Abstract: Preparing financial statements to file with the SEC for public use in investment decisions often means balancing the needs of the company and the needs of its stakeholders, and in particular the shareholders. The PCAOB wants to remove the "honors system" and "unavoidable risk" from financial reporting. The FASB believes that they are asking the impossible.
When auditing a publicly traded company's financial statements, accountants face a duality of answerability. The purpose of an audit is to assure users outside of the company that management is fair in its reporting. Auditors must be loyally vigilant in the interest of these outside users. On the other hand, the company pays for the audit of the financial statements. To reflect negatively upon the company risks harming the company's ability to negotiate with other companies and devalues the stock and stock options held by shareholders and employees. To make the audit too costly with additional tests risks losing money for the auditors and not being asked back the next year. Since management is directly involved with the audit, and the outside users are not, there is a strong temptation to lean toward the interests of management. The United States Government, through its independent commissions, has found it increasingly necessary to impose regulations and criminal penalties on the financial representation process to assure that the interests of the shareholders are properly represented during an audit.
The Securities and Exchange Commission (SEC) was founded by the Securities and Exchange act of 1934. It had three main objectives: to set margin requirements for trading securities, to police the security exchanges, and to register securities that are publicly traded (Cushman and Institute of Public Administration (New York, N.Y.) 1941, p.335). Like other independent regulatory commissions, it has the power both to make the rules and to enforce them. Defyin...