The Public Company Accounting Oversight Board is changing the rules on how audit firms must manage the outside auditors they hire to help with audit work.
The PCAOB has proposed for public comment a new standard and amendments to existing standards to direct auditors on how they must evaluate and supervise the work of outside individuals or firms they might engage to help complete an audit. In an increasingly global environment, the U.S. arms of global audit networks often rely on the work of affiliates in other jurisdictions to audit financial statement inputs arising in those locations, the PCAOB says.
In fact, a PCAOB analysis shows U.S. firms relied on other auditors for about 80 percent of audits performed for Fortune 500 companies. “Work performed by other auditors can account for a significant share of the audit,” the PCAOB says in a statement. “In audits involving other auditors selected by the PCAOB for inspection, other auditors on average audited between one-third and one-half of the total assets and total revenues of the audited company.”
The proposed new standard would require the lead partner on a public company engagement to secure representations from any outside auditors they engage to show those outside auditors are properly licensed and are registered with the PCAOB to perform audit work that is relied on in U.S. capital markets. The lead auditor also would be required to disclose the name of the other auditor in the audit report.
In addition to a new standard, the PCAOB also is proposing amendments to existing standards on audit supervision, audit planning, audit documentation, and engagement quality reviews to address the oversight and management of outside auditors. Supervision rules, for example, would prescribe certain procedures the lead auditor would need to perform with respect to outside auditors.
Audit planning rules would be modified to address a firm’s eligibility to serve as a lead auditor on an engagement that involves other auditors. Documentation rules would outline new requirements around audit work papers arising from outside auditors, and the engagement quality reviewer would be required to evaluate the lead partner’s determination of a firm’s eligibility to serve as the lead auditor.
The objective of the package is to direct the lead auditor’s supervisory responsibilities to the areas of the greatest risk, the PCAOB says. It’s also to make clear that a firm must itself audit a meaningful portion of financial statements to take on the role of lead auditor. Finally, the board wants to prompt the lead auditor to increase involvement in the work of other auditors through more communication and evaluation.
The PCAOB has already adopted a requirement for audit firms to provide in a separate filing with the board the name of the engagement partner on each engagement and the names of any outside individuals or firms that provided any meaningful level of support on an audit. That rule is awaiting approval from the Securities and Exchange Commission before it can become final.
This new proposed package “comes at the matter of other auditors from a different perspective – not one of ensuring transparency but one of ensuring appropriate involvement in that work by the lead auditor,” said PCAOB Chairman James Doty in an open meeting to issue the proposal for comment.
In routine audit inspections, the PCAOB sees engagements where work from outside auditors is not well managed or does not meet the objectives of the audit, said Doty. The proposal is intended to produce “a consistent level of quality assurance regarding other auditors’ participation in the audit,” said Doty.
PCAOB member Steve Harris said he's hopeful the board will also resume work on an earlier effort to address supervision not just of outside auditors, but also audit work within the firm. I believe that appropriate supervision of firm personnel at all levels within a firm is an essential ingredient for an audit practice to perform high quality audits," he said. The Sarbanes-Oxley Act even contemplated the need for better supervision, and the board issued a concept release in 2010 that has seen little action since, he said. "I would hope that we might revisit and move ahead soon on that proposal as well."
The PCAOB is accepting comments on the current proposal through July 29. PCAOB member Jay Hanson said he wants to see comments not only from auditors, but also preparers, audit committees, investors, and others. “I encourage audit committees and preparers, in particular, to discuss the proposals with their auditors in order to fully understand the degree to which the proposal will change existing practice and to consider any possible unintended consequences,” he said.