This Update addresses selected PCAOB developments since the Summer 2011 Update that are likely to be of interest to accounting and auditing researchers, educators, and students. The developments discussed include:
- Interim Inspection Program for Broker-Dealer Audits;
- Concept Release on the Auditor's Reporting Model;
- PCAOB Scholarship Program;
- Proposal of Standards for Broker-Dealer Audits and Auditing Supplemental Information;
- Announcement of Settled Disciplinary Orders;
- Concept Release on Auditor Independence and Audit Firm Rotation;
- PCAOB Cooperative Agreement with Norway;
- Staff Audit Practice Alert on Audit Risks in Certain Emerging Markets;
- Proposed Amendments to Improve Transparency through Disclosure of Engagement Partner and Certain Other Participants in Audits;
- Exchange of Letters with Japan.
Interim Inspection Program for Broker-Dealer Audits: On June 14, 2011, the PCAOB adopted a temporary rule, which has since been approved by the SEC, to establish an interim inspection program for registered public accounting firms' audits of brokers and dealers ("broker-dealers") while the Board considers the scope and other elements of a permanent inspection program.
During the interim program, the Board will provide public reports on the progress of the interim program and significant issues identified. In the absence of unusual circumstances, however, the Board will not issue firm-specific inspection reports before inspection work is performed under the permanent program and will not issue firm-specific inspection reports on any firms that are eventually excluded from the scope of the permanent program.
The temporary rule does not change anything about the rules or standards that govern audits of broker-dealers. The Board expects that insights gained through the interim program will inform the eventual determination of the scope and elements of a permanent program, and the Board expects to propose rules governing the scope and elements of a permanent program in 2013. A copy of the temporary rule is available on the PCAOB website at: http://pcaobus.org/Rules/PCAOBRules/Pages/Section_4.aspx#rule4020t.
Concept Release on the Auditor's Reporting Model: On June 21, 2011, the PCAOB issued a concept release to discuss alternatives for changing the auditor's reporting model. The concept release presents several alternatives for changing the auditor's reporting model and is seeking specific comment on these or other alternatives that could provide investors with more transparency about the audit process and more insight into the company's financial statements or other information outside the financial statements. These alternatives include:
- An auditor's discussion and analysis;
- Required and expanded use of emphasis paragraphs;
- Auditor assurance on other information outside the financial statements; and,
- Clarification of language in the standard auditor's report.
The comment period ended on September 30, 2011. A copy of the concept release on Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements is available on the PCAOB website at: http://pcaobus.org/Rules/Rulemaking/Docket034/Concept_Release.pdf. Comment letters are posted to the PCAOB website.
In addition, on September 15, 2011, the PCAOB hosted a public roundtable to discuss its concept release on possible changes to the auditor's reporting model.
The objective of the roundtable was to obtain insight from investors and other financial statement users, preparers of financial statements, audit committee members and auditors on the alternatives presented in the concept release for changing the auditor's report. Additionally, the roundtable provided participants with the opportunity to present other alternatives not discussed in the concept release.
The agenda of the roundtable is available on the PCAOB web site at: http://pcaobus.org/News/Events/Pages/09152011_Roundtable.aspx.
The list of participants at the roundtable is available on the PCAOB web site at: http://pcaobus.org/News/Releases/Pages/09082011_RoundtableParticipants.aspx.
A copy of the transcript from the roundtable is available on the PCAOB web site at: http://pcaobus.org/Rules/Rulemaking/Docket034/09152011_Roundtable_Transcript.pdf.
PCAOB Scholarship Program: On July 6, 2011, the PCAOB announced the inauguration of the PCAOB Scholarship Program and the academic undergraduate and graduate institutions who have nominated a student to receive an award this year.
The Sarbanes-Oxley Act of 2002 provides that funds generated from the collection of monetary penalties imposed by the PCAOB must be used to fund a merit scholarship program for students in accredited accounting degree programs. The PCAOB Scholarship Program therefore has been created to identify eligible students for scholarships and award funds through the students' educational institutions.
Students may be eligible for scholarships if they are enrolled in an accredited accounting degree program and attend a participating, nominating institution. Students eligible to receive a PCAOB scholarship must:
- Be enrolled in a bachelor's or master's degree program in accounting
- Demonstrate interest and aptitude in accounting and auditing
- Demonstrate high ethical standards
- Not be a PCAOB employee or a child or spouse of a PCAOB employee
The PCAOB scholarship program is merit-based but educational institutions are encouraged to give consideration to students from populations that have been historically underrepresented in the accounting profession. For the 2011–2012 academic year, the PCAOB awarded 52 merit-based scholarships of $10,000 each.
A description of the PCAOB scholarship program, along with information on the nomination process, information on the selection of nominating institutions and other program details, is available on the PCAOB website at: http://pcaobus.org/Research/Pages/AcademicScholarship.aspx.
Information about the 2011-2012 academic year scholarship recipient academic institutions is available on the PCAOB website at: http://pcaobus.org/News/Releases/Pages/07062011_Scholarship.aspx.
Proposal of Standards for Broker-Dealer Audits and Auditing Supplemental Information: On July 12, 2011, the PCAOB proposed two attestation standards related to the auditor's examination of compliance reports and review of exemption reports of broker-dealers proposed by the SEC as part of its amendments to the broker-dealer financial reporting rule under Securities Exchange Act of 1934 Rule 17a-5. The proposed examination standard and review standard would apply to compliance reports and exemption reports of broker-dealers in the event the SEC adopts its proposed amendments to the broker-dealer financial reporting rule under Exchange Act Rule 17a-5.
The PCAOB also proposed a new standard that would supersede the Board's auditing standard, AU sec. 551, Reporting on Information Accompanying the Basic Financial Statements in Auditor-Submitted Documents, and related amendments. It would establish the auditor's responsibilities when the financial statement auditor is engaged to audit and report on supplemental information that accompanies the audited financial statements. Examples of such supplemental information include the supporting schedules that broker-dealers are required to file with the SEC. The proposed standard also would apply to certain supplemental information of issuers that is included in SEC filings.
The comment period on the proposed standards closed on September 12, 2011. Comment letters are posted to the PCAOB website.
Copies of the proposed attestation standards are available on the PCAOB web site at: http://pcaobus.org/Rules/Rulemaking/Docket035/PCAOB_Release_2011-004.pdf.
A copy of the proposed auditing standard is available on the PCAOB web site at: http://pcaobus.org/Rules/Rulemaking/Docket036/PCAOB_Release_2011-005.pdf.
Announcement of Settled Disciplinary Orders: On August 1, 2011, the PCAOB announced settled disciplinary orders against a former Ernst & Young partner Peter C. O'Toole and senior manager Darrin G. Estella for their roles in providing misleading documents and information to PCAOB inspectors and altering working papers.
The Board found that, shortly before a PCAOB inspection of an E&Y audit, O'Toole and Estella — acting with O'Toole's knowledge and authorization — created, backdated, and added a document to the audit working papers that related to the most significant issue in that audit. The Board also found that O'Toole authorized other members of the audit engagement team, including Estella, to alter, add, and backdate other working papers in advance of the PCAOB inspection. Additionally, the Board found that O'Toole and Estella provided a written document to PCAOB inspectors in which E&Y represented to the Board that no changes had been made to the audit working papers following the documentation completion date for the audit. Neither O'Toole nor Estella ever disclosed to the PCAOB inspectors that, in fact, the working papers were altered after the documentation completion date and shortly before the inspection.
The Board found that O'Toole and Estella's actions violated PCAOB Rule 4006, which requires cooperation with Board inspections, as well as PCAOB Auditing Standard No. 3, which governs audit documentation.
Copies of the settled disciplinary orders are available on the PCAOB web site at: http://pcaobus.org/Enforcement/Decisions/Documents/Peter_C_OToole.pdf and http://pcaobus.org/Enforcement/Decisions/Documents/Darrin_G_Estella.pdf.
Concept Release on Auditor Independence and Audit Firm Rotation: On August 16, 2011, the PCAOB issued a concept release to solicit public comment on ways that auditor independence, objectivity and professional skepticism can be enhanced, including through mandatory rotation of audit firms. Comments are due by December 14, 2011.
Mandatory audit firm rotation would limit the number of consecutive years for which a registered public accounting firm could serve as the auditor of a public company. The concept release invites commenters to respond to specific questions, including, for example, whether the Board should consider a rotation requirement only for audit tenures of more than 10 years or only for the largest issuer audits. The concept release also seeks comment on whether there are other measures that could meaningfully enhance auditor independence, objectivity, and professional skepticism.
The Board will also convene a public roundtable on auditor independence and mandatory audit firm rotation in March 2012.
A copy of the concept release can be found on the PCAOB website at: http://pcaobus.org/Rules/Rulemaking/Pages/Docket037.aspx.
PCAOB Cooperative Agreement with Norway: On September 14, 2011, the PCAOB announced a cooperative agreement with the Financial Supervisory Authority of Norway for the oversight of audit work performed by public accounting firms that practice in the two regulators' respective jurisdictions.
This cooperative agreement provides a basis for the resumption of joint inspections of PCAOB-registered accounting firms that are located in Norway and that audit, or participate in audits, of companies whose securities trade in U.S. markets. In 2008, the PCAOB conducted a joint inspection in Norway with the FSA, but has since been blocked from inspections in that country.
This agreement also includes provisions governing the exchange of confidential information between the oversight authorities, consistent with the provisions of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. Those provisions amended the Sarbanes-Oxley Act of 2002 to permit the PCAOB to share confidential information with its non-U.S. counterparts under certain circumstances.
Staff Audit Practice Alert on Audit Risks in Certain Emerging Markets: On October 3, 2011, the PCAOB published Staff Audit Practice Alert No. 8, Audit Risks in Certain Emerging Markets, to increase auditors' awareness of risks when performing audits of companies with operations in emerging markets.
The practice alert focuses on the risks of misstatement due to fraud that auditors might encounter in audits of companies with operations in emerging markets, auditors' responsibilities for addressing those risks, and certain other auditor responsibilities under PCAOB auditing standards.
The PCAOB has observed from its oversight activities, and companies have reported in filings with the SEC, some conditions and situations in certain companies in emerging markets that indicate to auditors a heightened fraud risk. They include, for example, discrepancies between a company's financial records and audit evidence obtained from third parties; auditor difficulties in confirming cash and receivable balances; and the recognition of revenue from contracts or customers whose existence cannot be corroborated.
Although the conditions, situations, and fraud risks described in this alert have been observed in audits of companies in certain emerging markets, they might also be present at companies in other markets. The matters discussed in this alert are relevant whenever such conditions, situations, or fraud risks are present in audits of companies located in emerging or developed markets.
A copy of the practice alert can be found on the PCAOB website at: http://pcaobus.org/Standards/QandA/2011-10-03_APA_8.pdf.
Proposed Amendments to Improve Transparency through Disclosure of Engagement Partner and Certain Other Participants in Audits: On October 11, 2011, the PCAOB issued for public comment proposed amendments to its standards that would bring greater transparency to public company audits. The proposal would require registered accounting firms to disclose the name of the engagement partner in the audit report and on the PCAOB Annual Report form. It would also require disclosure in the audit report of other accounting firms and other persons not employed by the auditor that took part in the audit.
After careful consideration, the Board did not include in this proposal a requirement to sign the engagement partner's name on the audit report. Instead, the proposal would require that the engagement partner's name be disclosed in the audit report, which would make the engagement partner's name readily available to the users of the audit report while mitigating concerns about minimizing the firm's role in the audit.
In addition, the proposal would require the auditor to disclose in the audit report other accounting firms and other persons not employed by the auditor that took part in the audit. The proposed disclosure would enable investors to evaluate the other participants in the audit in the same manner that they evaluate the auditor. For example, knowing the name of a disclosed accounting firm that took part in the audit would enable investors to determine whether the firm is registered with the Board and has been subject to PCAOB inspection, or is located in a country that does not allow PCAOB inspections. Investors would also be able to verify whether a disclosed firm or person has had any publicly available disciplinary history with the PCAOB or other regulators.
Comments on the proposed amendments are due by January 9, 2012.
A copy of the concept release can be found on the PCAOB website at: http://pcaobus.org/Rules/Rulemaking/Docket029/PCAOB_Release_2011-007.pdf.
Exchange of Letters with Japan: On October 12, 2011, the PCAOB announced a cooperative arrangement with the Japan Financial Services Agency (JFSA) and Certified Public Accountants and Auditing Oversight Board (CPAAOB) of Japan for the oversight of auditors that practice in the regulators' respective jurisdictions.
In addition to carrying out joint inspections with the regulators in Australia, Korea and Singapore, the PCAOB has been regularly conducting inspections of PCAOB-registered firms in other Asian countries, including Indonesia, Malaysia, New Zealand, Philippines, Taiwan and Thailand. While the PCAOB has conducted inspections on its own of PCAOB-registered firms from Japan since 2007, the exchange of letters provides a basis to conduct on-site visits of the firms in Japan in close cooperation with the Japanese regulators.
The agreement also includes provisions governing the exchange of confidential information between the oversight authorities, consistent with the provisions of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. Those provisions amended the Sarbanes-Oxley Act of 2002 to permit the PCAOB to share confidential information with its non-U.S. counterparts under certain circumstances.
1 Martin F. Baumann is PCAOB Chief Auditor and Director of Professional Standards. Gregory Scates is PCAOB Deputy Chief Auditor. Dima Andriyenko is PCAOB Associate Chief Auditor.