The Securities and Exchange Commission (SEC) is paying added scrutiny toward audit firms’ increasing use of network affiliates in their work and the potential for inconsistent quality that comes with such an approach.
SEC Chief Accountant Paul Munter in a statement Friday emphasized the importance of the lead auditor’s role in ensuring quality and independence while citing a handful of enforcement actions brought by the Public Company Accounting Oversight Board (PCAOB) in 2022 against audit firms relying on the work of unregistered affiliates without proper documentation.
“An unregistered accounting firm causes a violation of PCAOB [rules] whenever it plays a substantial role in the audit of an issuer—irrespective of the audit engagement structure used by the lead auditor,” Munter said. “Any lead auditor should be aware of this requirement and safeguard against such violations in its use of other auditors during an audit engagement.”
The SEC oversees the PCAOB.
The PCAOB last year penalized registered KPMG affiliates in the United Kingdom, Canada, Italy, the Netherlands, and South Africa regarding the use of an unregistered accounting firm. The regulator in April fined WWC for similar supervision violations—its first such action.
Citing academic research, Munter expressed concern over how findings of inconsistent quality in the work of other auditors could prove “potentially detrimental to investor confidence in the quality of financial information.” He noted there is often misinterpretations regarding member firms within the same network and their level of quality control, which could lead to unfavorable market perceptions regarding the network as a whole.
Munter advised network firms address these inconsistencies regardless of PCAOB quality control requirements.
“[N]etwork firms may benefit from governance policies and procedures that support consistency and accountability among the member firms regarding the establishment and application of quality control and supervision and review policies and procedures,” he said. “This may include having strong, consistent client acceptance and continuance policies across the network, a vigorous internal inspection function, including cross-firm reviews within the network, continuous and consistent training, and robust audit methodologies and tools.”
Another area network firms can shore up is taking measures to identify and monitor foreseeable independence violations among members, Munter said. He said the SEC has observed through consultations instances of network firms inconsistently applying policies and procedures to ensure independence throughout all ends of an audit.
“An effective firm-wide or network-wide approach looks not only to the current impact of non-audit and business relationships on audit clients but also anticipates foreseeable future impacts, especially for those relationships that cannot be easily unwound,” he said.
Munter ended his remarks with best practices for audit committees to consider, including actively engaging with the lead auditor to “consider the sufficiency of their quality control system, specifically those policies and procedures around supervision and evaluation of the audit work performed by other auditors.”
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