Oversight Hearing on "Accounting and Investor Protection Issues
Raised by Enron and Other Public Companies."

Prepared Statement of Mr. James S. Gerson, CPA
Chairman, Auditing Standards Board, AICPA
National Office of PricewaterhouseCoopers, LLP

10:00 a.m., Thursday, March 14, 2002 - Dirksen 538

My name is Jim Gerson, Chair of the AICPAís Auditing Standards Board. I am also a partner with PricewaterhouseCoopers. My objectives today are toare to briefly describe the auditing standards board, the role of the independent auditor and to highlight some significant changes in auditing standards that have recently occurred, or will take effect shortly.

The Auditing Standards Board

The Auditing Standards Board is a senior committee of the AICPA authorized to set authoritative auditing standards commonly referred to as generally accepted auditing standards. Our committee is made up of 15 members, appointed to achieve an appropriate representation among CPA firms, as well as the public. At present two of the 15 seats are reserved for public members, currently filled by an academician and a government auditor. We hold regular meetings that are open to the public and attended by the SEC, POB and other constituents. Role of the Auditor

Let me focus briefly on the role of the independent auditor in the financial reporting process. The objective of a financial statement audit is to provide assurance as to the credibility of managementís financial statements. An audit consists of a series of test procedures, such as examining inventories, confirming accounts receivable and obtaining an understanding of a companyís system of internal controls. Such tests are designed to gather evidence to enable the auditor to express an opinion as to whether a companyís financial statements are presented fairly, in all material respects, in accordance with generally accepted accounting principles.

The auditorís conclusions are reflected in the auditorís report. The report may notify financial statement readers about material departures from GAAP, changes in accounting principles, or a variety of other matters. The intended goal of financial statements accompanied by an auditorís report is to provide information that is reliable and useful to investors, creditors and other constituencies.

One question that we are often asked is "What is the auditorís responsibility to detect fraud?" Let me assure this Committee that, as auditors, we recognize our responsibility to plan and perform every audit to obtain reasonable assurance, within the limitations inherent in the nature of an audit, as to whether the financial statements are free of material misstatements, whether caused by fraud or unintentional errors. Even a properly designed and executed audit however cannot provide a 100% guarantee that a material fraud will be detected. Nevertheless, we are working hard to continually improve both auditor performance and our fraud guidance.

Recent Initiatives

Let me briefly outline a few of our initiatives, many of which pre-date the issues surrounding Enron. First, we issued an exposure draft last month of a proposed standard entitled Consideration of Fraud in a Financial Statement Audit. This proposal supercedes prior guidance and will substantially enhance the ability of auditors to detect material misstatements arising from fraud. A major change in this new standard is the addition of required procedures that respond to the POB Panelís call for a forensic phase. Specifically, it responds to what they call a forensic phase by requiring, as part of every audit of an SEC registrant, even when fraud is not suspected:

I will very briefly outline some initiatives in other areas.

Last year, we formed a task force that is working to improve the auditorís risk assessment process. Through a more robust risk assessment process, auditors will be able to better understand where material errors are most likely to occur in the financial statements, and what auditing procedures are best suited to respond to those errors detected.

We have undertaken a project to create a new standard on auditing "fair value" that we intend to expose for comment this spring. We previously issued detailed standards on auditing derivatives and similar financial instruments. Additionally, we are in the process of updating and improving our related audit guide and will be adding a new chapter that will provide guidance on auditing energy and other commodity contracts.

In December 2001, in response to recent events and in time for this yearís audits, we issued an auditorís "toolkit" to serve as a valuable reference guide when dealing with the complex topic of the potential abuse of related-party transactions. Through this toolkit, we are advising auditors to evaluate the possibility that related-party transactions may be motivated by a desire to improve reported earnings or by fraud.

In response to growing demands for more timely reporting, we have actively participated in developing continuous auditing or assurance methodologies. This concept involves reporting on shorter time frames and can relate to either reporting on the effectiveness of a system that produces data or reporting more frequently on the data itself. We believe that the technologies, if not the tools, required to provide continuous assurance services are, for the most part, currently available. Their actual implementation will evolve, as the concept of more frequent reporting gains additional support and appropriate, specialized software tools emerge.


Investors depend on auditors to communicate the reasonableness of the companyís financial information and to provide confidence in the numbers. When an investor reviews a companyís financial statements, an independent audit should provide the investor with confidence that the company is playing by the rules.

As a profession, we know that we can and must do a better job. I believe the entire auditing community would agree with me when I say that we are deeply concerned about recent events that have shaken the publicís confidence in the financial reporting process. We are committed to continually improving auditing standards and the guidance we provide to auditors, so that investors and others who rely on an auditorís report can place full confidence in the audit process and the members of the profession who perform this valuable service.

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