Audit regulators have proposed two new standards to beef up requirements for auditors as they scrutnize accounting estimates and the contributions of specialists whose work is critical to financial statement assertions.
The Public Company Accounting Oversight Board issued a newly proposed auditing standard that would emphasize auditors are expected to apply professional skepticism and greater attention to the potential for management bias when auditing accounting estimates. The PCAOB has been saying as much for the past several years through its inspections of audit firms, with reports commonly noting auditors fail in a number of ways to adequately question management estimates.
Accounting estimates are becoming more prevalent throughout financial statements, with estimates necessary to arrive at reported numbers in recognizing revenue and in arriving at valuations of many financial and non-financial assets. Estimates also are required in calculating impairments of long-lived assets, allowances for credit losses, contingent liabilities.
Even further, the use of estimates will only grow over the next few years as companies adopt massive new rules around revenue recognition, recognition and measurement of financial instruments, and credit losses. Even the huge new standard on lease accounting contains judgments and estimates not found in current rules.
The new proposal, which the board has been developing for several years, would replace three current standards with a single new standard. The current language in AS 2501, 2502, and 2503 would replaced with a new AS 2501, building on historical approaches with new language to strengthen the requirements.
The PCAOB says the new standard would prompt auditors to devote more attention to potential management bias, extend certain key requirements in existing language on auditing fair value measurements to the audit of all accounting estimates, and would steer auditor focus to estimates with the greater risk of material misstatement. The new standard also would provide specific requirements and direction to address certain aspects that are specific to the audit of fair value measurements, and it would make other updates.
In the board’s companion proposal on the use of the work of specialists, the PCAOB is seeking to raise audit skepticism on work performed by outside professionals — like valuation specialists, engineers, or perhaps attorneys — whose work is critical to numbers booked in financial statements. The proposed standard would call for auditors to devote more attention to such work, and it would align the requirements with existing standards on risk assessments.
The standard would apply to specialists either hired by the audit firm as third-party specialists, employed by the audit firm to assist with the audit, or engaged by the company in advance of the audit as part of the financial reporting process
The board is asking for comments on both proposal by Aug. 31. Given the typical timeline for developing standards, it’s unlikely any new standards would take effect in time for application to the newest accounting around revenue recognition, which will start appearing in financial statements in 2018.