Communicate, Communicate, Communicate!
The Public Company Accounting Oversight Board or the PCAOB did 2 things this month to improve communication between board audit committees and their audit firms. Now as you know the PCAOB does regular inspections of audit firms. Audit deficiencies are made public, but other information arising from the inspection, especially deficiencies in the audit firm’s quality control, are not. Companies have no way of knowing unless the audit firm volunteers the information.
Now the PCAOB has issued a document to help audit committees gather useful information from their audit firms about PCAOB inspection outcomes. The board has also adopted a new auditing standard, A-S 16 on communications with audit committees. Two years in the making, this standard establishes requirements that enhance the relevance and timeliness of the communications between the auditor and the audit committee. To talk about both these developments, I have with me the PCAOB’s Board Member Jeanette Franzel.
Doshi: I am looking at this less from a compliance point of view and more from a best practice point of view and therefore I want to understand what prompted the Board to put out this release concerning its inspection process and how companies can get better information from their audit firms regarding inspection outcome.
Franzel: First of all let me just state the importance of audit committees and the overall corporate governance system and in overseeing audits and financial reporting and because of that role, we wanted to be sure that audit committees fully understood the information that could be available to them through PCAOB inspections and we had been receiving some questions and other indications that there was some confusion out there as to what types of information was available to audit committees from inspection process and whether or not auditors could share information with audit committees and there was also a variety in practices. So we wanted to put information out to get everybody on the same plain field and to help promote good constructive communication to help improve audit quality.
Doshi: I understand from the release that you have put out that there are two kinds of information available as the outcome of a PCAOB inspection- one that has to do with audit deficiencies and that is public information usually but there is non-public information as well - for instance if there are any deficiencies in the audit firm’s quality control processes. How do you hope that the approaches that the Board has laid out will help companies access information regarding quality control deficiencies from their audit firms?
Franzel: You are correct when you say that there is a public portion and a non-public portion of the report and so the public portion discusses specific deficiencies found in specific audits but we do not identify the issuer in part one and so one thing an audit committee may want to ask is whether its own audit had been inspected and whether it is being cited in the public portion of the report. In part 2, which is the non-public portion of the report, is where we report deficiencies in the firm’s quality control system which could impact its ability to do high quality audits and we also report on some potentially systemic issues within the firm and again the audit committee would be interested in knowing if any of those issues could potentially impact its own audit of the issuer and what the auditor’s response is in order to remediate those issues or to mitigate any risks to that company’s audit.
Doshi: Let me move to the second development of the month and that is the PCAOB has adopted its Auditing Standard 16 and this is the auditing standard that lays down I would imagine the framework of communication between audit committees and their audit firms. Could you take us through what some of the key highlights of Auditing Standard 16 in your opinion would be in terms of how it improves communication between audit firms and the audit committees?
Franzel: Certainly. It is involving communication throughout the audit- so initially the auditor is to establish a number of things with the audit committee about the audit and its scope and the nature and timing of procedures. So whether that can happen in the planning phase and then there was a second phase where the auditor communicates the results of the audits and those results would involve many difficult or contentious issues that were encountered during the audit- significant accounting policies, significant estimates, any areas where we auditors spent a lot of time due to risk, any misstatements that the auditor found and then the auditor also inquires every audit committee of certain matters doing the audits as well. So for instance if the audit committee is aware of any instances of potential fraud or misstatements to help guide the auditor as well and the big update is that all of this communication needs to be done in a timely manner and before the audit report is issued whereas the old standard didn’t specify the timing of communication.
Doshi: I have to ask you this- the PCAOB has no authority over audit committees - so does this Auditing Standard make it mandatory upon audit firms to make this information available to the committees in a timeline that you have laid out or how do you ensure that the audit firm toes the line so to speak because you cannot insist that the audit committee has asked for this information?
Franzel: That is correct, this is an Auditing Standard over the auditor’s actions and the PCAOB does not have jurisdiction over audit committees. However, because audit committees play such an important role in providing a healthy environment for a good independent audit, we felt that was very important to require that certain communications happen and that the auditors communicate with the audit committee and now if the audit committee refuses to take such communications or it refuses to meet with the auditor or the auditor would have to seriously consider the tone at the top and the governance structure and whether there is a material weakness at that issuer. So it is in the audit committee’s best interest to engage as well just because of the audit committee’s will but it could be feasible that you may have an audit committee that just doesn’t want to inquire the process but that is a much bigger problem in terms of the company’s corporate governance.
Doshi: The two majors combined seem to add substantially to the kind of work that audit committees need to do with their audit firms- what is the genesis of why you have come up with both the inspection approaches as well as AS-16?
Frazel: We are looking very broadly at how to improve audit quality and help ensure the independence of audits and the audit committees play such an important role in that process. I do think that perhaps it is coincidence that both of these releases came out in the same month but I also think there are some advantages to that because we can communicate all of this at the same time and educate auditors and audit committees about this.