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PCAOB OKs auditor responsibility and quality control standards

May 13, 2024

The Public Company Accounting Oversight Board approved two new standards Monday on a firm's system of quality control and the general responsibilities of the auditor in conducting an audit, albeit with pushback on the QC standard from one board member.

The new quality control standard would require all PCAOB-registered firms to identify their specific risks and design a QC system that includes policies and procedures to guard against those risks.

The standard aims to strike a careful balance between a risk-based approach that would require firms to proactively identify and manage the specific risks associated with their practice and a set of mandates to assure the QC system is designed, implemented and operated with an appropriately rigorous level. Under the new standard, all PCAOB-registered firms would have to design a QC system that complies with the new standard. Firms that do audits of public companies or SEC-registered brokers and dealers would need to implement and operate the QC system they design, monitor the system, and take remedial actions where policies and procedures are not operating effectively, creating a continuous feedback loop for improvement.

Those firms would be required to annually evaluate their QC system and report the results of their evaluation to the PCAOB on new Form QC, which would be certified by key firm personnel to reinforce individual accountability.

Firms that audit over 100 issuers a year would be required to establish an external oversight function for the QC system, known as an External QC Function (EQCF), comprising one or more people who can exercise independent judgment related to the firm's QC system. In response to comments received on the proposed, the new standard clarifies that the EQCF's responsibilities should include, at a minimum, evaluating the significant judgments made and the related conclusions reached by the firm when evaluating and reporting on the effectiveness of its QC system.

The new standard would apply to all PCAOB-registered firms, and if approved by the Securities and Exchange Commission, the new standard and related amendments would take effect on Dec. 15, 2025.

"When QC systems operate ineffectively, investors are put at risk," said PCAOB chair Erica Williams during an open meeting Monday to consider the new standards. "But, when QC systems operate effectively, quality audits performed in accordance with applicable professional and legal requirements are likely to follow — leaving investors better protected."

The PCAOB's current QC standards date back over two decades ago before the PCAOB was established by the Sarbanes-Oxley Act of 2002. They were originally developed and issued by the American Institute of CPAs. The PCAOB has been working to update those earlier audit standards due to the extensive changes in the auditing world over the years, and quality control has been a top modernization priority for the PCAOB.

However, one of the board members, Christina Ho, believes the new standard goes too far and voted against approving the new standard, although Williams and the three other board members voted for it. Ho pointed out that it would be difficult for small and midsized firms to comply with the requirements, and she doesn't believe the board did enough of an economic analysis of the potential effects.

"Small and medium size firms represent 99% of the total PCAOB-registered firms, but the remaining 1% audit over 99% of the S&P 500 companies, indicating that capital markets and investors need a more robust and competitive audit marketplace," she said. "Yet the PCAOB appears to be indifferent to this problem and keen to further exacerbate the large audit firm oligopoly by proposing and adopting standards and rules that add a disproportionate burden on smaller firms without articulating clear and supportable benefits. In my opinion, this standard is setting up smaller firms to fail by creating complex and prescriptive requirements that unnecessarily misalign with other standards, and possibly promotes more enforcement opportunities, all without an adequate economic analysis."

Ho pointed to some of the negative comments received in response to the proposed standard and is worried that it would discourage new accountants from entering the profession. Similarly, she had expressed her opposition to the so-called NOCLAR standard on noncompliance with laws and regulations that the PCAOB proposed last year that has also provoked pushback in the auditing profession.

"I agree that we need a robust and modernized quality control standard which was why I supported the proposal over 18 months ago," said Ho. "But we must do it right, and not rush to replace an outdated standard with one harmful to audit quality by increasing burdens without credible benefits that will likely reduce competition. Rather than potentially dismantling the audit profession and simultaneously setting copious standards that ironically make this profession exceptionally unappealing to future accountants and auditors, we as a regulator should thoughtfully balance the scale, using evidence-based quantitative and qualitative analysis to justify the need for our standards. In other words, requirements should promote a commensurate balance between benefits and the associated direct implementation costs to audit firms, that by extension are passed on to issuers and broker-dealers, and then indirectly reduce returns on investments."

She noted that the SEC has yet to approve the new standard and predicted it would generate opposition from stakeholders that could deter the SEC from finalizing it. "While I am disheartened, the Board's vote today is not the end of the process. Under SOX, the SEC must approve this adopting release in order for it to become effective.14 Under SOX and section 19(b) of the Securities Exchange Act of 1934,15 the PCAOB will submit a Form 19b-4 to the SEC, which will be posted on the PCAOB's website, and the SEC will solicit public comment," said Ho. "I look forward to reading comments submitted to the SEC by audit firms, audit committee members, emerging growth companies, and actual investors, with regard to design-only and its burdens on competition. I am confident that the Commission will do the right thing."

Auditor responsibility standard

The other new standard approved Monday during the open meeting, on the general responsibilities of the auditor in conducting an audit, along with related amendments to other PCAOB standards, received a unanimous vote in favor. The auditing standard, referred to as AS 1000, would enhance and consolidate a group of standards that were adopted on an interim basis by the PCAOB in April 2003 and that address the general principles and responsibilities of the auditor, such as due professional care, professional skepticism, competence and professional judgment. AS 1000 merges those foundational standards dating back to the early days of the PCAOB into a single standard.

"The new standard and amendments before us today would modernize, clarify, and streamline the general principles and responsibilities of auditors and provide a more logical presentation, which should enhance the useability of the standards by making them easier to read, understand and apply," said Williams.

The standard includes amendments to clarify the auditor's responsibility to evaluate whether the financial statements are "presented fairly." There are also amendments to clarify the engagement partner's due professional care responsibilities by adding specificity to certain audit performance principles set out in the standards, along with amendments that would speed up the documentation completion date to reflect changes in the auditing environment, including technology advances that have allowed auditors to assemble a complete and final set of audit documentation in less time than in the kind of paper-based environment that existed decades ago.

The new standard doesn't create any new principles or responsibilities but simply clarifies those that already exist so it's less controversial than the quality control or NOCLAR standard.

In response to comments on the proposal, revisions were made in the adopting release to express the longstanding principle that the auditor's responsibility to investors transcends the auditor's relationship with management and the audit committee of the company under audit. "The changes further clarify that this responsibility provides the foundation for an objective and independent audit, while making clear the standard does not create any new legal obligation for auditors," said Williams.

It also clarifies the auditor's responsibility to evaluate whether the financial statements are "presented fairly." In response to comments on the proposal, revisions were made in the adopting release to clarify it does not change the auditor's existing responsibilities for evaluating whether the financial statements are presented fairly in conformity with the applicable financial reporting framework. The standard clarifies the engagement partner's due professional care responsibilities by adding specificity to certain audit performance principles set out in the standards.

In response to comments on the proposal, the PCAOB made some revisions in the final version to clarify provisions that highlight the important role engagement partners play and to help draw a distinction between the responsibilities applicable to all auditors and those that are incremental for engagement partners.

The new standard would also accelerate the documentation completion date by reducing the maximum period for the auditor to assemble a complete and final set of audit documentation from 45 days to 14 days. The new documentation completion date would reduce the window of opportunity for improper alteration of audit documentation and also enable the PCAOB to potentially begin the inspection process sooner after completion of an audit.

In response to comments on the proposal, revisions were made in the standard to take a phased-in approach and give smaller firms extra time to comply with the new documentation completion date.

The standard would also clarify an auditor's professional skepticism extends to other information that is obtained to comply with PCAOB standards and rules.

In response to comments on the proposal, revisions were made to clarify that an auditor's professional skepticism extends beyond the evaluation of the sufficiency and appropriateness of audit evidence. In accordance with this change, an auditor exercises professional skepticism throughout the audit process.

"This standard is an evolutionary change that should not be considered trivial," said PCAOB board member George Botic. "AS 1000 and the related amendments modernize, clarify and streamline the general principles and responsibilities of the auditor.These changes reframe the auditor's fundamental obligations: those that address the general responsibilities of an auditor in the audit. Instead of changing or altering the auditor's responsibilities, the standard and amendments serve to streamline and clarify auditor responsibilities while also enhancing the useability of the standard by making it easier to read, understand, and apply. These changes are informed by 20 years of the PCAOB's inspection and enforcement experience."

The new standard would apply to all audits conducted under PCAOB standards. Subject to approval by the SEC, the new standard and related amendments would take effect for audits of financial statements for fiscal years starting on or after Dec. 15, 2024. For certain firms, the amendment relating to the documentation completion date will take effect for audits of financial statements for fiscal years beginning on or after Dec. 15, 2025.

[Accounting Today]

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