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INSIGHT: PCAOB Identifies Key Focus Areas for 2019 Auditor Inspections

Feb. 8, 2019, 3:02 PM

The new slate of directors at the Public Company Accounting Oversight Board has initiated a transformational series of projects to reevaluate (among other things) how it plans, conducts and reports on inspections of public accounting firms. George Botic, director, Division of Registration and Inspections, noted in a December 2018 speech, Protecting Investors through Change, the Board is taking a “clean sheet” approach, revisiting the objective of an inspection, the selection of audits to review, and the nature, timing and extent of engagement and quality control inspection procedures. Projects are ongoing but will also impact the 2019 inspection cycle. On Dec. 6, 2018, the PCAOB released Inspections Outlook for 2019; it provides insights into the board’s key areas of focus for this year, including 10) areas in which inspectors will have particular focus and interest. This article briefly describes each area.

Quality Control

Inspectors will increase their focus on quality control in 2019, which ties directly into the board’s strategy to improve audit quality via prevention, detection, deterrence and remediation. Firms should create systems of quality control that properly balance preventive and detective controls. As Mr. Botic said in his speech, “…the first change will be how we assess a firm’s overall system of quality control and its control environment. Consistent with our emphasis on up-front prevention of deficiencies, it is important that we expend additional effort understanding and analyzing a firm’s quality control system and culture.” He also noted that the board created the position of Quality Control Leader to direct the new approach across all inspections, beginning with the large annually-inspected U.S. firms.

This year, inspectors will employ a risk-based approach to inspecting firms’ quality control systems. As board member Kathleen Hamm said in a November 2018 speech, Quality Control: the Next Frontier, the intent is to “tailor our inspection procedures based on the size, complexity, and risk profile of firms, including their past inspection results, identified weaknesses and known changes in controls.” Inspectors will also consider which controls the firm has designed to self-identify compliance issues and in selecting files for review and assess whether the controls are working effectively.

Independence

Over the years, PCAOB inspectors have identified recurring deficiencies related to independence, including monitoring procedures that failed to identify violations. The Report attributes this failure to two possible causes: (1) lack of understanding of the rules or (2) lack of appropriate controls to prevent violations. Accordingly, inspectors will be particularly interested in how firms:

  • Educate their professionals on independence,
  • Maintain independence in fact and appearance,
  • Monitor compliance with independence requirements, and
  • Assess the impact of non-audit services on independence.

The Report cites two other specific areas in which inspectors will gauge compliance with independence rules, which are identified below.

Recurring inspection deficiencies

If you read the PCAOB’s Staff Inspection Briefs, you know that inspectors have identified certain recurring audit deficiencies in recent years, including in audits of internal control over financial reporting (ICFR), revenue recognition, and subjective areas of the financial statements, such as fair value measurements. Inspectors will continue to review firms’ responses to recurring deficiencies and evaluate their plans for reducing them. Mr. Botic also noted recently that improvements to audit quality have been observed when firms employ an effective root cause analysis program to remedy deficiencies, so firms should expect inspections to evaluate whether they are using these mechanisms.

External considerations

Inspection procedures will assess whether and how auditors have responded to changing economic conditions during the audit and whether the auditor appropriately weighed evidence derived from external data against data obtained from management.

Cybersecurity risks

Of continued concern, inspectors will assess how firms incorporate and act on the risks associated with their clients’ cybersecurity incidents and digital assets.

Software audit tools

Inspectors will continue to monitor the use and development of advanced software tools by auditors, including the effectiveness of those tools and whether firm professionals are applying due care and professional skepticism when using them.

Digital assets

Inspectors will evaluate firms’ reactions to risks posed by digital assets such as cryptocurrencies, initial coin offerings, and distributed ledger technologies, including how they impact firms’ client acceptance and continuance decisions, audit staffing, and procedures.

Independence Focus: Inspectors will judge how firms are managing independence when they perform nonaudit services that incorporate the use of digital assets.

Audit quality indicators

As part of its information gathering activities, the PCAOB is looking at how firms are using audit quality indicators (AQIs) in audit work and whether AQIs are being discussed with their clients’ audit committees. Of interest is what firms are doing as part of their monitoring procedures to prevent, detect, deter, and remediate audit deficiencies. Mr. Botic explained that “in 2019, we intend to understand these AQIs and how firm leadership utilizes them—at the engagement, local, regional, and national level—to drive quality throughout the audit process.”

The Board also plans to collect data, conduct research on the quality of audits, and issue thought leadership about AQIs.

Changes in the auditor’s report

Inspectors will monitor firms’ implementation of the parts of Auditing Standard 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, that are in effect (e.g., disclosure of auditor tenure and other changes to the report). Inspectors will begin assessing compliance with the communication of critical audit matters (CAMs) for certain large accelerated filers in late 2019.

Implementation of new accounting standards

Likewise, inspectors will continue to monitor firms’ implementation of processes and procedures for auditing new accounting standards for revenue recognition, lease accounting, and current expected credit losses. Areas of focus will be the:

  • Design and operating effectiveness of internal controls post-implementation
  • Areas requiring management judgment

Independence Focus: Inspectors will also closely review whether auditors maintained their independence when assisting clients with implementing new accounting standards.

Preparing

Auditors should familiarize themselves with the Board’s plans for inspections, in particular the heightened scrutiny of quality control, independence and other key areas, as described in the Report. The Board plans to release information about inspections timelier than in the past and share good practices they observe, which can help firms achieve their goals of enhanced audit quality.

Cathy Allen, CPA of Audit Conduct, LLC (callen@auditconduct.com) helps CPAs and others understand and apply auditor independence and professional ethics rules through consultation, training, litigation support and expert services. Ms. Allen was a Managing Director in PwC LLP and served as senior staff to the AICPA Professional Ethics Executive Committee (PEEC), where she was instrumental in developing standards and tools for the accounting profession such as the AICPA Plain English Guide to Independence and the Conceptual Framework for Independence.