Another front has opened in the debates to forge a better, more useful corporate audit: whether audit firms should get new rules to scrutinize the work of specialists, whose role is critical to producing fairly stated financial statements.
The Public Company Accounting Oversight Board is in the early stages of studying whether (and if so, how) to revise existing guidance primarily found in AU Section 336, Using the Work of a Specialist. The board is exploring whether to provide some new language to clarify the requirements, or write an entirely new standard. The board is even considering whether to jettison the standard outright and point auditors to other rules that already exist to govern the audit of accounting estimates, which is the work specialists perform.
Relying on specialists to produce and audit financial statements has become the norm in recent years rather than the exception. Business is more complicated, transactions are more complex, and rules require more use of judgments and estimates. Companies often engage specialists such as actuaries to determine employee benefit obligations, engineers to assess environmental obligations, or valuation experts and appraisers to determine values for intangible assets and real estate, the PCAOB says. Auditors rely on specialists of their own to evaluate that work—especially accounting estimates and fair value measurements.
The PCAOB says its inspection data suggests the largest accounting firms rely extensively on specialists. In 2014, for example, analysis of a sample of 50 audits inspected by the PCAOB revealed 90 percent of them involved using at least one specialist. The average audit engaged five separate specialists in an average of two fields of expertise on each audit. (The PCAOB intentionally selects tricky audits for inspection, so those figures aren’t necessarily representative of all audits.)
And regulators are pressuring auditors to look at everything, including work produced by specialists, more skeptically. “If you look at the inspection reports that come out, there are always comments about inadequate work surrounding use of specialists,” says Wendy Stevens, a partner with audit firm WeiserMazars.
The financial crisis in 2008 touched off events that have put considerable pressure on financial statement audits, including the way auditors rely on the work of specialists, Stevens says. “In a bad economy, a lot of stuff comes out,” she says. “Now, seven years later and three years past some recovery, the world has changed in terms of the instruments that are out there.”
Scott Showalter, a professor at North Carolina State University, says any standard-setting considerations around auditors’ reliance on specialists should be done in tandem with any changes to standards on auditing accounting estimates and fair value—which is another project the PCAOB is considering. “There’s an ancillary relationship,” he says. “They naturally go together.”
The PCAOB acknowledges that existing standards don’t give consistent direction to auditors when the work they use comes from different specialists, and how a specialist is treated can often depend on whether the company or the audit firm has done the hiring. For example, specialists employed by the audit firm are not subject to the same standards and independence requirements as the audit team itself.
“My suggestion is for the PCAOB to be clear about what the auditor’s responsibility is, reconcile any inconsistencies, and tie it in with standards on auditing accounting estimates.”
Scott Showalter, Professor, North Carolina State University
Auditors are expected to be skeptical of the skills and objectivity of others, depending on how those others came to be associated with the preparation of financial statements or the audit. Standards to clarify the different types of specialists and the auditor’s responsibility regarding each might be helpful, Showalter says. “My suggestion is for the PCAOB to be clear about what the auditor’s responsibility is, reconcile any inconsistencies, and tie it in with standards on auditing accounting estimates,” he says.
Let’s Get Clear
Sara Lord, a partner with McGladrey, says auditors would welcome some clarity in the standards to explain auditors’ responsibilities. “One of the big challenges here is that this is so different depending on the client and the company,” she says. “They need to write standards that work no matter how big or little you are.”
Lord does worry that a wholesale new standard might increase audit responsibility. “This seems to be increasing the areas that a core auditor is not going to be able to understand,” she says. “How do we maintain that central responsibility of assuring fairness of financial statements? What’s the role of the auditor in understanding enough about what we’re doing when we need to rely on the expertise of specialists?”
CAQ COMMENTS ON SPECIALISTS
In the following excerpt from a letter to the PCAOB, the Center for Audit Quality offered its views on specialists.
Extending the Auditor’s Supervision Requirements
The auditor’s determination of whether to use the work of a specialist in the audit is driven by the auditor’s risk assessment process, which includes considering the complexity of the estimate or fair value measurement, its significance to the audit, and the knowledge, skill, and ability of the engagement team members. When a specialist is employed by an accounting firm, we believe the specialist should continue to be considered a member of the engagement team and be subject to the same supervision and review requirements as any other engagement team member in accordance with AS10. However, the potential amendment to extend the supervision requirements of AS10 (which would include ensuring compliance with all PCAOB standards, including the Quality Control and Ethics and Independence standards) to an engaged specialist could be difficult to apply and, in some cases, compliance by the engagement partner may not be possible given that engaged specialists are not a part of the accounting firm’s training, resource monitoring, or overall system of quality control.
Evaluating the Work of an Auditor’s Specialist
We continue to believe that AU336 provides the auditor with the appropriate framework to evaluate the work of an auditor’s specialist, whether employed or engaged, and we are concerned with the potential requirement within the Consultation Paper to evaluate the work of an auditor’s specialist differently (i.e., “determine whether” versus “evaluate the conclusions”) depending on whether the specialist (i) develops an independent estimate or (ii) tests the methods and significant assumptions used by the company. This potential amendment could be interpreted as requiring the auditor to re-perform the work of the auditor’s specialist by developing an independent conclusion on the audit matter when the auditor’s specialist develops an independent estimate. However, if the auditor has concluded that a specialist is competent, objective, and has an understanding of his or her responsibilities, the auditor should be able to rely on the execution of the procedures and evaluate the reasonableness of the specialist’s conclusions. By requiring a level of effort that goes beyond evaluating the specialist’s conclusions, the alternative would mandate a level of expertise that auditors do not, and are not expected to, possess. We believe the requirements for the auditor in both situations should only include an evaluation of the specialist’s conclusions about the items outlined in the potential amendments.
Currently, when the auditor believes the findings are unreasonable, AU336 requires the auditor to apply additional procedures, which may include obtaining the opinion of another specialist, in order to use the work of the auditor’s engaged specialist. We believe potential enhancements could adopt an approach similar to ISA620. Under that guidance, in situations where the auditor believes that the findings of the specialist are not adequate (e.g., because the findings are not consistent with other audit evidence), the auditor should agree with the specialist on the nature and extent of further work to be performed by the auditor’s specialist, perform additional audit procedures appropriate to the circumstances, or engage another specialist to resolve the matter.
Source: Center for Audit Quality.
Mike Gullette, vice president of accounting and financial management for the American Bankers Association, says members report to him that auditors have dramatically stepped up their documentation demands in numerous areas of the audit. “What we’re hearing from bankers over the last year is about the amount of documentation and support needed for many aspects of the audit, especially allowance for loan losses,” he says. “It’s double what it was a year ago.”
Instead of adding more guidance—which logically would lead to more audit demands—Gullette advocates that PCAOB focus on interpretive guidance and more enforcement of existing standards. “Just put out a paper that says, ‘Here’s how we think things are going under existing standards and here’s what we’re looking for’,” he says.
Especially worrisome, Gullette says, is that smaller audit firms and smaller companies might be penalized with more work and costs because they don’t employ the same staff of experts in-house that larger companies or audit firms can. “Smaller audit firm don’t have the size of practice that requires hiring their own valuation experts full-time,” he says. “This is going to put them at a disadvantage.”
Showalter questions how closely the PCAOB seems to expect auditors to oversee the efforts put forth by outside specialists. “This is an opportunity for the PCOAB to recognize that the auditor is not all knowing,” he says. “They bring in specialists because they need that skill and don’t have it themselves. I used to audit coal companies, and I brought in engineers to analyze coal samples. I’m not an engineer.”
Robert Hirth, chairman of COSO, says the standards are worthy of study for updating because they haven’t changed in many years. “The landscape surrounding these matters has clearly changed since the applicable standards were developed,” he says. He also hopes to see any changes to standards targeted at clear issues that need correction.
“Have there been problems where specialists have been used?” he says. “Do you have cases where the use of specialists and the way that work was audited turned out to be wrong and led to restatements?”