PCAOB chair: 'The profession has an opportunity that is undeniable'

William McDonough previews his MACPA Annual Meeting speech by looking at what's happened ... and what's next

He is the most visible member of what has quickly become one of the most influential organizations in accounting. Now, after nearly a year as chair of the Public Company Accounting Oversight Board, William J. McDonough can reflect a bit on what the board has accomplished, what's to come and what the future holds for the CPA profession.

He'll do just that when he delivers the keynote address at the MACPA's Annual Meeting, scheduled for June 24-25 at the Hyatt Regency Chesapeake Bay in Cambridge.

In the meantime, he and the rest of the PCAOB have been laying the groundwork for an organization that, as a creation of the Sarbanes-Oxley Act, is charged with overseeing the auditing processes that surround public companies.

McDonough recently spoke with the MACPA about the PCAOB's work and the challenges that CPAs face. His answers to our questions follow.

MACPA: The PCAOB has more than a year under its belt now. What have been the board's most significant accomplishments?

McDonough: One of the board's most significant accomplishments — and one of our biggest challenges — was drafting an auditing standard for audits of internal control over financial reporting. (Click here for details.)

Before we set out to write the standard, we examined the existing standard, we held a roundtable discussion and we examined the requirements set for banks in the Federal Deposit Insurance Corporation Improvement Act of 1991.

We proposed the standard in October 2003, and we received robust feedback — 193 comment letters in all. We took the time necessary to digest these comments carefully because internal controls are simply too important to treat lightly.

The board determined that it was not enough to simply ask auditors to attest to and report on management's assessment of a company's internal controls. The Sarbanes-Oxley Act clearly required more — that auditors determine for themselves that the internal controls are adequate to support reliable financial statements.

Our standard requires that an auditor perform the audit of the financial statements and the audit of internal control as part of one engagement — not so much as a cost- and time-saving measure but because each audit could have consequences for the other.

On another issue — auditors' ability to rely on the work of others — the board tried to strike an appropriate balance between the work that an auditor must do himself or herself, and the work performed by management, internal auditors and others that the auditor might use to support his or her opinion.

We require that an auditor obtain the principal evidence supporting his or her opinion through procedures performed by the auditor, including walk-throughs. That in no way says an internal auditor's work lacks value, and we certainly do not want to discourage internal auditors from testing and evaluating internal controls, especially those related to the timely prevention and detection of fraud.

This approach should provide a strong incentive for companies to create strong and independent internal audit and compliance departments.

Finally, the standard requires that auditors should make note of the effectiveness of the corporation's audit committee, including whether the committee is independent of management.

MACPA: What have been the board's biggest challenges to date?

McDonough: The biggest challenge for the PCAOB is recruiting qualified staff. As a functioning entity, the PCAOB opened its doors on Jan. 1, 2003. At that time, there were four board members and barely as many staff.

As of mid-March, the staff has grown to a talented and dedicated band of almost 170 hardy souls, and we are continuing to grow and recruit.

We don't want zealots, but we don't want pussycats, either. We are looking for good, experienced accountants, and we are looking for the right spirit, too.

We want people who understand our mission: to oversee the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair and independent audit reports.

MACPA: Has your perspective of accounting oversight and reform changed at all over the past year?

McDonough: I approach my new job at the PCAOB as I approached my job as the top bank supervisor at the New York Fed.

I expect that accountants, as members of a regulated profession, know what the rules are. I expect that they are following those rules, both in their letter and their spirit. I bring those expectations and the respect they engender to the table when I deal with the firms as chairman of the PCAOB.

If they depart from those expectations — that is, if they break the rules, if they ignore the spirit of the law even while meeting the letter — our dealings will be most unpleasant. There will be consequences, and they will be grave.

MACPA: What do you see as the proposed hierarchy of auditing standards? Which organization's standards take precedent? And what impact will this new complexity of standards have on the auditing and business communities?

McDonough: The Sarbanes-Oxley Act of 2002 authorized the PCAOB to establish auditing and related professional practice standards to be used by registered public accounting firms. PCAOB Rule 3100, Compliance with Auditing and Related Professional Practice Standards, requires auditors to comply with all applicable auditing and related professional practice standards established by the PCAOB. The board has adopted as interim standards — on an initial, transitional basis — the generally accepted auditing standards described in the American Institute of CPAs' Auditing Standards Board's Statement on Auditing Standards No. 95, Generally Accepted Auditing Standards, in existence on April 16, 2003.

We hope that, like the Financial Accounting Standards Board's accounting standards, the PCAOB's auditing standards will provide appropriate guidance in other contexts. While some public companies do go private, in many, many more cases private companies go public. In addition, stakeholders other than public investors — such as lenders — have already begun to require auditors to provide audit reports according to our standards.

MACPA: Do you foresee a difference in accounting standards? What impact will this difference have on the accounting profession?

McDonough: We recognize the importance of coordinating our work with the FASB. The accounting standards have to be auditable, and the effective implementation of the accounting standards requires good auditing. So we are meeting periodically with the FASB. They have given us permanent observer status on their advisory groups and we have been attending those meetings. When our standing advisory group starts meeting, they will have a permanent observer seat.

MACPA: We understand that the biggest challenge facing public companies and their auditors is the upcoming implementation of Section 404 of the Sarbanes-Oxley Act, in terms of the cost involved in implementing 404 and the pool of available talent. What would you say to firms and companies facing these challenges?

McDonough: We heard from many public companies that these requirements are tough, and they will entail extra work and cost. But the goal of the requirements is simply too important to demand any less.

That said, the board will be watching and listening closely to learn whether companies — especially small and medium-size companies — are being unduly charged for these audit services. The internal controls necessary for one company might not be necessary for all companies.

MACPA: In the summer of 2002, even before Sarbanes-Oxley was implemented, the MACPA formed the Accounting Reform Task Force to develop recommendations for restoring faith in our capital markets and the CPA profession. These recommendations were compiled in a white paper entitled The Road to Reform: Protecting the Public Interest, Strengthening the CPA Profession. What is your impression of these recommendations?

McDonough: While the board has not taken a position on the white paper, I like the observations and recommendations of the MACPA's Accounting Reform Task Force that CPAs "should do what is necessary to preserve the profession and perpetuate (their) core values of competence, integrity and protection of the public."

MACPA: What else can state CPA societies like ours do to help improve the financial reporting process? How can we support your efforts to improve the process?

McDonough: I took this job because of the opportunity to make a difference, to do my part to help restore some of the confidence that people lost in our markets and our public companies. Yes, the PCAOB is going to require more work than I intended to be doing at this stage of my life, but the opportunity was undeniable.

I hope that is how the accounting profession will view the new regime of oversight represented by the PCAOB. We will ask a lot of you, and you will have to work harder than you could have imagined a year ago. We will pry into your records and your work habits, and yes, the rules will change as we go along.

But the profession has an opportunity that is undeniable. In the wake of Enron and Arthur Andersen, the accounting profession was weighed and found wanting, but it also was given a shot at redemption. Accountants can chafe at what we ask or they can accept the challenge for what it is.

What's at stake for all of us is the trust of the American people in our markets and the companies that drive our economy. We have an opportunity to reclaim that trust. I, for one, am delighted to grab that opportunity, and I hope accountants will join me.

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