Audit committees at corporate boards were seeing plenty of new proposals last year from the Securities and Exchange Commission and the Public Company Accounting Oversight Board that could turn into final rules this year.
“Audit committees have a lot on their minds and a lot on their plates,” said Pat Niemann, EY Americas audit committee forum leader. “When you think of the purview of the audit committee, in addition to the auditor relationship, audited financial statements, and internal controls, audit committees are dealing with so many constant changes in the regulatory environment relating to cyber, climate and other ESG matters. It’s an ever expanding agenda.”
Audit committee members are also concerned about a possible recession and the latest inflation trends.
“When I think of a potential downturn in the economy, and recessionary trends, the very full audit committee agenda gets even more complicated and more full,” said Niemann. “With just the macroeconomic trends of inflation and the supply chain disruptions we’ve seen in the past couple of years, there are already so many trends and factors that are complicating things in doing the quality job that most companies want to do with their financial statements. Then you think about how so many assumptions underlying some of the estimates and financial statements get impacted. The job of the audit committee to keep up with all that and stay on top of it. We will continue to talk with audit committee chairs and members about continuing to be vigilant in their role, asking the right questions of management, internal audit, external audit, and so forth, to make sure not just that people are trying to do the right thing, but that they’re considering all the implications. It is such a dynamic environment right now, that it is not hard to let the best of intentions overlook some important implications that might need to be considered in the underlying assumptions and the estimates that help to generate a company’s audited financials and all that disclosures in a 10-K or a 10-Q.”
CFOs may be looking to cut costs ahead of a potential recession, focusing on travel and office space. “What executives won’t be able to cut consistently is wages and bonuses,” said Wes Bricker, co-chair of U.S. Trust Solutions at PricewaterhouseCoopers. “There’s just not enough skilled labor to meet the pressing demand going forward. But when it comes to all of the areas that frankly should be transformed in the way business gets done — IT systems, future of work, etc. — those are the areas they are cutting the old way in order to accelerate the new way.”
Concerns over a potential recession are the biggest concern Bricker hears from his C-suite clients. They want to know what immediate actions they can take so they can weather the storm. “That means investing in the long term, where those investments go in the balance sheet and not the income statement,” he said.
Corporate boards faced ongoing geopolitical challenges in 2022 and that’s likely to continue this year. “The challenge headed into 2023 will be figuring out how to model those risks to mitigate the impact of those challenges,” said Kathryn Kaminsky, who co-chairs U.S. Trust Solutions at PwC. “How do you frame these risks and distill them into a qualitative framework that allows for decision making?”
In 2023, corporate leaders will focus on transformation. “Part of that coincides with lease terms coming up; many lease terms are 10 years for commercial real estate,” said Bricker. “Many have leases up in the next couple of years which is where the transformation planning comes in.”
According to Kaminsky, 2023 will be the year where individuals with certain sets of skills and talents will be in demand. “Talent will still very much be in demand in 2023 but prospective employers are likely to be more selective in seeking out those with a unique set of skills,” she said. “This focus on certain skill sets will be in part motivated by pressure on companies to lower overhead costs overall, including across employee compensation.”
PCAOB and SEC changes
Auditors will probably need to update their skills as well. The PCAOB is making some long overdue changes in auditing standards with the encouragement of the SEC, proposing updates last year to quality control and confirmation standards that it inherited 20 years ago from the American Institute of CPAs after passage of the Sarbanes-Oxley Act of 2002 created the PCAOB.
“As we talk with audit committees, they’re always interested in staying up to date with regulators, be that the SEC or the PCAOB,” said Niemann. “I think there is a collective goal of getting things right, understanding the environment, understanding the goals, and working together. Clearly the SEC has expectations that the investment community has good data and reliable financial information, and the PCAOB, the SEC and the broader investment community have high expectations of the audit profession.”
PCAOB chair Erica Williams has been outspoken about the need to update the new standards and take a tougher stance on overseeing auditing firms.
“There’s a new chair of the PCAOB, Chair Williams, who is communicating fairly regularly with registrants, with the audit profession, and we are all collectively focused on making sure we understand what changes are coming, if any, and what’s most important to the PCAOB and the priorities there,” said Niemann. “We recently had the 20th anniversary of Sarbanes-Oxley, which brought about the PCAOB and a lot of changes in the audit profession. We went from being self regulated to a regulated profession. I think the clients, the audit committees, the management teams and the SEC registrants have become very accustomed to being in a regulated profession and understanding the goals and expectations of the PCAOB and the broader investment community, but also meeting those goals and wanting to exceed those goals.”
Ernst & Young itself may be making changes this year with a proposed spinoff of its consulting practice into a separate company that eventually would be publicly traded. The member firms and partners around the world are expected to vote early this year on the proposed split. Niemann declined to comment much on the proposed split when interviewed last year, but added, “anything we would do in the future as a firm, whether it’s structural or otherwise, the quality of our audits is at the center, and I would say the highest priority. And that’s the expectation of our firm and of our partners and of our clients and of the regulators as well. It’s always the top priority.”
EY is helping audit committees prepare in the meantime for the proposed climate-related disclosures from the SEC, which may be finalized this year.
“With companies and their boards and their management teams, and with the audit committees at the center of much of this, ESG is very real,” said Niemann. “It’s been on the agenda of audit committees for some time, and it’s another thing that companies with audit committees are trying to get right. A big part of that is being transparent about what their companies are doing on the ESG front. As it relates to climate, that is clearly a very big focus for audit committees and their companies. Even before the recent SEC proposed guidance for companies, I would say the vast majority of companies out there were already going down a road of being more transparent about their ESG and climate efforts. Clearly, certain companies and boards and audit committees think that doing the right thing when it comes to climate or the broader ESG effort is the right thing for their business and for their shareholders from an economic perspective. And then, very clearly, the expectations of shareholders and other constituents are very high for companies to be talking about what they’re doing as it relates to ESG and especially on the climate front.”
He noted that the SEC received thousands of comments on the proposed rule on climate-related disclosures after the SEC unveiled it last year.
“As it relates to the SEC disclosure requirements that have been proposed, they remain in draft form on climate as part of ESG,” said Niemann. “There were almost upwards of 15,000 comments received on that draft guidance. Clearly the SEC has gotten a lot of input from SEC registrants and others and they are sorting through that, presumably trying to understand what can be executed by SEC registrants, what will work for the future, what will accomplish their goals as a regulator and perhaps what might not work, at least not now, and only time will tell. There is no certainty when that draft guidance and what parts of it will go final, and from that point forward, companies will be expected to adopt. There is certainly more to come. It’s a dynamic area. Audit committees are focused on it. The really leading audit committees and boards are not waiting for that final guidance. I’d say they are getting ready to be able to implement whatever guidance goes final.”
It may take a while for any climate rules to be finalized and they could be challenged in court. The SEC only recently finalized other rules on executive bonus clawbacks and pay versus performance stemming from the Dodd-Frank Act of 2010.
“The SEC remains active, and we’ve seen some recent rulemaking that will change things,” said Niemann. “Audit committees are paying attention. Of course, it’s management’s responsibility to implement and execute, but we do see audit committees looking to understand in more detail what the expectations and requirements are, so they can serve their governance and oversight role in a quality fashion and make sure that their companies are getting it right, meeting the expectations and ultimately, being as transparent as they need to be and issuing quality financial statements and other filings such as 10-Ks and 10-Qs.”