Key insights from New Developments at the PCAOB in Washington, DC

Introduction

• The PCAOB has a $270m budget, 800 staff members, headquartered in Washington, DC with 15 offices around the country.
• Their reach is vast; covering all firms that conduct audits of companies that trade on US markets. 1,900+ public accounting firms are registered with the PCAOB.

PCAOB Standard Setting

• The PCAOB has released three new standards: The New Auditor's Report, Accounting Estimates and Using the Work of a Specialist.

Auditor's Reporting Model

It involves the most significant change to the auditor's report in decades, most notably the disclosure of Critical Audit Matters (CAMs). Audit opinions are more often than not "clean, "but investors want to learn more about what the auditor thought about, what they considered:

• The Final standards continue to have the pass / fail opinion.
• Auditor must communicate the CAMs or state there were none. CAMs have required to be communicated to the Audit Committee and are considered to be "challenging, subjective or complex auditor judgements that were material to the financial statements: "Risk of material misstatement, auditor judgements, nature and timing of unusual transactions, audit effort required and audit evidence obtained.
• The PCAOB's expectation is that most audits would have at least one CAM, and maybe more than one.
• Once it is established that there is a CAM, the auditor is required to explain that it was identified, the assessment that led to it being a CAM, describe how the CAM was addressed in the audit, and refer to accounts and disclosures in the financial statements to which it relates.
• CAMs disclosure language will be at the discretion of the auditor. The PCAOB has been intentional to not issue boilerplate scripted language as they want the CAMs to be tailored to the individual circumstances and judgements made by the auditor.
• The PCAOB Board looked at the experiences in other countries, such as the UK, who have adopted similar requirements and believed the feedback was positive. Key Audit Matters are similar to CAMs and were put into place in some markets prior to the PCAOB's standard.

The panel discussed the implications of the new standard on an audit committee's interactions with the auditor. They believe that auditors will likely share draft CAMs with the audit committee and it will be important that the committee applies appropriate influence over this process to understand what the auditor relied on to identify a CAM, what influenced their position of the CAM, and did this CAM exist in prior audit periods. Audit committees need to be armed to ask the appropriate questions. It was noted that every time you increase the level of disclosures you risk claims of inaccurate or misleading statements. This standard could trigger inquiries that would not have been received otherwise if it was not disclosed. Audit committee members should, therefore, ensure that the discussion takes place and is robust.

Other improvements are also incorporated into the new standard including statements on auditor tenure, an independence statement and a few other improvements to the flow of the audit opinion.

The standard on Auditing Accounting Estimates reflects the PCAOB's belief that this area requires strengthening given the increasing shift to fair value accounting in financial statements. The standard requires the auditor to address management bias, integrate required risk assessments and update clarity around pricing requirements.

The Auditor Use of a Specialist is linked to the Accounting Estimates as outside parties are implicit in assisting with valuation. The PCAOB included a diagram in its staff consultation paper that compared how company's and auditor's use a specialist. The proposal tried to rectify some of the overlap and create more uniform rigorous practices.

Enforcement Trends

• The PCAOB Board believes that enforcement should be aimed at improving audit quality and protecting investors. They want to deter bad behavior and promote compliance. They will continue to focus on "reckless audits."
• The PCAOB has been looking for ways to enhance the sourcing of cases, how to investigate, and what type of cases to bring. Data could play a large role in these efforts going forward.
• The mix of cases range from audit deficiencies, non-cooperation cases, non-compliance with prior sanctions, and auditor independence.
• There have been numerous international cases brought, which has been a key achievement given the power of the PCAOB. The Board has entered into many Memoranda of Understanding (MoUs) with foreign regulators to conduct inspections and enforcement actions. This has on occasions resulted in effective joint inspections with foreign regulators.
• There is a focus on the Audit Quality Control system at audit firms. The enforcement program has received many referrals from the inspection division for what they saw as very poor audits. Firm Audit Quality Control Systems will likely identify individual audits that are poor in quality. The System of Audit Quality Control should assist in ensuring audit standards are being complied with. Individuals within audit firms responsible for such functions will be scrutinized if a function does not appear to be operating adequately.
• The PCAOB does draw distinctions between audit firms based on their size in some areas, but not in others. Audit Quality Control systems established by a firm are likely reflective of its size, complexity and nature: one size does not fit all. However, related party procedures, professional skepticism, audit evidence standards are universal requirements that form the foundation of an audit. If a firm cannot get these basic requirements right it can result in a charge against the firm. If a small firm does not perform a quality inspection across all audits in the required time no action may be taken; however, if there is no Audit Quality Control system existing at the firm, that would be an issue that could result in a charge against the firm.