Audit regulators have published the latest report cards for three more major audit firms—PricewaterhouseCoopers, Grant Thornton, and BDO Seidman—calling out continued problems with valuations, loan loss allowances, revenue recognition, and impairments.

For PwC, the PCAOB studied parts of 76 different audits and found fault with nine, or 11 percent of the audits it examined. In one instance, the PCAOB said the inspection process led one of the firm’s clients to change its accounting and disclosure practices, though PwC said in its response attached to the report that none of the post-inspection follow-up work led to changes in audit conclusions or restatements of the financial statements.

The PCAOB said PwC failed to properly test the fair value of investment securities or derivatives in four separate audits, leading to insufficient audit evidence to support the audit opinion. Testing problems centered largely around failures to test assumptions and pricing information that was used to value various securities and derivatives, according to the PCAOB’s report.

Inspectors also flogged PwC for failing to check up on audit work performed overseas, an issue the PCAOB raised more recently in a broader practice alert to the entire audit profession. “Issuer G” in PwC’s inspection report had numerous foreign locations accounting for more than 20 percent of the company’s revenue, yet PwC didn’t visit any of those foreign locations or send any if its affiliates in those locations to check up on the reported revenue. Inspectors said the firm put too much faith into the entity-level controls, analytical procedures for a few of the locations, and questions posed to management.

Grant Thornton faced PCAOB scrutiny on 39 audits, with five of those, or 12.8 percent, getting criticism. BDO Seidman’s inspection report noted the PCAOB had issues with eight of the 33 audits studied, for a failure rate of 24 percent.

Inspectors noted that one of BDO’s errors, and more than one of Grant Thornton’s, looked like they could have been material to the client’s financial statements. Both firms said in their response letters that their audit conclusions did not change as a result of the scrutiny and any follow-up audit corrections.

For all three firms, the PCAOB pointed out that auditors had difficulty in meeting the documentation standards of Auditing Standard No. 3, Audit Documentation. The PCAOB often notes in inspection reports that auditors may claim to have performed certain audit procedures, but they’re not in compliance if the work papers do not show adequate documentation of those procedures or other audit evidence to support the audit conclusion.

In one fell swoop, the Public Company Accounting Oversight Board adopted a slate of new auditing standards that tell auditors how to assess risk, doubling the number of standards in the board’s rulebook.

The board adopted Auditing Standards No. 8 through No. 15, giving auditors a detailed roadmap for assessing and responding to the risks of material misstatements in financial statements. The standards address audit procedures to be performed throughout the audit, from planning through evaluation of audit results.

The board first proposed the standards in 2008, then revised and reproposed them based on feedback in December 2009. The final package, if approved by the Securities and Exchange Commission, is expected to become effective for audits of fiscal periods beginning on or after Dec. 15, 2010.

The eight standards will improve audit quality, said Acting PCAOB Chairman Daniel Goelzer, who described them as “a significant step forward in promoting sophisticated audit risk assessment and minimizing the risk that the audit will fail to detect material misstatements. … Of course, most firms’ audit processes already incorporate risk-based methodologies, and the changes to audit manuals and staff training needed to implement these standards should not be overwhelming.”

The standards include:

AS No. 8: Audit Risk describes the components of audit risk and the auditor’s duty to reduce audit risk to an appropriately low level to get reasonable assurance that the financial statements will be free of material misstatement.

AS No. 9: Audit Planning outlines the requirements for planning the audit and developing an appropriate audit strategy.

AS No. 10: Supervision of the Audit Engagement tells the audit engagement partner and other members of the engagement team who supervise audit work how to supervise the audit. The PCAOB also separately published a notice putting audit supervisors on notice that it plans to hold them more accountable for keeping tabs on audit staff and may consider a new rule requiring closer documentation of supervisory responsibilities.

AS No. 11: Consideration of Materiality in Planning and Performing an Audit explains the auditor’s duty for considering materiality as the audit is planned and performed.

AS No. 12: Identifying and Assessing Risks of Material Misstatement establishes requirements for auditors to follow to assure they’ve covered all the bases in identifying and assessing risk, including information gathering procedures and analysis of identified risks.

AS No. 13: The Auditor’s Responses to the Risks of Material Misstatements tells auditors what to do if they identify a risk of concern, outlining the general conduct of the audit that should follow and the specific audit procedures that should be performed regarding significant accounts and disclosures.

AS No. 14: Evaluating Audit Results tells auditors how to evaluate their audit results and determine whether they have adequate audit evidence, addressing the evaluation of misstatements identified during the audit, presentation and disclosure in financial statements, and the potential for management bias.

AS No. 15: Audit Evidence explains what constitutes sufficient appropriate audit evidence, an area often described as deficient in PCAOB inspection reports.

The Public Company Accounting Oversight Board is seeking comment on a proposed new standard for auditors to pursue third-party confirmations of various details in corporate financial statements.

In the audit process, confirmation refers to direct communication between the auditor and a third party, such as a vendor or a customer, to verify assertions contained in a company’s financial statements. Auditors rely on confirmations to verify the existence, completeness, or value of items appearing in corporate accounts.

The proposed standard would both expand and modernize the requirements of AU Section 330, The Confirmation Process, a 15-year-old audit rule that governs how auditors should go about pursuing third-party confirmations and what they may accept as audit evidence. Martin Baumann, PCAOB’s chief auditor and director of professional standards, said the proposal reflects the importance of audit evidence obtained from third parties and strengthens and extends the requirements for using confirmations.

PCAOB member Steven Harris said the proposed standard expands the use of the confirmation process by requiring auditors to confirm receivables that arise from credit sales, loans, or other transactions; cash and other relationships with financial institutions; and other accounts or balances that pose a significant risk to the financial statements. Currently, auditors are required only to verify receivables if they arise from the sale of goods or services in the normal course of business.

The standard also would relax the requirements for confirmations written on paper, reflecting advances in electronic communication. The proposal would allow auditors to use electronic media to send confirmation requests and receive confirmation responses, and it would make provisions under certain circumstances for auditors to use direct access to a third party’s records to obtain the audit evidence they need.

Acting Chairman Daniel Goelzer said the proposed standard “would more explicitly incorporate consideration of the risk of error or fraud into the selection, design, and planning of confirmation procedures.” That would make it consistent with other standards that are also developing, such as new standards around risk, he said. “In its emphasis on fraud and other misstatement risk, this proposal dovetails with the approach in the proposed risk assessment standards.”

The PCAOB first unveiled its thinking about audit confirmation in a concept release published in April 2009. That release drew 24 comments, which the PCAOB says it took into consideration in developing the current proposal. The board is accepting comments on the proposal through Sept. 13.

The Public Company Accounting Oversight Board has issued an alert to auditors to remind them to take a hard look at “significant unusual transactions” and the risk that they may be driven by error or fraud.

Staff Audit Practice Alert No. 5, Auditor Considerations Regarding Significant Unusual Transactions, is a compilation of existing auditing standards regarding how auditors should review significant unusual transactions in interim financial information and audits of financial statements.

Marty Baumann, the PCAOB’s chief auditor and director of professional standards, said in a statement the alert expands on the message of Staff Audit Practice Alert No. 3, Audit Considerations in the Current Economic Environment, by looking more closely at the risk of misstatement arising from significant unusual transactions. It is “a risk that the staff believes continues to exist today,” the PCAOB said.

The alert makes no mention of any particular event or trend that inspired the staff to issue it, but the connection to the significant unusual transactions described by Lehman Brothers’ bankruptcy examiner is hard to miss. Lehman’s accounting for repurchase transactions and Ernst & Young’s role as auditor is getting close scrutiny after the examiner described aggressive accounting maneuvers to shuttle debt off the balance sheet. E&Y has defended its audit work and has assured its clients it will prevail in any legal challenge.

Alert No. 5 groups auditing requirements with respect to unusual transactions into some key topical categories: identifying and assessing risks of material misstatement, responding to risks of material misstatement, consulting others, evaluating financial statement presentation and disclosure, communicating with audit committees, and reviewing interim financial information.

The Public Company Accounting Oversight Board has issued for comment a proposal to adopt a new auditing standard that gives auditors some new requirements about what and how they should communicate with audit committees.

The standard would require auditors to come to a mutual understanding of the terms of an audit engagement with the audit committee and to document those terms in an engagement letter. It also would establish requirements for auditors to communicate to the audit committee an overview of the audit strategy, including a discussion of the significant risks and the extent to which the auditor will rely on the internal audit function or other audit firms.

Auditors also would be required to apprise audit committees of the critical accounting policies, practice, and estimates that might come into play and to provide their assessment of the company’s viability as a going concern. Auditors would also be required to discuss with audit committees their take on how adequately the auditor and audit committee are communicating.

The standard would replace two existing interim standards, AU Section 380, Communication with Audit Committees, and AU Section 310, Appointment of the Independent Auditor. It also would amend a number of other interim standards to assure they are consistent with the new standard.

In a prepared statement, PCAOB member Steven Harris said the proposed standard follows on the requirements of the Sarbanes-Oxley Act for the auditor and the audit committee to work together independent of management. “In short, the proposed standard updates and enhances existing auditor communication requirements to ensure that the audit committee has access to the critical knowledge an auditor gains during the course of the audit,” he said.

Daniel Goelzer, acting chairman of the PCAOB, said the standard would expand and clarify the rules that govern the auditor’s responsibilities in communicating with the audit committee. “The new framework is intended to implement the Sarbanes-Oxley Act’s objectives by enhancing and making more concrete the substance of these communications,” he said, also through a prepared statement.

The proposal is open for public comment through May 28.

Audit regulators are putting down early notions that a new rule on internal reviews requires copious documentation.

The Public Company Accounting Oversight published a single question and answer addressing implementation of Auditing Standard No. 7: Engagement Quality Review addressing the new standard’s documentation requirements. The Securities and Exchange Commission called for the guidance when it approved the new standard in early January.

AS7 replaces earlier professional standards established by the American Institute of Certified Public Accountants for how audit firms should review their audit work internally before publishing their audit reports. The standard provides more rigorous requirements for all accounting firms auditing public company financial statements to review engagements internally in the hope that it will reduce audit deficiencies before reports are issued.

The PCAOB developed the standard in response to observations by inspectors that audit firms weren’t putting enough elbow grease into the internal review process, causing audit reports to be issued that should have been cleaned up internally before they were issued. Critics of the new standard worried the new requirements would lead to redundant audit work, driving unnecessary audit costs for public companies.

The standard is in effect for audits of interim and annual periods beginning after Dec. 15, 2009. When the SEC issued its order approving the new standard, it instructed the PCAOB to provide implementation guidance to address questions about how much documentation should be provided to comply with the review standard.

The resulting guidance addresses a single question in less than three pages. It says audit firms should not read language in the release adopting the standard to mean that they are required to provide documentation of all the interactions between the engagement quality reviewer and the engagement team, including those that take place before an audit deficiency is identified.

Instead, the PCAOB says, the new standard focuses on how to document interactions once a significant engagement deficiency is identified. The documentation should contain enough information “to enable an experienced auditor, having no previous connection with the engagement, to understand the procedures performed by the engagement quality reviewer, and others who assisted the reviewer, to comply with the provisions of this standard,” the PCAOB wrote.

Based on initial comments to seven proposed standards on assessing and responding to risk, the Public Company Accounting Oversight Board has reworked the package and is asking for public comment on the revisions.

The board unanimously approved the revisions suggested by the staff of Chief Auditor Marty Baumann and agreed to put them out for a 75-day comment period. According to Dan Goelzer, acting chairman of the PCAOB, the revised standards are “not fundamentally different in approach” from the original seven proposed standards, but they provide for numerous enhancements and clarifications.

The most significant changes, said Goelzer, focus on better aligning the proposed new requirements with existing requirements in Auditing Standard No. 5, which governs the audit of internal control over financial reporting, and on emphasizing the auditor’s duty to evaluate financial statement disclosures in addition to data. The new standards also provide “beefed up requirements” regarding considering the possibility of fraud, Goelzer said.

The suite of seven risk standards focus on audit risk, audit planning and supervision, the consideration of materiality in planning and performing the audit, identifying and assessing the risks of material misstatement, the appropriate audit response to risks of material misstatements, evaluating audit results, and audit evidence.

The PCAOB originally proposed the package in October 2008 and accepted comments through late February. Goelzer said the seven standards are meant to serve as a “bedrock” for much of the board’s future standard setting. “The standards will provide a base that focuses on appropriate risk identification and on auditing planning tailored to those risks,” he said.

Board member Steven Harris said he’s hopeful the PCAOB will hear from more investors on the revised standards, noting the first proposal raised only one investor reaction from a grand total of 33 comment letters. “Since these standards were first proposed last year, the world has witnessed firsthand the consequences of ineffective risk management,” he said.

The new standards more explicitly describe the auditor’s responsibility to consider business risk as an important element of audit risk, said Harris. “The standards require the auditor to do the homework necessary to identify and to assess the risk of error or the risk of fraud in the financial statements,” he said.

PCAOB member Charles Niemeier, who is remaining on the board past his term until the SEC names his replacement, said he’s not “completely comfortable” with all the decisions in the seven-standard package, but he’s comfortable seeing it exposed for further comment.

The 252-page proposal provides an appendix comparing the proposed standards with prevailing international requirements, the International Standards on Auditing written by the International Audit and Assurance Standards Board. Niemeier said he would prefer to see more attention focused on improving the board’s own standards than comparing them to standards in other jurisdictions.

Both in the United States and abroad, audit rule makers are developing new guidance on how to audit fair-value measurements.

The Public Company Accounting Oversight Board recently asked its Standing Advisory Group for its input on the board’s preliminary ideas around developing a new standard that would govern how to audit fair-value measurements. The board so far has given auditors staff guidance on auditing fair-value measurements, first in 2007 and again in 2009, but now is developing a standard that would carry more authority over the audit process.

The board asked its advisory group whether auditors should be instructed to automatically assume that if there’s heightened uncertainty a measurement, there must also be a heightened risk of fraud. In a small group discussion that was closed to the public, advisers said that’s probably taking it a bit too far, said Jennifer Rand, deputy chief auditor for the PCAOB.

Advisors generally agreed that there’s an inherent risk associated with measurements that are reached amid some uncertainty, said Rand, such as those that involve a great deal of estimation and judgment. Auditors should give those items some additional audit attention, but “there were pretty strong feelings that those types of measurements should not be labeled as fraud risks,” she said.

The staff told its advisory group that inspection and enforcement efforts indicate auditors typically aren’t skeptical enough when reviewing such measurements, which led the board to begin to develop an authoritative standard. A new standard could provide new direction on identifying and assessing risks of material misstatements, evaluating disclosures, and supervising specialists hired by auditors to help assess fair-value measurements.

Dan Goelzer, acting chairman for the PCAOB, said a fair-value measurement standard is being developed along with standards on auditing related-party transactions, communications with audit committees, risk assessments, and confirmations as part of a “very ambitious standard setting agenda” for the coming year. “The coming months are likely to see more activity with more potential impact on financial statement auditing than any similar period in the board’s existence,” he said.

While the PCAOB gets started on a fair-value measurement standard, the International Auditing and Assurance Standards Board has published a consultation paper looking for views on developing international guidance. The paper acknowledges strong demand from auditors and preparers for guidance on how to audit complex financial instrument measurements, especially in illiquid markets. The IAASB is looking for feedback that will help in the revision of its Practice Statement 1012 on auditing derivatives.

Although the audit engagement quality review will soon be subject to new rules, it has not been a common target for enforcement action, according to a recent academic analysis.

Since 1993, only 28 enforcement cases at the Securities and Exchange Commission or the Public Company Accounting Oversight Board have resulted in sanctions against the audit partner in charge of the quality review, according to the analysis. Of those only eight arose from one of the major international audit firms. “It’s surprising to me that there weren’t more,” said William Messier, accounting professor at the University of Nevada, Las Vegas, who led the research.

The SEC began calling in the 1990s for more rigor in the engagement quality review, which audit firms perform internally to review their own audit work before issuing audit reports. The PCAOB is revising the rules with a proposed new standard that would generally require the engagement quality reviewer to take a closer, more skeptical look at the audit engagement team’s work.

In the handful of cases since the early 90s that led to enforcement, engagement quality reviewers typically relied too heavily on management’s representations without obtaining corroborating evidence, the research showed. They also commonly made bad calls around materiality or failed to show enough skepticism, Messier said.

Too often, the research shows, the reviewing partner overlooked unresolved audit issues, didn’t require enough additional audit work, or relied too heavily on the audit team or management. In about half of the cases, the sanction against the reviewing partner involved denial of the right to practice before the SEC or PCAOB for three or more years.

Messier said the PCAOB’s proposed new standard on engagement quality review provides more specific guidance on what’s expected of the engagement quality reviewer, which should address some of the shortcomings that have led to sanctions in the past. “No standard is foolproof,” he said. “But the new standard should help improve engagement quality review and reduce the kinds of actions that have occurred in the past.

Although the research offers insight into where quality reviews have gone wrong in the past, it doesn’t answer any question about why the number of enforcement cases is low, Messier said.

Corporate audit committee members are getting more tuned in to risk and demanding better quality information in light of recent economic events.

In a recent survey, three-fourths of audit committee members said they are working more “hands on” with management to assess risk management and oversight as a result of economic turmoil. Audit committee members said risks related to the financial crisis and the company’s oversight of risk management are the top two agenda priorities for 2009.

“Audit committees are at an inflection point in their taking oversight responsibilities very seriously,” said Mary Pat McCarthy, executive director of KPMG’s Audit Committee Institute, which conducted the survey with the National Association of Corporate Directors. “They are putting much more time, energy, and thought into exercising oversight in light of the financial crisis.”

One of the daunting challenges facing audit committees in this newfound focus on risk is poor quality information, according to the survey results. Audit committee members said they are concerned about the quality of information they receive, particularly as it relates to financial risks posed by the economic crisis, fraud risk, tax risk, and information technology risk.

Two-thirds of audit committee members said they would they want to see more meeting time devoted to dialogue and questions rather than presentations, and one-third said agendas need to be better prioritized with less box-checking. They also called for pre-meeting materials to be more timely and more consise, with more benchmarking against competitors and less extraneous information.

“Audit committee members want to make sure that timely, important things get to them fast,” said McCarthy. “They want to make sure they have clear, relevant, focused information.”