On the one hand, one can make a strong case for uniform national auditing standards with appropriate checks and balances being desirable—even necessary—to keep our economic system working. On the other hand, different types of entities are accountable to different stakeholders in different ways. Trying to apply a set of auditing standards developed for a certain kind of entity—such as the standards the PCAOB will develop for publicly held entities—in a one-size-fits-all manner could invite more problems.

Another concern driven by current events is that standards other than those set by the PCAOB may be increasingly viewed as inferior, obsolete, or irrelevant. The role of the AICPA has been to create general-purpose auditing standards for all entities, including those not currently covered by the PCAOB or the GAO. The events of the last two years, however, may have left the AICPA’s ability to continue to be the auditing standards setter for private companies and nonprofits not covered by the Yellow Book in question. If these entities’ auditors are not following standards established and maintained by a body with public credibility and legitimacy, their financial health will suffer.

More Questions Than Answers

I make no claim to having the answers about what entity or entities, now in existence or yet to be formed, can do the best job of sorting out the tangled mass of our different sets of standards. But as a strong advocate of constructive dialogue, I have to say that if we allow this opportunity to pass without attempting to get our various houses in order, we’ll regret it.

Louis Grumet
Publisher, The CPA Journal
Executive Director, NYSSCPA

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