PCAOB May Stall Pace Of Audit Inspections

In a public admission that it may not be able to live up to its responsibilities, the Public Company Accounting Oversight Board is considering whether it should reduce the frequency of audit inspections for firms that audit fewer than 100 public issuers.

The PCAOB made an 11th-hour addition to its meeting agenda for today, Dec. 19, to consider at least temporarily scaling back the number of times it would inspect the vast majority of firms under its authority. The Board gave no further indication of how it may be planning to alter its inspection schedule.

The Sarbanes-Oxley Act requires the largest accounting firms to be inspected annually, but “not less frequently than once every three years” for smaller accounting firms that audit 100 or fewer public registrants. The law does, however, allow the PCAOB to alter the schedule if it finds that a different arrangement is “consistent with the purposes of this act, the public interest and the protection of investors.”

As of last week, the PCAOB had 1,732 accounting firms registered, meaning they audit public issuers or want to be allowed to do so. Of those, only nine firms audit more than 100 issuers, and so must be inspected annually in accordance with the law. The board is not required to inspect firms that have registered but not audited a public company, so the exact number of inspections it should conduct is “a moving figure,” according to a board spokesman.

When the Board opened its doors and began registering firms in 2003, it began with nearly 600 firms on its rolls. By August of 2004, it doubled to just more than 1,200 firms and has continued to grow steadily since.

As a startup operation conducting its first full year of inspections in 2004, the PCAOB made its rounds to only a fraction of the firms it was required to inspect. In 2005, the regulator inspected 281 companies and issued 173 inspection reports based on prior-year inspections. In 2006, the board has published 206 reports so far based on inspections conducted in 2005, according to data provided by the board.

Increased Staff Expected

With the Board’s recently approved 2007 budget, Chairman Mark Olson said he wants to increase the inspection staff in the coming year by 20. The goal is to have a total employee headcount of 519, with 250 staff members devoted to the inspection process.

The Board has been criticized for not keeping pace with its statutory requirements for inspections, as well as for the long delay from the time an inspection is conducted until the PCAOB’s findings are published. Olson, who assumed his post in July 2006, has said he wants to see the reports issued in a more timely way.

REMARKS

Below are Mark Olson’s comments from the AICPA’s annual conference, held Dec. 11, on the scope and purpose of PCAOB inspections.

AUDITOR OVERSIGHT — THE PCAOB’S SUPERVISORY APPROACH

As some of you know first hand, the core of the PCAOB’s supervisory model is its inspections program. PCAOB inspections are designed to identify auditing problems at an early stage and focus firms on correcting them. PCAOB inspections begin by looking at the professional environment in which audits are performed and focus on the influences–both good and bad–on a firm’s audit practice. These influences include a firm’s culture and the relationships between the firm’s audit practice and its other practices, as well as between engagement personnel in field or affiliate offices and a firm’s national office.

PCAOB inspections are also risk-based, in that they focus on the aspects of audits that present the greatest risk of undetected material misstatements of financial statements. When inspectors find an audit that is not satisfactory, they discuss with the firm precisely what the deficiency is. Often this dialogue leads to immediate corrective action. I place a great deal of emphasis on making this supervisory dialogue–and therefore the PCAOB supervisory model–be as valuable as possible …

We look at whether strains on individual partner capacity may contribute to issues with audit quality, and whether a firm’s compensation practices provide incentives likely to promote audit quality and technical competence.

With respect to consideration of fraud, we look to see whether audit teams are mechanically complying with the requirements of AU 316, which sets out the auditor’s responsibility with regard to fraud, rather than with its substance and intent by applying appropriate professional skepticism.

For example, we check to see whether auditors appear to be appropriately modifying the nature, timing, and extent of audit procedures directly in response to an identified fraud risk, and whether auditors are varying their audit procedures to bring an element of unpredictability to the audit process.

In addition, we look at whether firms’ information technology resources are being used to their fullest extent to aid in the efficient and effective identification of certain potential indicators of fraud.

We look at how the concurring partner review process is implemented. This includes an assessment of the quality of the execution of the concurring partner reviews, and whether the level of concurring partner involvement appears to correspond with the firm’s assessment of the audit risk. We also are attentive to whether the concurring review is a genuinely independent and objective assessment of the significant auditing, accounting, and financial reporting matters.

We look at these and other issues, and seek to engage with a firm in a constructive manner rather than an adversarial one. While still evolving, I believe the PCAOB’s supervisory model is working. Our approach avoids attempting to manage the firm’s quality control systems through overly prescriptive remedies, and the process is based on the assumption that each firm knows best how to manage its operations and to define the specific methods by which it can address a particular quality control criticism. This approach also allows each firm to craft effective remedies based on its particular organizational structure and operations …

Additionally, the PCAOB’s investigations and enforcement program is an important component of our auditor oversight; it provides a necessary tool for addressing the more serious violations of professional standards and other applicable law that we encounter in our auditor oversight activities. While I am mindful that remediation efforts are our preferred tool in addressing most deficient auditing practices, I believe that our enforcement efforts are vital for assuring that public confidence is not undermined by firms or individual audit professionals whose conduct does not reflect the profession’s high standards of quality, independence, and competence.

Source

PCAOB Chairman Mark Olson’s Remarks On Current SEC and PCAOB Developments (AICPA Conference; Dec. 11, 2006)

George Diacont, director of registrations and inspections for the PCAOB, told an audience at the American Institute of Certified Public Accountants annual conference last week that Olson has sent a clear message to the staff to pick up the pace. “Chairman Olson has said that getting reports out quicker this year is his No. 1 priority,” Diacont said. “That’s the beginning, the middle and the end of it. I can’t imagine, with him saying it’s his No. 1 priority, that the organization is going to fail in 2007.” (Diacont made his comments before the PCAOB’s last-minute move to consider reducing its inspection workload.)

Olson

In a separate address to the AICPA conference, Olson said he wants the regulatory body to apply a “supervisory model” to overseeing the audit profession. “The Board’s mandate to oversee the auditors of public companies continues to be best accomplished through robust supervision that is premised on a communicative relationship,” he said.

The Board continues to assess its approach to oversight, “as we learn from our inspections program and the open and frank dialogue that we have with the audit firms,” Olson said. “Based on what we learn, the Board is prepared to make appropriate adjustments to assure it achieves the objectives of the Sarbanes-Oxley Act in the most effective and efficient manner possible. A supervisory model must remain flexible to keep pace with a dynamic industry.”

Focus Of Inspections

Olson said the inspection process is meant to focus on whether audit teams are being objective enough with their clients, and whether auditors are adequately skeptical when looking for evidence of fraud. “We look at whether auditors are treating their role as that of merely trying to gather enough evidence to support the issuer’s position, or whether they are rigorously evaluating both corroborative and contradictory evidence,” he said.

The inspection also focuses on the concurring partner or engagement-quality review, an area the PCAOB said it is studying for possible future rulemaking. This is the review undertaken by a partner-level auditor who is within the same audit firm, but not part of the audit engagement team for the client in question. “We are attentive to whether the concurring review is a genuinely independent and objective assessment of the significant auditing, accounting, and financial reporting matters,” he said.

Diacont said he regularly hears complaints from public companies that their financial statements may have been selected by the PCAOB for audit inspection, but they have no way of knowing what’s taking place with that review. “They have a more than moderate concern about what we’re finding,” he said.

He reiterated that the Board’s authority is over the audit and not the filing of the financial statements with the Securities and Exchange Commission, but he emphasized that auditors are free to discuss any part of the inspection at any time with their clients. “There are no prohibitions, legal or otherwise, that prevent an accounting firm from discussing inspection issues with their clients,” he said.

Diacont said problem areas that tend to crop up in numerous inspections include accounting related to business combinations, debt agreements, independence, excessive reliance on systems to generate reports, impairment considerations, and accounting for goodwill and cross-border transactions.