Auditors would have to tell corporate boards' audit committees of any doubts the auditors may have about a company's prospects for survival, under a standard proposed on Tuesday by the U.S. watchdog group that polices the audit industry.
The Public Company Accounting Oversight Board's (PCAOB) proposal would also require auditors to discuss with the audit committee any significant unusual transactions discovered in an audit, as well as the rationales for the transactions.
Auditors were criticized in the 2007-2009 financial crisis for failing to flag risks at large financial institutions that collapsed or had to be bailed out by the U.S. government.
Assessing a company's financial health is an important part of any audit, and auditors should already be having discussions with audit committees about that, said Lynn Turner, former chief accountant for the U.S. Securities and Exchange Commission.
"You'd have to ask yourself, how could an audit committee be doing its duties if it wasn't having that conversation with the auditors," Turner said.
The PCAOB said it will seek public comments until February 29 before issuing a final standard.
PCAOB standards already require auditors to issue going concern warnings in their annual audit reports attached to companies' financial statements. However, doubts about a companies' ability to continue as a going concern do not get publicly reported if a company mitigates the auditor's worries.
The proposed standard would require auditors to tell audit committees about going concern doubts, even if the company had mitigated their worries, and talk about why they are no longer concerned.
FRAUD RISKS TO BE DISCUSSED
Auditors' findings on fraud risks, contentious issues that surfaced during an audit, unusual transactions, and significant judgments and estimates used to come up with a company's financial numbers would also have to be discussed.
Audit committees need to know about significant unusual transactions to be sure they are legitimate and properly disclosed, Turner said.
"If you look at any of the major frauds -- WorldCom, Enron, Adelphia -- there were large unusual transactions that got booked that didn't get disclosed," he said.
More recently, Lehman Brothers and MF Global were also accused of using complicated transactions to disguise their risk before they filed for bankruptcy protection.
The 2002 Sarbanes-Oxley reform act, passed after the Enron and WorldCom accounting frauds, entrusted audit committees with overseeing auditors and companies' financial reports, but the committees need information from auditors to do their jobs, PCAOB board members said.
"Since the audit committee is now the supervisor of an issuer's outside auditor, robust and complete communications between the auditor and audit committee are vital," board member Lewis Ferguson said in a statement.
(Reporting By Dena Aubin; Editing by Kevin Drawbaugh, Phil Berlowitz)