Telling Auditors How to Audit Themselves

The PCAOB will consider proposing a new standard for audit firms' internal evaluations.

The Public Company Accounting Oversight Board could soon move forward on one of its long-standing projects: how the audit firms should conduct their internal reviews.

Under the Sarbanes-Oxley Act, which led to the creation of the PCAOB, the audit firm overseer is required to set a standard for the conduct of engagement quality reviews. For each audit, a partner not deeply involved with the work opines on the job before the firm signs-off on the review process. The partner may conduct this objective review during the audit and when the work is completed.

To carry out the reviews, auditors rely on legacy guidance from the American Institute of Certified Public Accountants, which the PCAOB has adopted as an interim standard, along with their own policies and procedures. The new proposal being considered at the PCAOB’s board meeting on Tuesday will likely create “uniformity” in terms of guidance that the firms can follow, says Kathryn Epps, an assistant professor at Kennesaw State University who has been paying close attention to the subject.

The topic has been on the PCAOB’s list of priorities for years. In 2004, the board asked for input from its Standing Advisory Group on how to craft a new rule and emphasized the importance of the reviews. “The engagement quality reviewer plays a critical public interest role in the process of preparing and issuing audit reports that are necessary to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports,” the PCAOB staff wrote in their agenda for their advisers.

At the time, the staff suggested that a new standard could address several objectives, including, the reviewers’ required qualifications, the differences between the reviewer’s and the engagement partner’s responsibilities, and the review processes for the audits themselves.

The reviews are meant to identify mistakes, as well as improve the quality of all audit work released by firms, Epps told CFO.com. Under the current guidance, the reviewers who evaluate an audit confirm that the client’s financial statements follow generally accepted accounting principles, and that the performance of the engagement partner and his or her team followed generally accepted auditing standards.

However, the existing guidance didn’t seem to be enough to prevent lax or faulty audits, some of which were tied to the corporate scandals that led to the passage of Sarbox, the PCAOB has noted. Indeed, the Securities and Exchange Commission has sanctioned review partners for not giving complete evaluations. For example, the regulator faulted a KPMG Canada review partner for not ensuring that the lead partner was up-to-date on his knowledge of audit independence rules.

Section 103 of the 2002 Sarbox law requires that audit firms have a “concurring or second partner” review audit work. However, the PCAOB has found those terms to be confusing, and favors the wording of “engagement quality review.”

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