My Advice to the PCAOB: Input on the 2015 Agenda

 

Takeaway

  • Big Data has the potential to fundamentally change the audit approach.
  • Focusing on auditors in foreign jurisdictions is critical. Auditor skepticism and management override results in high fraud risk.
  • The PCAOB should encourage audit committees to take a hard look at the qualifications of its own members.

The Public Company Accounting Oversight Board (PCAOB) was established by the Sarbanes-Oxley Act of 2002 to regulate the public company auditing profession in the United States. The PCAOB is responsible for establishment of auditing standards, inspections of the quality of auditors’ work and enforcement of discipline for violation of PCAOB standards by auditors. The PCAOB has established various advisory bodies comprised of private sector volunteers, including the Standing Advisory Group (SAG) to advise the PCAOB on the development of auditing and professional practice standards.

 

The Public Company Accounting Oversight Board (PCAOB) has declined my offer of voluntary service in 2015. I have been informed I won’t be needed on the regulator’s Standing Advisory Group (SAG) this year either. Nevertheless, because I remain committed to the PCAOB’s mission of improving audit quality, I respectfully offer my advice to the new SAG as its members begin their important work. My suggestions are made in context of the overarching concept that improvement of sustainable audit quality is a shared responsibility of the four key participants in the process—client management, the audit committee, the auditors and the PCAOB. (More on this here.)

Audit Quality Indicators/Root Cause Analysis

Stay focused on this important project and finalize it. Don’t make it too complicated. The potential audit quality indicators (AQIs) being discussed are the right ones for the most part, but I recommend specific focus on these:

(a) Industry experience of key members of the engagement team;

(b) Actual audit hours and fees incurred compared with those of prior years (and previous auditors, if applicable); and

(c) Positive quality indicators. The PCAOB staff members know quality when they see it. Use examples of good quality to educate everyone.

Keep the results of all AQIs private, sharing them only with company management and the audit committee.

The PCAOB staff’s effort to get real, effective root cause analysis done is one of its best contributions to quality. Keep pushing audit firms to get to the real cause of failure in each case. Real improved quality will be the result.

Inspections

Future inspections should include specific focus on (a) unadjusted errors and (b) materiality judgments. Both of these areas are key to understanding potential disagreements between auditors and management and identifying where management is pushing the envelope on issues (and maybe pushing the auditor). In addition, focusing on the work of other auditors in foreign jurisdictions is critical. This isn’t a new topic (see Standard-Setting Projects below), but it should be at the top of any agenda. There are real issues in auditor skepticism in many jurisdictions outside of the United States, which results in a high fraud risk when combined with a lack of effective internal controls and management override.

Finally, a forward-looking area: The PCAOB staff needs to understand and monitor audit firms’ methodology changes in analytics and procedures using so-called “Big Data.” This emerging development in technology has the potential to fundamentally change the audit approach.

Standard-Setting Projects

I won’t spend any time on the current “big 2” topics involving naming participants in the audit (including the partner) and disclosure of critical audit matters. These topics are already thoroughly vetted and moving to closure on predictable paths. I believe two current projects merit timely focus. First is the “Supervision of Other Auditors and Multi-Location Engagements” project for the reasons discussed in the “Inspections” category above. The other project to prioritize is “QC Standards – Assignment/Documentation of Firm Supervisory Responsibilities.” As discussed in the “AQI” category, I believe a key to audit quality is the industry experience of key members of the engagement team. The assignment of partners and managers is, of course, linked to supervisory responsibilities. However, it is important not to take the determination of “upstream fault” too far. The resulting aversion to consultation and involvement by higher-level partners is counterproductive to quality.

Audit Committees

The PCAOB’s outreach and education efforts to audit committees is a worthwhile effort. It should continue. At the same time, the PCAOB should not be shy about encouraging audit committees to take a hard look at the qualifications of their own members. Push for members with real expertise and experience in auditing, accounting, internal controls and risk management. Also, the staff should be cognizant of audit committees over-delegating their responsibilities under SARBOX to management—particularly in the areas of audit firm and audit partner selection and negotiation of fees.

Other Advice

I recommend the PCAOB look at implementing a method for identifying and understanding the reasons for all audit partner changes that occur before normal required mandatory partner rotation. In many cases, the reason for a change is that management is unhappy with the partner’s stand on issues of accounting treatment, potential fraud or internal controls. The standard excuse of a “lack of attention or service” often masks the real intent to rid management of a partner pushing back on the client. There is a lot to learn from really understanding why partners are replaced prematurely.

If the PCAOB is interested in any more unsolicited input, they have my number.


 

 

About The Author

Jeff Johanns

Jeff Johanns is an accounting lecturer at the McCombs School of Business. He is a former U.S. Assurance Risk Management Leader...

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