During its inspections process last year, the PCAOB held conversations with nearly 400 audit committee chairs in conjunction with inspections of the audits of U.S. issuers, a substantial increase over the number of such conversations the prior year. Last month, the PCAOB staff released “Conversations with Audit Committee Chairs: What We Heard & FAQs” to provide transparency into the inspections process and report what inspections teams heard in terms of what is working well to help improve audit quality. In addition to focusing broadly on audit quality, the conversations with audit committee chairs covered such specific topics as audit committee perspectives of the auditor, new auditing and accounting standards, and technology and innovation.
This Flash Report highlights key points in the PCAOB’s publication as well as our commentary.
What’s Working Well to Improve Audit Quality
The PCAOB views “an engaged and informed audit committee” as a critical factor in promoting audit quality. To that end, most audit committee chairs evaluate audit quality with an emphasis on the audit engagement team with less emphasis on the audit firm itself. For example, if the engagement team is performing well, firmwide metrics (for example, relevant audit quality indicators (AQIs)) addressing audit quality for the audit firm as a whole are less relevant to them. Other chairs noted that audit quality primarily centers on the exercise of judgment, which everyone acknowledged to be a difficult-to-measure attribute.
Many chairs are aware that their audit firm uses shared service centers and have virtually no concerns about them, particularly since the lead engagement partner is ultimately responsible for the quality and service of all aspects of the audit. They note that with proper oversight and controls, shared service centers are a good way to concentrate and leverage expertise while providing quality, consistency and cost-efficient service.
As to what’s working well, several practices are noted by the chairs, including inquiring of the auditor if the audit firm has an annual audit quality or transparency report (or other document that outlines how the firm measures audit quality), understanding and discussing the processes that the auditor has in place to address the previous year’s PCAOB inspections report and selecting relevant AQIs to discuss with the engagement team and use as part of an annual evaluation of the audit process. With respect to the audit firm’s use of shared service centers, committee chairs suggest discussing at least annually the audit procedures performed at the shared service centers, what controls are in place, the impact on the quality of the work product, and whether the audit firm is considering additional shared service center usage.
Relationship and Communication With the Auditor
Most audit committee chairs indicate that they are satisfied with their relationship with their auditors, the service from the audit firm and engagement teams, and the team’s skepticism and judgment. Likewise, they are also generally satisfied with their communications with the auditor and with the information they receive regarding auditor independence.
Regarding what’s working well, the chairs note several best practices: holding pre-calls with the lead engagement partner prior to scheduled committee meetings; an annual assessment of the engagement team and audit; and committee chair visits to various location(s) on multi-location audits. In addition, they suggest dedicating some committee meetings to deep dives on specific topics, such as cybersecurity, and having the auditor comment on relevant practices or other trends relevant to those areas.
New Auditing and Accounting Standards
The PCAOB reports that audit committee chairs spend significant time discussing new accounting and auditing standards with their auditors, and most chairs are of the view that their auditors are proactive and timely in addressing new requirements. However, some chairs are concerned about the effects of overlapping implementations of several new accounting and auditing standards on both internal and external auditors’ resources and time.
Critical Audit Matters (CAMs) are also addressed in the PCAOB’s summary. Most audit committee chairs indicate that, while most external auditor firms had not yet been required to report on CAMs in their audit reports, preparations are proceeding smoothly and they do not anticipate that CAMs will create significant changes to their communications with the auditor. It is important to note that only the first few rounds of reported CAMs for accelerated filers with fiscal years ended June 30, 2019 and through September 30, 2019 have been published to date (read our blog on Public Company Transformation). So a lot more action is still to come.
Many are focused on the number of CAMs that may be included in the auditor’s report as well as if they are comparable to the number and type of CAMs disclosed by peers. This is an understandable concern, as it could reflect on the quality of financial reporting and auditing. Some chairs also note that while initial discussions around CAMs focus more on the language that the auditor plans to use to describe them, they hope that in the future that the conversations address what the CAMs really mean and how they impact the audit process.
As to what’s working well, the chairs recommend a proactive approach of discussing new accounting and auditing standards with the auditor as early as possible at least a year in advance of the scheduled implementation deadlines and creating a timeline to make sure the appropriate processes are in place and milestones are met to ensure that the implementation of new standards, including the auditing of the implementation, is successful. Another best practice is the use of outside consultants or experts to educate the audit committee on new or complex accounting standards.
Audit committee chairs are familiar with auditing software tools and technologies. While generally supportive of automation, some chairs note that return on investment should be carefully considered. Other chairs report the jury is still out whether technology will improve audit quality. The majority of audit committee chairs note that the committee is primarily responsible for cybersecurity, which remains a top priority for the committee and the board. Other topics covered include implementation of machine learning into internal audit work and the audit firm’s use of data analytics.
Suggested best practices include, among other things: using project management software or a website or app where the audit committee, auditor, and management can all track audit plan status; discussing the technology and software tools the audit firm use and how they are being used; and scheduling deep dives on new and emerging technologies on the audit committee agenda.
The PCOAB’s publication offers audit committees insights as to what many peers are doing to enhance audit quality. It also addresses common questions raised by the audit committee chairs about the basics of the inspections process. In addition, the chairs raised other questions the PCAOB staff believed may be of interest to a broader audit committee audience and a few of these questions are also included. All told, the PCAOB report is worth a look.
In addition, Protiviti has published materials that may be of interest to audit committees in 2020:
- “Setting the 2020 Audit Committee Agenda” outlines several agenda items for audit committees to consider in the upcoming year based on input from our interactions with client audit committees as well as insights from roundtables and surveys we conducted during 2019 and discussions with directors in numerous forums. It includes discussions about CAMs and new accounting pronouncements.
- “Assessment Questions for Audit Committees to Consider” offers audit committees a tool they can use when they assess their composition, charter, agenda and focus in light of the company’s industry, circumstances, risks, financial reporting issues and the current challenges.
We note with interest the PCAOB’s comment that audit committee chairs foresee moving beyond the description of CAMs to understanding what the CAMs really mean and how they impact the audit process. We believe two categories of CAMs are likely to emerge down the road after the first-time-through implementations are completed: (1) industry-related issues that require significant auditor judgment due to their inherent complexity and significance and (2) matters pertaining to the issuer’s aggressive accounting policies. When audit committees understand the distinction with these two categories with one being a CAM due to the inherent nature of the business, and likely commonality in disclosure amongst industry peers, and the other being a CAM due to management’s choice of accounting it’s possible that adjustments in approaches to accounting policies may result.
The PCAOB report also addresses common questions raised by the audit committee chairs about the basics of the inspections process. In addition, the chairs raised other questions the PCAOB staff believed may be of interest to a broader audit committee audience. A few of these questions are also included.