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PCAOB Member Gradison Sees Inability to Conduct Int?l Inspections and Advent of IFRS as Major Challenges

By Jim Hamilton

In his farewell remarks, PCAOB Member Bill Gradison said that the current inability to conduct inspections in the EU, Switzerland, and China is the weakest link in the Board?s inspection program involving not only limits on inspecting the work of the signing auditor, but also substantial role work and work referred by U.S.-based firms to their international affiliates. In a speech to the American Accounting Association, Member Gradison also said that the move to IFRS presents the Board with unique challenges. He also noted that the PCAOB enjoys excellent relations with the SEC under a Commission oversight that is both detailed and comprehensive.

Member Gradison is hopeful that progress will be made in entering into bilateral auditor inspection agreements in Europe, but he is pessimistic about China. The key question about audits of foreign private issuers, or of U.S. companies with substantial international activities, is whether investors care that the auditors of companies they invest in are not subject to inspection. A related issue is whether the price-earnings ratios of such companies are lower than those of companies whose audits are subject to inspection. And, if not, what does this say about investors' perception of the value of PCAOB inspections.

More broadly, the Member questions whether the PCAOB's international inspection program is viable in the long run. He is concerned that some countries that now permit PCAOB inspections may decide not to do so based on reasoning that if other major countries won't enter into inspection agreements with the PCAOB why should they. To be more direct, he wonders if the Board?s entire international inspection program might unravel over time. A related issue is whether and how the Board can gain a better understanding of the role of the global entities of the big firms that are not registered with the PCAOB; and therefore not currently subject to inspection or enforcement.

In his view, the move towards global accounting standards presents the Board with both tactical, short range issues and long-term strategic issues. In the immediate future, the recruiting of skilled auditors with IFRS experience is urgent, he noted, but will not be easy. It is urgent because foreign private issuers can already use IFRS without reconciling to US GAAP and Canada, which is the home jurisdiction of more foreign private issuers than any other country, is moving to IFRS this year.

The strategic challenge grows out of the principles-based nature of IFRS, which in many cases is less prescriptive than US GAAP. He questions whether the PCAOB's ability to protect investors will be diminished if the FASB and the IASB make the accounting world safe for diversity. There is a concern on how auditors will audit accounting standards that are written without much attention to their auditability and whether issuers and auditors will be able to keep up with the pace of change in accounting standards. Member Gradison also said a mechanism may be needed to resolve conflicts between more judgment-based accounting standards and auditing standards that are more prescriptive, which are intentionally written so that they can be inspected against.

Full post as published by Jim Hamilton's World of Securities Regulation on February 13, 2011 (boomark / email).