Compliance Week – August 14, 2012
First, the Public Company Accounting Oversight Board hit most large audit firms with intensely critical audit inspection reports. Now, it’s telling audit committees how to find out more about all the unflattering details of the reports.
Last week, the PCAOB armed audit committees with a list of questions to ask audit firms about the latest inspection reports, giving committee members new ideas on how to probe past dismissive answers.
Savvy audit committees may already be asking the right questions, and forthright audit firms are providing the right answers, but that’s not the case across the entire profession, says PCAOB Chairman James Doty. “We prepared this document in part
because of concerns we have heard audit committee members express regarding a lack of information about PCAOB inspections of their auditors and because of questions from audit committee members about how to understand what their auditors say about
inspection results,” he says.
Although the board has no authority over audit committees, the PCAOB directed the guidance toward them to help them draw more information out of their auditors about the board’s inspection process and the audit firm’s own inspection findings. Audit committee members like Charles Bowsher, former comptroller general for the United States who has served on several
audit committees, says he believes the document will help audit committees that have struggled to get good information.
The release explains to audit committees that the PCAOB takes a risk-based, not random, approach to selecting individual audits for inspection and that inspectors also examine aspects of each firm’s quality control processes. Audit deficiencies—where inspectors find that auditors have failed to gather enough evidence to support an audit opinion—are described in inspection reports, although individual auditors and issuers are not identified. Concerns about quality control are not made public in the reports, but can be made public later if the PCAOB is not satisfied with the firm’s work to address concerns.
With the guidance, the PCAOB is also urging audit committees to ask auditors whether the company’s own audit was selected for inspection and whether inspectors identified deficiencies in its own audit or in audits for other companies with similar issues. Audit committees should question auditors about how they are responding to any PCAOB findings, the board advises, and audit committees should be skeptical if auditors downplay the importance of a PCAOB finding with explanations like, “It was just a documentation problem,” or “There was a difference in professional judgment.”
“A lot of times in the past, auditors just said we had an inspection and there was no problem, other than they think we should do more documentation,” Bowsher says. “Most audit committee members would kind of accept that and move on to the next agenda item. If an audit committee has a lot of background in finance, we can get a dialogue going and auditors are responsive. But if you don’t have the right people on the audit committee, auditors don’t volunteer too much information.”
Denny Beresford, former chairman of the Financial Accounting Standards Board and an audit committee member of Legg Mason’s board, says good audit committees are already having robust conversations with auditors about inspection findings, but the guidance may prove useful for those at smaller companies or that are less sophisticated.
Big 4 firms have been generally unwilling to discuss PCAOB inspections, but “second tier” firms Grant Thornton and Crowe Horwath say they already instruct auditors to discuss the issues that the PCAOB has suggested in the audit committee guidance with client companies.
Trent Gazzaway, national managing partner of audit services for Grant Thornton, says the firm has already instructed its staff to discuss all of the things that are described in the PCAOB release. “There wasn’t anything in the release that gave me concern about anything we are not already doing,” he says.
Crowe Horwath also had already prepared information for its clients’ audit committees on its most recent inspection report, says Rick Ueltschy, managing partner for audit services for the firm. The information includes an overall description of the PCAOB inspection process, a summary of the deficiencies identified in the public portion of the report, and quality control concerns that are not made public in the report. “Our information also describes the responsive actions we have taken already and are continuing to take,” Ueltschy says.
The PCAOB guidance for audit committees on audit inspections also explains the basis for deficiency findings. “The PCAOB bases deficiency findings on an absence of available evidence in the audit files or elsewhere to support that adequate work was done to support an audit opinion, not just a failure to document work that was in fact done,” the board says in the release. “The PCAOB bases deficiency findings only on failures to obtain sufficient audit evidence, not on disagreements when reasonable judgments appear to have been made about such matters.”
That message is a bit stark for Beresford. From his vantage point, it’s plausible for experienced auditors and audit regulators to have reasonable differences in professional judgment. “The PCAOB is saying here we’re always right and the accounting firms are always wrong on those issues,” he says. “I find that to be somewhat one-sided. There’s no way for me to know that that’s a fair way of assessing all of the differences of opinion on judgment issues unless I can look at each of the relevant circumstances and apply my own judgment.”
The point is a fair characterization of the nature of PCAOB findings, says Gazzaway. “The PCAOB is our chief regulator, and when they interpret a matter of judgment, that judgment prevails,” he says. “They set the standards, and they interpret the standards, so when they put something in the report, in their view it is the correct interpretation.”
Dee Mirando-Gould, a director at consulting firm MorganFranklin and a former staff member at the PCAOB, says inspectors in recent years have made more of an effort to assure that findings in inspection reports represent only important audit flaws. Auditing standards have gotten tighter, she says, especially around documentation, so there’s less room for judgment than there was when inspections began in 2004, she says. “Essentially, if it’s not documented it’s not done,” she says. She acknowledges there may still be differences of opinion at times, “but the bottom line is the regulator is going to win that one.”
Although the PCAOB is working separately on the second draft of a standard to outline communication requirements for auditors, specifying issues they must discuss with audit committees, the board chose to direct guidance at audit committees in part to get it out more quickly. It also helps facilitate dialogue on the non-public portion of the reports, says Doty, where firms are not required to provide audit committees with information that is not publicly available but aren’t prohibited from doing so either.
Jim Feltman, senior managing director at Mesirow Financial Consulting, says he sees the release as a “pretty clever way” for the PCAOB to inspire more dialogue over inspection findings. “This is positive, certainly for audit committees that don’t have the best relationship with their auditors,” he says.
Scott Peterson, managing director at Warbird Consulting Partners, says the guidance should prove to be a useful framework for opening discussions that might otherwise be difficult to initiate. “While the discussion of the inspection report may be awkward initially, auditors can focus on what remediation steps are under way or have been completed to address deficiencies noted,” he says.