Aloke Ghosh

Public Company Accounting Oversight Board (PCAOB) report, based on inspections of registered public accounting firms from 2012 to 2014, finds significant deficiencies in auditing firms’ assessment of clients’ risk. The risk assessment standards, Auditing Standards No. 8 through No. 15 adopted in 2010, are designed to assist the auditor in assessing audit risk, to respond to the risks of material misstatement, and to evaluate results of procedures performed in an audit.

In audits performed in accordance with PCAOB standards, risk underlies the entire audit process, including the procedures that the auditor performs to support the opinion expressed in the auditor’s report. PCAOB adopted eight Risk Assessment Standards to establish audit requirements to enhance the effectiveness of the auditor’s assessment of and response to the risks of material misstatement in an audit. Proper application of these standards is important for performing effective audits of internal control and audits of financial statements.

The eight auditing standards that address procedures performed from initial planning through the evaluation of audit results to support an opinion include:

• AS No. 8, Audit Risk
• AS No. 9, Audit Planning
• AS No. 10, Supervision of the Audit Engagement
• AS No. 11, Consideration of Materiality in Planning and Performing an Audit
• AS No. 12, Identifying and Assessing Risks of Material Misstatement
• AS No. 13, The Auditor’s Responses to the Risks of Material Misstatement
• AS No. 14, Evaluating Audit Results
• AS No. 15, Audit Evidence

PCAOB Findings

Based on 2012 inspections, the Board staff found that while accounting firms generally made appropriate adjustments to their audit methodologies to implement the new risk assessment standards, 26% of the 632 engagements inspected had audit deficiency related to one or more of the risk-based standards, which contributed to an insufficiently supported audit opinion. The number of audit deficiencies increased to 27% in 2013. The Board finds similar audit deficiencies in 2014.

The most frequently identified Risk Assessment Deficiencies related to AS No. 13, The Auditor’s Responses to the Risks of Material Misstatement, AS No. 14, Evaluating Audit Results, and AS No. 15, Audit Evidence.

Examples of Common Deficiencies Include:

• Firms did not perform substantive procedures, including tests of details, that were specifically responsive to fraud risks and other significant risks that were identified (AS No. 13)

• Firms did not perform sufficient testing of the design and operating effectiveness of controls to support their planned level of control reliance, including testing controls over the system-generated data and reports that were used to support important controls or substantive procedures performed in response to the assessed risks of material misstatement (AS No. 13 and AS No. 15)

• Firms did not evaluate the accuracy and completeness of financial statement disclosures. (AS No. 14)

• Firms did not take into account relevant audit evidence that appeared to contradict certain assertions in the financial statements. (AS No. 14)

Implications?

Recurring audit deficiencies related to the risk assessment standards suggest that audit quality challenges remain and, according to PCAOB, more can be done to improve the quality of audits. Audit committees may also find this report useful in fulfilling their responsibilities with respect to independent auditors. Audit committees may consider inquiring of the Issuer’s auditor:

• Have the PCAOB’s inspections or firm’s internal inspections identified any significant deficiencies in the firm’s compliance with the Risk Assessment Standards, and if so, what actions has the firm taken to address these?

• Which audit areas have been identified by the auditor as having significant risks of material misstatement and, at a high level, how does the audit plan address those risks?

• In the auditor’s view, how have the areas of significant risk of material misstatement changed since the prior year and why? What new risks has the auditor identified?

October 16, 2015, 10.50P

http://pcaobus.org/Inspections/Documents/Risk-Assessment-Standards-Inspections.pdf

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KPMG and Forbes Insights recently compiled a survey of 151 respondents who are audit committee chairs and members, CEOs, CFOs, other C-level executives and controllers, directors of financial reporting, investors, audit associates, accounting students, and audit professors. Some key conclusions of the survey respondents include:

• 93% believe that the audit profession needs to evolve, yet the direction of the evolution remains uncertain. A third believe that auditors should go beyond certifying numbers. In contrast, the majority believe that the auditors’ role should remain unchanged—only the way they perform the audit should evolve.
• The majority agree that a trio of skills are essential for future auditors: experience in the client’s industry, investigative financial skills, and critical thinking.
•  The majority consider culture and the regulatory environment as the biggest challenges to enhancing the role of the audit. The intertwining of these two factors leads to a highly structured, process-oriented working environment, which can create resistance to change.
•  The majority agree that increasing the profession’s status is the most important way for audits to evolve in the future. Audit should be perceived as a profession, not a job, and career tracks should be more rewarding.
•  The consensus is that technology is likely to have the biggest impact on the audit profession, especially for young auditors who benefit from technology because it provides tools for more sophisticated analysis.

In the US, and in most countries, public companies are required to have their financial statements audited by an independent public accountant. The Supreme Court, in United States v. Arthur Young (1984) describes the audit as a “public watchdog” function that “demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust.”

http://www.forbes.com/forbesinsights/kpmg_audit/index.html

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In the U.S., the auditor’s report discloses only the name of the audit firm issuing the report but never any information about the identity of the partner(s) who led the work.The Public Company Accounting Oversight Board (PCAOB) is proposing that audit firms should be required to file a new form to make the identity of the audit engagement partner public in the audit report.

The crucial economic question is whether disclosing the identify of the lead audit partner improves the transparency of public company audits and whether such information aids investors and creditors in their decision-making process?

As this information becomes publicly available over multiple years, investors get to observe, and assess, whether a particular lead audit partner is more likely to be associated with: (1) fewer financial reporting misstatements, (2) higher audit quality, (3) higher audit fees, which is presumably because of rendering high audit quality,  (4) lower earnings management, and (5) higher frequency of modified going concern reports when a client is in financial trouble. Thus, using data from the past to draw inferences about the type of audit quality rendered by a particular audit engagement partner is likely to increase the reliability of financial statements to its users, but this benefit is likely to accrue over time.

It is also possible that disclosing the identity of the lead partner would alter the behavior of the audit partner relative to the current regime where such disclosure is not mandated (a classic disclosure problem extensively analyzed in economics, finance and accounting), which could lead to immediate improvements in audit quality. Users can also infer whether the engagement partner had any prior relationship with the client which has implications for auditor independence and therefore might impact audit quality. These are some of the benefits, there are other benefits as well.

However, it is important to highlight that there might be some costs. Audit fees are likely to increase as audit firms might begin to charge more  because of higher litigation costs. Firms might also charge more if they exert more effort. However, the net benefit is likely to be overwhelmingly larger (especially over a longer period).

http://www.accountingweb.com/aa/auditing/pcaob-proposes-new-form-for-identifying-audit-engagement-partner

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