Communication Between Auditors and Audit Committees Regarding the PCAOB Inspection Process

The Public Company Accounting Oversight Board (the “PCAOB”) recently issued Release No. 2012-003, Information for Audit Committees About the PCAOB Inspection Process (the “Release”), to assist audit committees in (1) understanding the PCAOB’s inspections of their audit firms and (2) gathering useful information from their audit firms about those inspections.  The goal of the Release is to provide audit committees with information about the inspection process and the meaning of report findings in order to facilitate meaningful discussions between audit committees and their audit firms about the results of inspections.  Information about the results of inspections can help an audit committee carry out its oversight role by informing an audit committee about how its audit firm performed on specific audits and in high-risk areas across audits. 

The Nature of a PCAOB Inspection of an Audit Firm

Each year, the PCAOB conducts inspections of audit firms.  These inspections are designed to identify and address weaknesses and deficiencies related to how a firm conducts audits.  To achieve that goal, PCAOB inspections include an evaluation of the firm’s performance in selected audit engagements and an evaluation of the design and effectiveness of a firm’s quality control policies and procedures.  For every inspection performed by the PCAOB, the PCAOB prepares a written inspection report.  PCAOB inspection findings are contained in two of the four parts of an inspection report.  Part I of the report describes audit deficiencies where inspection staff found that the auditor failed to gather sufficient audit evidence to support an audit opinion.  Part I findings are made public and are available on the PCAOB’s website.  Part II of the report describes deficiencies in the firm’s overall system of quality control.  The PCAOB is prohibited by law from publicly releasing these Part II findings unless the firm fails to remediate these findings to the PCAOB’s satisfaction within twelve months of issuance of the inspection report. 

Possible Questions Audit Committees May Wish to Ask Their Audit Firms About PCAOB Inspections

The Release contains four main questions that audit committees may wish to consider asking audit firms about the inspection process:

  1. Was the company’s audit selected for PCAOB inspection?
  2. Did the PCAOB identify deficiencies in other audits that involved auditing or accounting issues similar to issues presented in the company’s audit?
  3. What were the audit firm’s responses to the PCAOB findings?
  4. What topics are included in Part II findings?

Required Communications Between Auditors and Audit Committees

The PCAOB recently approved Auditing Standard No. 16, Communications with Audit Committees (“AS 16”).  Effective for fiscal years beginning after December 15, 2012, AS 16 is intended to improve overall audit quality by (1) enhancing communications between audit firms and audit committees and (2) improving audits by fostering constructive dialogue between audit firms and audit committees.  AS 16 creates new and, in some cases, expands existing communications requirements as outlined in PCAOB Audit (AU) Section 310 and AU Section 380.   Broadly speaking, AS 16 requires audit firms to do the following as part of their communications process:

  1. Obtain written confirmation from the company that the audit committee has acknowledged and agreed to the terms outlined in the engagement letter.
  2. Discuss certain matters related to the company’s accounting policies, practices and estimates, including (i) management’s initial selection of, or changes in, significant accounting policies, (ii) the effect on financial statements or disclosures of significant accounting policies and (iii) a description of the process and significant assumptions used by management to develop critical accounting estimates.
  3. Obtain information related to significant unusual transactions, including the business rationale for the transactions.
  4. Provide an overview of the audit strategy, including timing, significant risks identified, significant changes to the planned audit strategy or identified risks.
  5. Disclose information about the nature and extent of specialized skill or knowledge needed in the audit, and the extent of planned use of internal auditors, company personnel, other independent certified public accounting firms, or resources not employed by the audit firm that are involved in the audit.
  6. Provide an evaluation of going concern items.
  7. Discuss planned departures from the audit firm’s standard report.
  8. Disclose items significant to the oversight of the company’s financial reporting processing including concerns regarding audit or accounting matters that have come to the auditor’s attention during the audit process.

As companies seek and obtain stockholder approval of their independent auditors during the 2013 annual meeting season and audit committees finalize their 2013 engagements with independent auditors,  audit committees should plan on addressing these matters in the engagement process.