Four questions audit committees should ask their audit firms

by Cydney Posner

Audit Committee members may be interested in this release issued by the PCAOB in August 2012 designed “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 PCAOB regularly performs inspections of registered audit firms, large and small, as well as a selection of the audits they have conducted.  The PCAOB issues two-part inspection reports that describe, for each firm inspected, in Part I, audit deficiencies identified by the PCAOB inspection staff, and, in Part II, deficiencies in the firm’s overall system of quality control. The PCAOB makes Part I of the reports publicly available on its website, but is prohibited from publicly releasing Part II (unless the firm fails to remediate identified deficiencies within 12 months of issuance of the applicable report). However, the audit firms themselves have the entire report and may release it if they so choose.

As highlighted by some of the panelists at the PLI Securities Regulation Institute, the release suggests that audit committee members may benefit from learning more about some of these inspection reports and, in particular, identifies four possible questions that audit committee members should consider asking their audit firms about their inspection reports:

“1.  Was the company’s audit selected for PCAOB inspection?

Committees may want real time updates about whether their audit has been selected, what is being looked at, and any deficiencies identified by the PCAOB in the audit.   The release provides additional information about specific areas for possible further inquiry in this regard.

  1. Did the PCAOB identify deficiencies in other audits that involved auditing or accounting issues similar to issues presented in the company’s audit?

Committees may wish to understand whether similar deficiencies exist in the company’s audit and, if so, what has been done in response.

  1. What were the audit firm’s responses to the PCAOB findings?  

Committees may want to understand whether the audit firm agreed with the PCAOB’s findings and, if not, why not. If the firm agreed, what did the firm do in response?  The PCAOB is aware of certain audit firm responses that should be viewed with skepticism, such as:

             A. “It was just a documentation problem.” The PCAOB bases deficiency findings on an absence of available evidence in the audit files or elsewhere to support that adequate work was done to support an audit opinion, not just a failure to document work that was in fact done. Audit firms are provided an opportunity to describe the details of work that was done but not documented.

             B.  “There was a difference in professional judgment.”  The PCAOB bases deficiency findings only on failures to obtain sufficient audit evidence, not on disagreements when reasonable judgments appear to have been made about such matters.

             C. “The  firm  has  addressed  the  criticisms  in  accordance  with  PCAOB standards.”   Professional standards require that when a required auditing procedure was omitted, certain remedial steps must be taken. Ask whether the firm performed more work in response to the finding or in subsequent audits, or whether the firm concluded that no additional steps were required – in other words, that the firm disagrees with PCAOB inspection conclusions.

4. What topics are included in Part II findings? 

Firms may be reluctant to share the details of Part II findings in an inspection report for a number of reasons, but even in that case, audit committees may want to ask for certain generic information about the findings such as:

A.  what  changes  the  firm  is  making  to  address  any  quality  control deficiencies;

B.  what is the progress of the quality control remediation process, including a discussion of any submissions the audit firm made to the PCAOB as part of that process;

C.  the  inspected  years  about  which  the  PCAOB  has  made  a  final determination  about  the  firm’s  remediation  efforts  and  the  nature  of  that determination; and

D.   whether the PCAOB has provided initial indications that the audit firm may not have sufficiently remediated any items.”

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