This Update addresses selected PCAOB developments since the Fall 2011 Update that are likely to be of interest to accounting and auditing researchers, educators, and students. The developments discussed include:
- Sanctions Against an Audit Partner and Registered Firm;
- Cooperative Agreements;
- Annual International Auditor Regulatory Institute;
- Standing Advisory Group (SAG) Meeting;
- Announcement of SAG Members;
- Staff Audit Practice Alert;
- Reproposal of Auditing Standard Related to Communications with Audit Committees;
- Announcement of Public Meeting on Auditor Independence and Audit Firm Rotation;
- Appointment of New Board Member;
- Announcement of Settled Disciplinary Order; and
- Proposed Auditing Standard on Related Parties and Amendments Related to Significant Unusual Transactions.
Sanctions Against an Audit Partner and Registered Firm: On October 13, 2011, the PCAOB announced that it had permanently barred a Denver-based audit partner and permanently revoked the registration of a registered public accounting firm because of the audit partner’s participation in audits while subject to a previous PCAOB bar.
The PCAOB's Chief Hearing Officer found that Samuel D. Cordovano, CPA, violated the Sarbanes-Oxley Act and PCAOB rules when he willfully became or remained associated with a registered public accounting firm after he was barred from doing so by a December 2008 PCAOB settled disciplinary order.
In addition, the Hearing Officer found that, after being barred from association, Cordovano participated in significant activities relating to the audits of four issuer clients of his firm, including advising audit team members on important accounting and auditing issues. The decision noted that Cordovano’s firm, Cordovano and Honeck, LLP removed Cordovano from overt participation in the Firm’s audits of issuers while allowing Cordovano to remain involved in the audits behind the scenes.
A copy of the Healing Officer's decision is available on the PCAOB web site at: http://pcaobus.org/Enforcement/Adjudicated/Documents/Cordovano_and_Honeck.pdf.
Cooperative Agreements: During the fall of 2011, the PCAOB announced cooperative agreements with the Israel Securities Authority (October 31, 2011); the Netherlands Authority for the Financial Markets (December 5, 2011); and the Dubai Financial Services Authority (December 20, 2011). These agreements authorize the PCAOB and the respective regulatory authority to exchange confidential information, consistent with the provisions of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. The PCAOB also announced that it entered into a cooperative agreement with the Financial Supervisory Commission of Taiwan (November 18, 2011) for the oversight of auditors that practice in both of the regulators’ respective jurisdictions. Although the agreement with Taiwan does not provide for the exchange of confidential information, it strengthens ties between the two sides so that they may work more closely together.
Annual International Auditor Regulatory Institute: From October 31 to November 2, 2011, the PCAOB held its fifth annual International Auditor Regulatory Institute. Seventy-seven representatives of auditor oversight bodies and government agencies from 36 countries convened in Washington, D.C., to exchange views on issues that have an impact upon the oversight of auditors.
The Institute included a panel of senior audit regulators from Canada, France, Germany, Japan, The Netherlands, Singapore, Switzerland, and the United Kingdom. In addition, PCAOB inspectors conducted an interactive session on inspection case studies. Participants also heard about the structure of PCAOB audit oversight programs, international inspection considerations, and current topics in enforcement and standard setting.
Standing Advisory Group (SAG) Meeting: On November 9-10, 2011, the Board's SAG held its second meeting of the year. The meeting agenda included: an update from the Office of Chief Auditor (OCA) on its standard-setting agenda and other related developments and OCA staff-led discussions on (1) the Board's concept release on auditor independence and audit firm rotation, (2) proposed amendments for improving the transparency of audits, (3) comments received regarding the Board's concept release and roundtable on the auditor's reporting model, and (4) activities of the Pricing Sources Task Force. Additionally, the SAG also discussed the auditor's consideration of an entity's ability to continue as a going concern, as well as year-end audit risk and financial reporting issues.
The meeting materials, including the agenda, briefing papers, slides, and meeting webcast and podcast are available on the PCAOB web site at: http://pcaobus.org/News/Events/Pages/11092011_SAGMeeting.aspx.
Announcement of SAG Members: On November 29, 2011 the PCAOB announced 28 new and re-appointed members to its SAG. The Board expanded the size of the advisory group and increased SAG members' terms from two years to three years. This brings the total SAG membership to 42.
The longer term allows the PCAOB to benefit from the insight and advice of the SAG members for a longer period of time and will bring the SAG member terms in line with the terms of the Board’s Investor Advisory Group. Initially, individual SAG terms will be staggered to allow a greater continuity of membership.
A list of SAG members, including their biographies, is available on the PCAOB web site at: http://pcaobus.org/Standards/SAG/Pages/Current.aspx.
Staff Audit Practice Alert: On December 6, 2011 the PCAOB published Staff Audit Practice Alert No. 9, Assessing and Responding to Risk in the Current Economic Environment (Practice Alert No. 9), to assist auditors in identifying matters related to the current economic environment that might affect the risk of material misstatement in financial statements and, therefore, require additional audit attention.
Practice Alert No. 9updates Staff Audit Practice Alert No. 3, Audit Considerations in the Current Economic Environment (Practice Alert No. 3), which was issued in December 2008. Many of the matters discussed in Practice Alert No. 3 - including fair value measurements, accounting estimates, going concern, and financial statement disclosures - continue to be critical in audits of 2011 financial statements. Certain of the PCAOB standards referenced in that alert regarding assessment of, and response to, risk, however, were superseded by the Board's eight new risk assessment standards (Auditing Standard Nos. 8-15) that became effective in December 2010.
Practice Alert No. 9 is organized into four sections: 1) considering the impact of economic conditions on the audit; 2) auditing fair value measurements and estimates; 3) the auditor's consideration of a company's ability to continue as a going concern; and 4) auditing financial statement disclosures.
A copy of the alert is available on the PCAOB web site at: http://pcaobus.org/Standards/QandA/12-06-2011_SAPA_9.pdf.
Reproposal of Auditing Standard Related to Communications with Audit Committees: On December 20, 2011, the PCAOB reproposed for comment an auditing standard, Communications with Audit Committees, and other amendments to PCAOB standards. The standard was initially proposed on March 29, 2010.
Like the original proposal, the reproposed standard would establish requirements that enhance the relevance and quality of the communications between the auditor and the audit committee. The reproposed standard, in addition, would better align the communication requirements with performance requirements in other PCAOB standards, including the implementation of the risk assessment standards (Auditing Standard Nos. 8-15). It also would provide commenters with an opportunity to comment on the standard in relation to the audits of brokers and dealers.
The proposed auditing standard would supersede PCAOB standards AU sec. 380, Communication With Audit Committees, and AU sec. 310, Appointment of the Independent Auditor, and amend other PCAOB standards. The comment period on the reproposed standard closed on February 29, 2012. Comment letters are posted on the PCAOB website at: http://pcaobus.org/Rules/Rulemaking/Pages/Docket030Comments.aspx.
A copy of the reproposed standard and related amendments is available on the PCAOB web site at: http://pcaobus.org/Rules/Rulemaking/Docket030/Release_2011-008.pdf.
Announcement of Public Meeting on Auditor Independence and Audit Firm Rotation: On February 2, 2012 the PCAOB announced that it will host a public meeting to obtain further input on ways to enhance auditor independence, objectivity, and professional skepticism, including through mandatory rotation, or term limits, for audit firms. The meeting will be held on March 21- 22, 2012.
The Board issued a concept release on August 16, 2011, that invited commenters to discuss measures that might meaningfully enhance auditor independence, objectivity, and professional skepticism. The release included a number of questions related to mandatory audit firm term limits, such as whether the PCAOB should consider a firm rotation requirement for audit tenures of more than 10 years, or for the largest issuer audits only.
The public meeting will consist of panel discussions, during which panelists will be invited to present their views on the matters raised in the concept release and the Board will have the opportunity to ask panelists follow-up questions. Panelists will include investors and investor advocates, senior executives and audit committee chairs of major corporations, chief executive officers of audit firms, academicians and other interested parties. The meeting will be held at 1201 15th Street N.W., Washington, D.C. It will be open to the public, and also available via webcast on the PCAOB website.
In addition, on March 7, 2012, the PCAOB announced the panelists and schedule of appearances for its March 21-22 public meeting. In light of the public meeting, the Board is reopening until April 22, 2012 the comment period on the concept release.
The panelists and schedule of appearances are available on the PCAOB web site at: http://pcaobus.org/News/Releases/Pages/03072012_PublicMeeting.aspx.
Appointment of New Board Member: On February 3, 2012, the Securities and Exchange Commission (“SEC”) appointed Jeanette M. Franzel to the Board. Her term started on March 5, 2012. With over 20 years of public service, Ms. Franzel most recently served as a Managing Director of the General Accounting Office ("GAO") where she led all aspects of GAO’s financial audit oversight of the U.S. federal government. Ms. Franzel also participated in the PCAOB's Standing Advisory Group through GAO's role as an observer. She is a Certified Public Accountant, Certified Internal Auditor, Certified Management Accountant, and Certified Government Financial Manager. She received her bachelor’s degree from the College of St. Teresa and holds an M.B.A. from George Mason University. Ms. Franzel replaced Daniel L. Goelzer, one of the founding members and a former interim Chairman of the five-member Board.
The press-release announcing Ms. Franzel’s appointment to the PCAOB can be found on the SEC website at http://www.sec.gov/news/press/2012/2012-24.htm.
Announcement of Settled Disciplinary Order: On February 8, 2012, the PCAOB announced a settled disciplinary order censuring Ernst & Young LLP (“E&Y”), imposing a $2 million civil money penalty against the firm, and sanctioning four of its current and former partners for violating PCAOB rules and standards. The $2 million civil money penalty against the firm is the Board's largest civil money penalty to date.
The order related to three E&Y audits of Medicis Pharmaceutical Corporation, and a consultation stemming from an internal E&Y audit quality review of one of the audits. The Board found that during the audits of Medicis's December 31, 2005, 2006 and 2007 financial statements, E&Y and its responsible partners failed to comply with PCAOB standards in evaluating Medicis's practice of reserving for most of its estimated product returns at the cost of replacing the product, instead of at gross sales price. The Board also found that, in auditing the company's December 31, 2005 financial statements, E&Y and its responsible partners violated PCAOB standards by accepting the company's basis for reserving at replacement cost when the auditors knew, or should have known, that it was not supported by the audit evidence.
The Board further found that during an internal audit quality review of the December 31, 2005 audit, E&Y personnel who were not associated with the audit identified the rationale as conflicting with both GAAP and E&Y's internal accounting guidance that specifically addressed revenue recognition for sales with rights of return. Rather than appropriately addressing this material departure from GAAP, E&Y and its personnel wrongly decided in an internal consultation that another flawed accounting rationale supported the company's existing practice of reserving for most of its product returns at replacement cost.
The Board also found that E&Y and its responsible partners violated PCAOB standards in auditing the company's new methodology for calculating its year-end product returns reserve estimates for 2006 and 2007. The Board found that they failed to sufficiently audit key assumptions and placed undue reliance on management's representation that those assumptions were reasonable.
A copy of the settled disciplinary order is available on the PCAOB web site at: http://pcaobus.org/Enforcement/Decisions/Documents/Ernst_Young.pdf.
Proposed Auditing Standard on Related Parties and Amendments Related to Significant Unusual Transactions: On February 28, 2012, the PCAOB issued for public comment a proposed auditing standard, Related Parties. The proposed standard would improve the auditor's evaluation of a public company's identification of, accounting for, and disclosure about its relationships and transactions with related parties.
The Board also proposed amendments to enhance the auditor's identification and evaluation of a company's significant unusual transactions, which are described as significant transactions that are outside the normal course of business or that otherwise appear to be unusual due to their timing, size or nature. In addition, the Board proposed amendments that, among other things, would improve the auditor's understanding of a company's financial relationships with its executive officers.
The proposed standard would supersede the Board's auditing standard AU sec. 334, Related Parties. The proposed amendments would amend other auditing standards, including AU sec. 316, Consideration of Fraud in a Financial Statement Audit, and Auditing Standard No. 12, Identifying and Assessing Risks of Material Misstatement. Comments on the proposed standard and related amendments are due by May 15, 2012.
A copy of the proposed standard and related amendments is available on the PCAOB web site at:
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.