June 23, 1999
Judith M. Sherinsky
Dear Ms. Sherinsky:
The Committee on Corporate Reporting (CCR) of the Financial Executives International appreciates the opportunity to comment on the Auditing Standards Board Exposure Draft, Audit Adjustments, Reporting on Consistency and Service Organizations. We would like to address some concerns regarding the amendments relating to Audit Adjustments.
Our membership in CCR is drawn from chief financial officers, controllers and other senior financial executives that have responsibility for accounting and external reporting in U.S. public companies. As such, the topic of resolution of audit adjustments (and in fact the resolution of accounting errors in general) is an area we address on a regular basis.
We believe that material errors, trend-affecting errors and deliberately fictitious entries absolutely need to be corrected, as well as discussed with the appropriate individuals, including higher levels of management and, when appropriate the Audit Committee and others. However, we do not believe the same treatment is warranted for accidental errors causing minor misstatements that arise out of the normal process of closing the books, that are both individually and in the aggregate immaterial. Unless such minor items are indicative of some larger problem or control fault that is of concern to the auditor, errors, we fail to see a good purpose that would be served by booking them in the current period, and have serious concerns that any such expectation could work to the disadvantage of shareowners and other financial statement users. Furthermore, raising the recording of such minor items to the level of the representation letter or discussion with the Audit Committee could create voluminous lists of extremely minor details, adding administrative costs with no real user benefit.
Currently the management representation letter acknowledges management's responsibility for the fair presentation of the company's financial statements and states that to the best of management's knowledge and belief, any unrecorded amounts recorded amounts are not material. Immaterial errors that are random oversights are currently the responsibility and should be the responsibility of management. Auditors have the responsibility to report to the Audit Committee any material unresolved items, or to report that they concur with management that any unresolved items are immaterial individually and in the aggregate.
Immaterial errors identified presented by the auditors generally occur for two main reasons - mistakes made through accidental human oversight, or minor differences in either estimate areas (e.g., warranty or bad debt provisions) or interpretations of GAAP. Systems and procedures are designed to identify and correct errors. Inescapably, at times human mistakes can occur; when minor, such mistakes are normally corrected in the next reporting period. Immaterial differences over judgmental interpretations of GAAP - representing minor differences that management and auditors agree need not be resolved in the current period due to their immaterial impact of the fair presentation of financial statements - are typically handled by "agreeing to disagree" in the current period, often with plans to conduct follow-up discussions in the next period - again, this is when the amounts are clearly immaterial.
Management currently uses auditor listings of any and all items not only to assure that the financial statements are properly and materially presented, but also to assist in improving systems and procedures, to correct errors, and to assess the performance and training needs of the staff. If a requirement is promulgated to identify all items which individually or in the aggregate are not material, by attaching a description of each one to the representation letter and discussing them with the Audit Committee, the time and cost to document and formally discuss such minor matters will far outweigh the benefit derived.
In some companies, particularly large enterprises with numerous operations and legal entities through out the world, lists of immaterial uncorrected items could be very lengthy. In our experience, such minor faults typically arise randomly and unexpectedly, and in addition to being of extremely minor amounts, often tend to offset one another. But if each must one be made part of a formal list, as opposed to being part of audit workpapers and discussions with management, the list could be quite long.
We anticipate that an Audit Committee will react to receiving such lists of minor items with concerns and uncertainty over differential expectations of action that might exist, and will legitimately wonder whether this could create additional liability for Audit Committee members. We question the need for individuals at the level of the Audit Committee to spend time on minor items when these are not indicative of any underlying problem of concern to an auditor. And if auditors and Audit Committees react to all this detail and uncertainly by simply instructing that any item found is to be booked, no matter how small or insignificant, we can all expect extensive recycling in book close processes and major delays in announcing results to the public, with little if any difference in the final results.
We believe there could be many unintended and undesirable implications from of this proposal. We have already noted a potential for higher costs throughout both management and auditing, as more time is spent discussing and dealing with immaterial items. A second negative consequence is that some auditors, recognizing that many minor items are not significant enough to discuss with the Audit Committee, may then hesitate to list them. If this occurs, and some auditors now apply a more restrictive standard of interpretation to what should be listed, the result will be that they tend to not bring every minor item forward to management. This could have the unintentional and serious effect of restricting the ongoing and open discussions that occur between management and the auditors, which clearly would not be a positive development. A similar effect appears to haveA similar result occurred at some financial institutions when regulatory changes paralleling the current proposal regarding auditor disclosure of minor items in the management letter were made. Previously, helpful though insignificant comments were made which management used to improve the system of internal control. After the change in requirements, many of these comments were no longer made as before.
In closing, we would like to emphasize that we continuously strive to attain quality in financial reporting, and appreciate the contribution made to this end from the external audit function and process. We are also cognizant and appreciative of the value added by a vigilant and effective Audit Committee. Taking all these roles and responsibilities into account, we do not believe that a cost-benefit threshold has been crossed by a proposed requirement which would expose an Audit Committee to items which have been deemed immaterial by both management and the auditor, and which have been fully discussed with management having the ultimate responsibility for the financial statements. We would be pleased to discuss our comments further with representatives of the Board. If you have any questions, please contact Michael Mathieson of Fortune Brands, Inc. at (203) 698-5383.
Vice President - Professional Development
and Technical Activities