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Remarks Before the 2011 AICPA National Conference on Current SEC and PCAOB Developments


James L. Kroeker

Chief Accountant, Office of the Chief Accountant
U.S. Securities and Exchange Commission

Washington, D.C.
December 5, 2011

As a matter of policy, the Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the SEC Staff.


Good morning and thank you Brad [Davidson] for the kind introduction, and thanks once again for the invitation to share my views at this 39th annual AICPA National Conference on Current SEC and PCAOB Developments. It has been very exciting time to be a member of the Staff of the SEC, and we have much to update you about during the course of this conference.

One thing that has left a lasting impression on me during my nearly 5 years of service at the SEC is the ability, passion, and dedication of the men and women of the agency. You will get the chance to hear from a number of staff over the course of the next few days; but the faces you’ll see do not do justice to the fact that for each person you hear from, there a literally hundreds of dedicated employees that are hard at work - heads down - reviewing a filing, investigating a potential fraud, inspecting a registered broker dealer, or developing a rule proposal. They are working to protect investors, facilitate capital formation and maintain the fairness and efficiency of our capital markets. While there is always room for improvement, and it is clear that the actions of a small few can have a tremendous impact on an organization as a whole, the agency has accomplished much under the leadership of Chairman Schapiro and the other Commissioners, and I am pleased to be able to update you on the activities in the Office of the Chief Accountant.

I need to start, as always, by reminding you that for all of the SEC staff speaking at this conference, the views expressed are each speaker’s own and not necessarily those of the Commission, the individual Commissioners, or other colleagues on the Commission staff.

Interaction with the Office of the Chief Accountant

At the outset, let me say that you will hear our perspectives on a host of issues over the coming days, and if we don’t address something that is on your mind, we hopefully will have time to respond to your questions. However, you do not need to attend this conference, or any other conference for that matter, to interact with us. Preparers and auditors are always welcome to seek our input through the pre-filing consultation process. I hear from many that this process works well, especially when addressing matters involving unusual, complex, or innovative transactions. You can expect to be heard and treated professionally, but let me also offer a few words of advice:

  • Understand and follow the guidance outlined on our website
  • Consider the issue from the stand point providing transparent reporting to investors
  • Let us know upfront about timing considerations
  • Involve you auditor and audit committee in the issue
  • Consult prior to reporting for an issue

We continue to live in challenging times, and the accounting profession is certainly faced with its share of both challenges and opportunities. I am always looking for suggestions for improvements to the usefulness of financial reporting for the benefit of investors. If you have ideas - we want to hear them — so call us up, ask to meet with us, let us know what’s on your mind and your suggestions. Of course, concrete, actionable suggestions are always appreciated. With this in mind, let me turn to an initiative that I am really excited about: the Financial Reporting Series.

Financial Reporting Series

As part of our oversight of financial reporting, we have instituted a series that we are referring to as the Financial Reporting Series. We have instituted this ongoing series of roundtables to facilitate a balanced discussion of existing pressures or emerging issues in financial reporting.

The Financial Reporting Series is designed to assist us in early identification of risks related to, as well as areas for potential improvements in, the reliability and usefulness of financial reporting to investors. The approach will be a series of roundtables where we invite a cross section of capital markets participants, including investors, preparers, auditors, and others, to discuss their individual views.

The purpose of the Series is to gather a broad spectrum of views and foster an informed dialogue on some of the most difficult financial reporting topics. I expect that the Series will provide the Commission staff, as well as the FASB and the PCAOB, with useful information about emerging issues and changes in the business environment that affect each of our respective roles in the financial reporting system.

I believe participation of the FASB and PCAOB is important given the fundamental nature of their respective roles and responsibilities. In addition, depending on the topic will we will invite other interested observers, for example staff from the federal banking regulators or other federal or state regulatory or oversight bodies.

The inaugural roundtable occurred on November 8th with a focus on understandably a broad topic: “Uncertainty in Financial Reporting — How Much to Recognize and How Best to Communicate It.” From my perspective, it was a very interactive, engaging and productive discussion focusing on investors views as to how to improve the financial reporting of results in areas where significant uncertainty may exist (for example in the reporting of contingences or goodwill impairment)

Of course, a productive and engaging discussion is important, but I believe the real benefit will be from action. We will work with the FASB and the PCAOB as we consider potential next steps and action items. However let me share a few themes or take away items that made an impression me:

  • We should exercise caution to provide that financial reporting is not comingled with financial analysis (that is, individual participants often drew an important distinction between reporting on past events versus projecting the outcome of future events);
  • We need a sharper focus on improving the communication content of the financial reporting package, as a whole. A common theme among investors was that they are looking for reported results that are transparent, objective and comparable; and
  • There should be established clear measurement and disclosure frameworks (that is, a “compass” or “anchor” for financial reporting). For example, many expressed (in different ways) that financial reporting should be designed to assist investors in understanding how a company uses inputs to generate value to investors (such as, a focus on linking reported amounts to cash generation capacity or cash flows);

Global Accounting Standards

Not surprisingly, one of the questions that I get with some degree of frequency of late is whether the SEC will take action in 2011 regarding the incorporation of IFRS for U.S. issuers. I will address this topic shortly, but let me start with a discussion of the current state of the IASB FASB convergence agenda.

I start with the premise that execution of the convergence projects and the results of that work are important as the staff considers the issue of incorporation of IFRS. As you might recall in the February 24, 2010 Commission statement, completion of the MOU projects was highlighted as a criteria relevant to the Commission consideration of IFRS.

At the time of the Commission statement, the FASB and IASB had nearly a dozen joint projects planned for completion by both boards by mid-2011. As we all know, plans can change, particularly when you are talking about developing reporting standards dealing with some of the most pervasive, complex and in some cases politically charged areas of accounting.

To the credit of both the FASB and IASB, they have listened to constituents who have suggested that additional time (by way of added deliberation and due process) was warranted. Many of these requests suggested that such a response was necessary to provide that the MOU projects result in final standards that represent long-term, implementable, and sustainable improvements. The Boards, wisely in my view, also agreed that a number of projects would be delayed even further to allow for a sharper focus on a smaller number of key MOU projects and to allow for a phased approach to the issuance of exposure drafts and the resulting final standards.

So as we look toward the end of 2011, we are still many months away from finalization of even the small group of key MOU projects. One could chose to look at the results and say that the Boards failed to meet their plan. I, on the other hand, believe that when historians (yes there are accounting historians) look back and measure success, success in this endeavor should and will be measured not by the precise timing of completion of any of the given projects, nor should it be measured by whether the timing was delayed to provide for a phased approach to issuance of an exposure draft. Instead of focusing on a few additional sands of time, I believe success should be, and ultimately will be, measured by the quality of the resulting output.

So where does that leave us?

On a number of fronts, I believe that there is reason to be quite encouraged. For example, in recent months converged standards have been finalized that result in increased transparency related to items reported in Other Comprehensive Income, and the Boards have fully converged guidance related to how fair value should be determined for financial reporting purposes. While these projects may not be viewed generally as “major” convergence projects, however that is defined, the impact of global comparability should not be underestimated.

As it relates to the revenue and leasing project, it seems the prospect for globally consistent standards is a vision that is becoming more focused and nearer to reality. In both cases, the Boards have made changes from their proposals, many of which have been considered as an effort to address concerns related to complexity and operationality and to introduce a measure of pragmatism. Both Boards decisions to re-expose these projects have been well received. Constituents want a chance to evaluate the changes in relation to the standard as a complete project. I believe this is not an unreasonable request, especially when you a dealing with the top line on the income statement.

As it relates to their MOU project on financial instruments, the prospect for a converged solution, to date, has not been as encouraging. While the Boards are working jointly and constructively on an improved impairment model, it appears that a time frame for finalization of such a model is still unclear. Unfortunately, on other aspects of the financial instruments project prospects for a converged high quality solution is even more uncertain.

Accordingly, I continue to believe it is critical, as it relates to each of the MOU projects, that the Boards take all reasonable steps to maximize the prospect of converged, high-quality solutions. Hedging is just one example (there are others such as offsetting). The Boards are not aligned as it relates to their approaches to consideration of hedge accounting in the context of their financial instruments project. Numerous conceptual, operational, and practical questions have been raised based upon proposals to date that I believe should be considered jointly by both Boards. I believe that, in the long run, history will judge this endeavor much more favorably if all the necessary steps were taken to provide for joint projects with integrated teams, joint deliberations and shared timelines. Such an investment in the outcome will prove to be far more beneficial than any gains I believe are perceived by deliberating these issues individually.

As most, if not all of you, know, the staff has been executing on a work program exploring whether and, if so, how the Commission could or should proceed with a decision to incorporate IFRS for U.S. issuers. In the February 2010 Commission statement I mentioned earlier, the Commission has indicated that execution of the Work Plan, combined with the completion of the convergence projects of the FASB and the IASB according to their current work plan, were designed to position the Commission to make a determination as soon as 2011.

I'm not here this morning to announce how the Commission will proceed. That determination, as it should be, can be resolved only by action of the Commission.

What I can tell you is that the staff has at this point completed or is in the final stages of completion of what I would consider the majority of the “field work” related to the Work Plan. In that regard, the staff recently issued two progress reports in the form of Staff Papers. The first is a comparison of the differences between U.S. GAAP and IFRS. The second is an analysis of the use of IFRS in practice around the globe. I am very pleased by the work of the staffs in the Division of Corporation Finance and OCA on these papers, and I encourage you to study these two reports, both of which are available on the SEC’s website. Shelly Luisi and Nili Shah will walk you through the highlights later today.

We remain committed to completion of a final comprehensive report on our Work Plan, consistent with the high caliber of reporting embodied in our previous progress documents. In that regard, the staff will need a measure of a few additional months time to produce a final report. At the same time, the staff is in the process of developing an approach for Commission consideration. Given the number of things on our agenda, I cannot give you a precise schedule. I can tell you that we will do so carefully and thoughtfully, being guided by an ideal that produces the maximum benefit for the investing public and the capital markets.

I can also tell you that I am encouraged about the potential prospects of IFRS incorporation, particularly as I consider and reflect on the input received on the May staff paper exploring a potential incorporation approach.

However, as with the completion of the MOU projects, I believe that the passage of a grain of sand in the hour glass of time is not nearly as critical as ensuring that we take this opportunity to establish a strong and lasting framework. A framework that I believe should:

  • Demonstrate a high level of support for U.S. commitment to continued development and use of global consistent high quality accounting standards;
  • Provide both in fact and in substantive operation clear U.S. authority over standards applicable in the U.S. capital markets;
  • Provide for and facilitate a strong U.S. voice in the process of establishing global accounting standards;
  • Be responsive to the economic and other impacts of change;
  • Consider whether to retain “U.S. GAAP” as the basis for U.S. financial reporting, thereby mitigating the costs and complexity of introducing a new set of standards under regulatory regimes, contractual documents, and U.S. laws under which compliance with U.S. GAAP is often specifically contemplated.

The Auditing Profession

Turning from accounting to auditing, last year at this time the Commission was in the process of appointing three new board members to the PCAOB, including a new chairman. The Commission completed this process earlier this year through the appointments of Chairman Jim Doty and Board Members Jay Hanson and Lew Ferguson. They join Board Members Dan Goelzer, and Steve Harris. I consider myself fortunate to have the opportunity to work closely with this group. Although Board Member Goelzer’s term has recently ended, I am pleased that he is continuing to serve while the Commission completes its current efforts to appoint his replacement. The Sarbanes-Oxley Act provides that two of the board members must be current or former CPAs. So while I cannot share any surprises with you, I can tell you that his replacement will be a former or current CPA. Although my remarks this morning are my own, I know I speak on behalf of many in expressing my deep appreciation for Dan’s tireless effort and service since his appointment as a founding member in 2002, including having served as Acting Chairman prior to Chairman Doty’s appointment.

Since the appointments earlier this year, the Board has rolled up their sleeves and quickly began debating and putting forth numerous audit policy ideas for consideration. Chairman Doty has described the PCAOB’s overarching policy projects on the auditor’s reporting model, auditor independence (including mandatory audit firm rotation), and the proposal related to the identification of engagement partners and firms involved in conducting audits as being focused on enhancing the relevance, credibility, and transparency of audits, respectively.

I hope that investors, preparers, audit committees, auditors and others will view these related concept releases and proposals as opportunities to provide input on the specific ideas and questions that the PCAOB has raised for consideration. Just as important, I hope that you also view these releases as an open invitation to provide ideas of your own that focus on improvements to audits for the benefit of providing investors with reliable and useful financial reporting. You’ll be hearing more about the broader global audit policy initiatives, such as the three initiatives I mentioned above as well as others being considered around the world, from Brian Croteau as part of the Deputies panel. He’ll also provide some related thoughts about how root cause analysis might be used by auditors and regulators alike in informing regulatory and firm policy choices. I’d like to start the discussion this morning, though, with some fundamental audit quality considerations in the context of auditor objectivity, skepticism and independence.

Before I do that, I’ll acknowledge that I believe that auditor performance and the reliability of financial reporting have improved significantly in the past decade, which has seen the creation of the PCAOB and the implementation of other reforms, including strengthening of the role of audit committees. However, audit deficiencies in PCAOB inspection reports are a continuing indication that auditor performance requires the ongoing attention by audit firms, audit committees, the PCAOB, and the SEC. To be sure, not all audit deficiencies are created equally in terms of their nature or severity. Likewise, the presence of an audit deficiency does not necessarily mean that the related financial reporting contains material undetected errors. However, audit deficiencies have the potential to increase the risk that a material misstatement goes undetected in financial statements relied upon by investors. While existing auditing standards require the auditor to consider the need to perform previously omitted procedures when identified subsequent to the date of his or her report, it is equally important for audit firms and regulators to consider why the procedures were omitted in the first place when there are recurring themes so that broader corrective actions can be considered.

As I discussed at this conference last year, I believe that one way to improve audit quality may be to increase the level of auditor objectivity and skepticism brought to bear in an audit. Auditor objectivity underpins the qualification of accountants under the federal securities laws. It also underpins the confidence that investors place in audit opinions. There may be a number of ways to promote greater objectivity; and compliance with the SEC’s independence rules is only the starting point to avoiding the inappropriate influence on, or impairment of, an auditor’s objectivity.

Last year at this conference, I spoke about the importance of credibility and of auditors acting independently. I also spoke about the importance of being perceived to be independent, as perceived independence can be every bit as important as independence in fact. I used the example of rethinking who the “client” is in the audit relationship and ensuring that investors remain top of mind.

Unfortunately, regulators continue to find examples that illustrate that, at least in appearance, some auditors many not be consistently embracing the importance of this mindset. In some situations, I wonder if the problem might even go beyond appearance and indeed negatively impacts auditor behavior. In particular, I wonder about examples in which auditors do not step back to adequately challenge information that is provided to them by management or, even worse, putting themselves in an advocacy role for management in attempting to defend inappropriate accounting and disclosure. The credibility of the profession is weakened when auditors put themselves consciously or subconsciously in this position. While I continue to encourage auditors to challenge themselves in this regard, I also believe that senior members of audit engagement teams and leadership of accounting firms should reflect on what more they can do to establish a strong tone at the top in this regard. This includes considering the question of whether leadership of an accounting firm is appropriately focused on continuous development of a firm’s auditing practice and not letting themselves, their partners and staff, become overly distracted by any efforts or pursuits apart from the protection of the public trust.

In addition to the attribute of being skeptical that I just discussed, I would like to discuss three more important attributes that could be useful to the longer-term improvement of audit quality. They also happen to start with the letter “s” so they should all be easy to remember. They are: skill sets, supervision, and standards.

Skill Sets

Regarding skill sets, as obvious as it seems, it may be appropriate for auditors to pause periodically to ask yourself whether you and those that you supervise have the appropriate skill sets for the task at hand—skill sets that include competence in both accounting and auditing. In an increasingly complex business environment, it is not surprising that even the most experienced auditors find they need to seek advice from others, including specialists, related to certain complex accounting and auditing matters that may extend beyond their own skill sets. I believe encouraging an environment where seeking advice is viewed as a strength rather than a weakness is important. Equally important to consider, in my view, is whether sufficient training is provided in what I call the fundamental “blocking and tackling;” that is, items such as the need to be and how to be skeptical, how to ask probing questions, how to professionally handle conflict, and items as fundamental as training on the purpose of an audit and the role of the profession in the capital markets.


Regarding supervision, I believe it is critical that auditors take the time to appropriately supervise engagement staff, specialists, and other audit firms involved in their audits. In looking at the findings of the PCAOB, one could ask whether additional supervision and involvement by more senior members of an engagement team could have averted an audit deficiency. As a related matter, another area of focus for any auditing firm should be its willingness and ability to self-discipline its members. Self-discipline can take on many forms, ranging from the process by which a firm goes about engagement acceptance and retention to the corrective action, instruction, and, where warranted, discipline a firm provides to members who fail to adhere to the standards of a professional. As stated eloquently by one of my predecessors, “I have a strong belief that when discipline only comes from the shareholders we are responsible to, from the courts and government agencies, it sends a clear message to interested parties that the profession is not willing to uphold the standards of performance and quality it has set for itself.”

As it relates to supervision, I also believe an area for potential gain in global audit quality exists as it relates to the level of oversight and supervision provided by—for the lack of a better term—the global “parent.” In this area, I certainly have more questions than answers, but it does appear to me there are questions worthy of further consideration including; what role the global “parent” firm plays in driving quality, consistency, and objectivity. For example, do these organizations play a role that should be considered a substantial role as it relates to the conduct of the work of member firms? If not, should they? If they do play a substantial role, are there supervision standards that should be applied consistently? And finally, is independent oversight of the role played by the global organization necessary or desirable?


Lastly, let me mention auditing standards. While broader policy considerations are obviously important to address, I believe that improving the existing audit performance standards, coupled with the Board’s present inspection and enforcement programs, might be the most direct and effective way to positively impact audit quality. The PCAOB has significant work ahead of them to update existing auditing and quality control standards, but has an appropriate standard setting agenda through which they can take into account what has been learned from many years of inspections. Improving existing PCAOB standards is particularly important since many of the PCAOB’s auditing and quality control standards have not yet been updated to take into account the results of inspections since the Board began conducting them in 2003.

In looking at ways to improve the quality of audits, in August of 2000, the Panel on Audit Effectiveness observed, “many of the Panel’s recommendations to the ASB in specific areas suggest the need to examine existing auditing standards critically, with the objective of revising or replacing some or all of them with more specific and definitive guidance containing imperatives to guide auditors in formulating their judgments and carrying out their work... In so doing, the ASB should not pay blind homage to the current audit risk model when there are more useful or practical alternative approaches.” Many of our auditing standards today remains vastly unchanged from those that the Panel recommend for reconsideration over eleven years ago.

Audit Committees

While I’m on the topic of audit quality and auditor oversight, let me address as a final topic the importance of a group that plays a key role in assisting auditors and regulators in improving audit quality. I am talking about audit committees. Others around the world also recognize, or are beginning to recognize, the importance of audit committees and are looking at enhancing the role of audit committees in various ways. However, audit committees of U.S. listed issuers, as result of the Sarbanes-Oxley Act, have for some time now had greater responsibilities in acting as shareholders’ representatives and overseeing auditors. These responsibilities build off of other efforts over the past decade to enhance the role of audit committees by Congress, the Commission, and the exchanges. Audit committees of listed issuers are directly responsible for the appointment, compensation and oversight of the registered public accounting firm. There are likely varying degrees to which audit committees internalize these responsibilities. But I suspect that even the best audit committees can find ways to improve.

For example, while it is important to understand that the auditors and management can work together, audit committees should not forget their role over the appointment and compensation of auditors. For example, what role did management have in recommending the appointment, or considering the retention of, the auditors? Did management interview different auditors looking for prospective views on accounting matters? If so, why? What is the tone and tenor of the proposal from the auditor? Does the proposal align more with the audit committee’s own oversight responsibilities, or does it read more that the auditor would like to be an advocate for, or a partner with, management? I believe appropriate audit committee oversight includes asking tough questions of the auditor, for example, about the culture at the audit firm, the results of PCAOB and internal inspections, the impact of non-audit service on auditor independence and objectivity, the audit team’s risk assessments, and the quality and sufficiency of audit evidence obtained by audit team.

The PCAOB intends to re-propose later this month a standard about required communications to be made by the auditor to the audit committee. The intent of the proposed standard is to provide the audit committees with the information they need to assist them in effectively fulfilling their obligations to shareholders. I encourage audit committee members to provide the PCAOB with feedback on the proposal. And I encourage audit committees to take a fresh look at how they can improve their current auditor oversight responsibilities so that they can be an even greater influence on improving audit quality.

Thank you for listening and I’ll be pleased to address your questions.


Modified: 12/05/2011