AS7 sets forth requirements applicable to interim reviews and annual audits. PCAOB went through two rounds of proposed standards on this one, with the reproposed standard issued earlier this year to address earlier concerns about whether engagement quality review was in effect a “second audit;” (PCAOB states it is not a second audit.)
The effective date for AS7 is fiscal years beginning on or after Dec. 15, 2009. As a practical matter (as discussed at the meeting), for calendar-year companies, AS7 would be effective with the first interim filing for quarter ending March 31, 2010 and for the first annual filing for period ending Dec. 31, 2010.
Among the questions raised at today's meeting prior to the final vote to issue the standard, board member Dan Goelzer (who will become acting chairman of the PCAOB effective Aug. 1 upon current Chairman Mark Olson's retirement) asked the staff to clarify some of the adjectives and verbs in paragraph 10 in the EQR standard (AS7).
Goelzer asked: "Para 10 talks about what the reviewer is supposed to do, requires evaluating certain judgments the engagement team made, to review certain documents, and to read certain other documents [potentially the other SEC filings]. Can you explain what the difference is between evaluating, reviewing and reading?"
Deputy Chief Auditor Greg Scates explained that those terms were not specifically defined in the standard, but he gave an idea as to the staff's intent in using those particular words. "Let’s start with evaluate: he or she [the engagement quality reviewer] will challenge audit scope, judgments about materiality, other matters, evaluate decisions the engagement team arrived at; 'evaluate' is more of a challenge on a particular issue."
He continued, "Review and read are somewhat similar terms: some people would view them to be almost synonymous, others would view [them as] distinct[ly] differen[t]; I view read as ...... [to] glean certain knowledge; [whereas] review, I view more as the person will scrutinize or analyze the information."
Goelzer summed up: "When we use ‘evaluate’ there is an element of challenge, [to] analyze critically," adding that the Engagement Quality Reviewer's conclusions on the acceptability of the audit (or interim review) are 'tethered to the performance [of] procedures."
The concept of 'tethering' conclusions to procedures performed was emphasized by Goelzer earlier in his remarks (see second point below), when he commented on how the staff had addressed the significant concerns raised by commenters in the original proposal, and reproposal, of the EQR standard, before reaching this final standard. Specifically, Goelzer said:
- First, commenters have been concerned that the EQR standard could inadvertently drive the engagement reviewer to, in effect, perform a re-audit. In its final form, Auditing Standard No. 7 focuses the reviewer on the engagement team’s significant judgments and on the team’s responses to the significant risks it identified. While this will require judgment and sophistication on the part of reviewers, the standard makes clear that they are responsible for evaluating how the engagement team identified and responded to risk, not for starting from scratch to assess risk independently. This should alleviate the concern that engagement quality review could turn into a re-audit.
- Second, the standard that the reviewer must meet in determining whether to provide concurring approval has been a major source of debate. Understandably, reviewers are sensitive to the criterion against which the Board, the SEC, and potentially the courts will measure their work. Under Auditing Standard No. 7, the reviewer may provide concurring approval only if, after performing the required review with “due professional care,” he or she is not aware of a significant engagement deficiency. This tethers the reviewer’s responsibility to his or her performance of the procedures required in the standard, rather than to a free-floating obligation not to concur if he or she “knows or should know” any fact that makes concurrence inappropriate. Further, the concept of acting with due professional care has long been embedded in auditing and should be familiar to the profession.
- Third, the extent and nature of the documentation that the reviewer must create to memorialize his or her work has been a major concern. Auditing Standard No. 7 invokes the same principle that governs the audit team’s work paper documentation: The EQR documentation must be sufficient to enable an experienced auditor, having no previous connection with the engagement, to understand the procedures performed by the reviewer. The adopting release makes clear that this requirement is not intended to cause the reviewer’s documentation to duplicate the audit work papers. For example, if the reviewer raises an issue with the engagement team, the reviewer’s documentation only needs to reflect that discussion if it is necessary to an understanding of his work and if it is not fully reflected in the engagement work papers.
Goelzer concluded (as did the other board members who voted unanimously to approve the final standard): "I believe that AS No. 7 strikes the right balance in addressing these and other difficult issues that the two comment periods have exposed. The burden will now fall to our inspections staff to monitor how the standard works in practice and how it affects audit quality." See the related statements of Chairman Olson, and board members Steven Harris. (Statements of board members Bill Gradison and Charlie Neimeier on AS7 are currently not posted.)
Concept Release on Engagement Partner Signature
Also today (July 28), the PCAOB agreed to release for public comment a Concept Release on Requiring the Engagement Partner to Sign the Audit Report. Currently, the audit firm signature appears on the audit report; the Concept Release asks whether the signature of the engagement partner should appear in addition to the firm’s signature. The Concept Release includes 16 specific questions on which PCAOB seeks public comment, in addition to any other general comment. There is a 45-day comment period on the Concept Release.
Issuance of the Concept Release results in part from a recommendation in the final report of the U.S. Treasury Advisory Committee on the Auditing Profession (ACAP), and related discussion at a number of meetings of PCAOB's Standing Advisory Group (SAG) that the PCAOB consider recommending engagement partner review.
PCAOB board members noted several example of feedback at SAG meetings, including from former SAG member Arnold Hanish, vice president and chief accounting officer, Eli Lilli & Co, who said: “I think the accountability issue is critical. I think having the individual sign their name as partner of the firm is most critical. You get different behaviors when somebody has to sign their name to something.”
It was noted that other commenters at ACAP and SAG meetings (especially audit firms), were concerned that this requirement could increase personal liability of the engagement partner, without necessarily enhancing audit quality.
There was some discussion at the PCAOB board meeting as to whether a safe harbor from Section 10b5 liability (for the engagement partner) could be provided by the SEC (or Congress), although the answer to that was not known at this time, nor was it known whether the SEC or Congress would have the appetite to provide such a safe harbor.
Separately, board member Steven Harris said: "[R]ecognizing that some auditors are concerned that such a requirement would somehow increase their personal liability on the job... I would note that this issue was reviewed by the Treasury’s Advisory Committee, and by the European Parliament -- in its consideration of the E.U. Eighth Directive, Article 28, Audit Reporting -- and neither found the issue unmanageable in this context."
In closing remarks, Harris added, "I am increasingly struck by the fact that the international community is far ahead of us, this is one example, when I see what has been done abroad, I think we have to catch up; I am fully aware of liablity concerns... .[but] they have dealt with [those] abroad... ACAP notes [this signature requirment] should not impose any duties , obligations, liability than imposed as member of an audit firm." He also noted, on the subject of a potential safe harbor, "There may be a number of ways to potentially deal with this issue.... similar to (the safe harbor offered by the SEC in its rule implementing) Sarbanes-Oxley Section 407 on audit committee financial experts."
Board and staff members acknowledged the EU 9th Directive (requiring engagement partner signature) only recently came into effect, and the legal environment differs in the EU vs. the U.S. Questions as to liablity are among the 16 questions raised in the Concept Release.
[Note: my two cents (my personal observation, see disclaimer on the right side of this blog): a couple of board members referenced that discussions to date, at ACAP, in the EU and otherwise, indicated that an engagement partner signature requirement was not expected to increase the audit firm's liablity. I am not certain if that is the right metric ('firm liablity') vs. a potential increase in the individual partner's liablity alone (or perception thereof) which could impact partner turnover or impact the quality of people who choose to enter (or avoid) the profession, due to potential concerns about personal liablity.]
Additional issues for consideration in the Concept Release, as noted by board and staff members, include whether signature of partners from audit firms within global networks should also be required, where the overall engagement partner is relying on another office in the global network to perform a certain portion of the work, in addition to the overall engagement partner signature.
Read the board members' statements and other material relating to the Concept Release.
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