By Cydney Posner
As noted in thecorporatecounsel.net blog, the PCAOB has just issued an informational release to advise audit committees about the PCAOB inspection process. The PCAOB believes that a candid discussion regarding a PCAOB inspection "can have value for an audit committee not only in relation to the audit committee's oversight and evaluation of the audit engagement generally, but also in relation to the audit committee's role in the oversight of the company's financial reporting process." (Note that audit committees of NYSE-listed companies are required annually to obtain and review a report by the auditor describing, among other things, "any material issues raised by the most recent internal quality-control review, or peer review, of the firm, or by any inquiry . . . by governmental or professional authorities, within the preceding five years, respecting one or more independent audits carried out by the firm, and any steps taken to deal with any such issues…")
One especially useful aspect of the 26-page report is a list of four possible questions, copied in their entirety below, that audit committees should consider asking their audit firms about PCAOB inspections:
1. Was the company's audit selected for PCAOB inspection? Committees may want real time updates about whether their audit has been selected, what is being looked at, and any deficiencies identified by the PCAOB in the audit. The release provides additional information about specific areas for possible further inquiry in this regard. [discussed below]
2. Did the PCAOB identify deficiencies in other audits that involved auditing or accounting issues similar to issues presented in the company's audit? Committees may wish to understand whether similar deficiencies exist in the company's audit and, if so, what has been done in response.
3. What were the audit firm's responses to the PCAOB findings? Committees may want to understand whether the audit firm agreed with the PCAOB's findings and, if not, why not. If the firm agreed, what did the firm do in response? The PCAOB is aware of certain audit firm responses that should be viewed with skepticism, such as:
A. "It was just a documentation problem." 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. Audit firms are provided an opportunity to describe the details of work that was done but not documented.
B. "There was a difference in professional judgment." 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.
C. "The firm has addressed the criticisms in accordance with PCAOB standards." Professional standards require that when a required auditing procedure was omitted, certain remedial steps must be taken. Ask whether the firm performed more work in response to the finding or in subsequent audits, or whether the firm concluded that no additional steps were required – in other words, that the firm disagrees with PCAOB inspection conclusions.
4. What topics are included in Part II findings? Firms may be reluctant to share the details of Part II findings in an inspection report for a number of reasons, but even in that case, audit committees may want to ask for certain generic information about the findings such as:
A. what changes the firm is making to address any quality control deficiencies;
B. what is the progress of the quality control remediation process, including a discussion of any submissions the audit firm made to the PCAOB as part of that process;
C. the inspected years about which the PCAOB has made a final determination about the firm's remediation efforts and the nature of that determination; and
D. whether the PCAOB has provided initial indications that the audit firm may not have sufficiently remediated any items."
Note that Part I findings describe audit deficiencies where inspectors found that the auditor failed to gather sufficient audit evidence to support an audit opinion; these findings are publicly available. Part II typically describes "deficiencies in the firm's overall system of quality control such that the Board has doubts that the system provides reasonable assurance that professional standards are met." These findings are not publicly released by the PCAOB (although the firms may do so) unless the firm fails to remediate adequately within 12 months.
If the company's audit is selected (question 1 above), the audit committee may want to ask the audit firm to keep the committee informed throughout the process about "which areas of the audit are reviewed and about any concerns inspectors raise concerning the audit or the company's financial reporting. Audit committees should also understand that the Board routinely communicates inspection information to the Commission, on an issuer-specific basis, including information about auditing deficiencies, possible material misstatements, potential auditor independence violations, and other issues, all of which inspectors usually will have first raised with the inspected firm, and which the firm is free to discuss with the audit committee." For example, the committee may want the audit firm to keep the committee apprised of the following:
- "whether anything has come to the firm's attention suggesting the possibility that an audit opinion on the company's financial statements is not sufficiently supported, or otherwise reflecting negatively on the firm's performance on the audit, and what if anything the firm has done or plans to do about it;
- whether a question has been raised about the fairness of the financial statements or the adequacy of the disclosures;
- whether a question has been raised about the auditor's independence relative to the company;
whether any of the matters described in the public portion of an inspection report on the firm, whether or not they involve the company's audit, involve issues and audit approaches similar to those that arise or could arise in the audit of the company's financial statements;
- to the extent any such similarity exists, whether and how the firm has become comfortable that the same or similar deficiencies either did not occur in the audit of the company's financial statements or have been remedied; and
- how issues described by the Board in general reports summarizing inspection results across groups of firms relate to the firm's practices, and potentially the audit of the company's financial statements, and how the firm is addressing those issues."