November 30, 2012
Volume 19, Issue 31

by Megan Zietsman, Deloitte & Touche LLP; Jennifer Burns, Deloitte LLP; and Brent Simer, Deloitte LLP

At the November 15–16, 2012, PCAOB Standing Advisory Group (SAG) meeting, the PCAOB gave an update on recent developments, including an overview of its current and future standard-setting activities. In addition, the PCAOB and SAG discussed:¹

• Potential approaches to the auditor’s reporting model that could increase its transparency and relevance to financial statement users.
• Whether and, if so, how to engage in outreach and research regarding the auditor’s approach to detecting fraud.

The next SAG meeting is scheduled for May 15–16, 2013.

Recent PCAOB Developments

Chairman James Doty summarized recent PCAOB activities and policy initiatives that have been completed or are in progress, including:

• The issuance of PCAOB Release 2012-003² on August 1, 2012. (For more information on Release 2012-003, see Deloitte’s August 30, 2012, Heads Up.)
• The adoption of PCAOB Auditing Standard 16³ on August 15, 2012. (For more information on Auditing Standard 16, see Deloitte’s September 18, 2012, Heads Up.)
• Gathering input on its concept release⁴ on auditor independence and audit firm rotation (for more information on the concept release, see Deloitte’s August 26, 2011, Heads Up):
  • The PCAOB has held a total of three public meetings on the concept release: one on March 21–22, 2012, in Washington, D.C.; one on June 28, 2012, in San Francisco; and one on October 18, 2012, in Houston.
  • The PCAOB is continuing to consider this issue and potential alternatives for enhancing auditor independence but has not provided a timeline for when it expects to release a proposal or complete this project. In addition to continuing its consideration of this project, the PCAOB plans to issue a practice alert on professional skepticism. See further discussion in the Standard-Setting Agenda section below.
• Creating a permanent program for the inspection of audits of brokers and dealers, including conducting an interim program to gather information to use in developing the permanent program. On August 20, 2012, the PCAOB released a report⁵ describing the significant observations made thus far in the program.
• Continuing to work on developing cross-border arrangements so that the PCAOB can conduct additional joint inspections outside the United States. The number of PCAOB inspections outside the United States has increased in 2012 as a result of additional cooperative agreements reached with other countries (e.g., Germany, the Netherlands, and Spain). And the number of cooperative agreements is expected to increase as the PCAOB continues to negotiate with authorities in additional countries (e.g., Italy, France, and Sweden). The PCAOB is also focusing on developing an agreement with Chinese authorities. As part of this effort, in October 2012, members of the PCAOB staff traveled to China and for two weeks observed Chinese authorities examining the quality-control portion of the inspections of local accounting firms.
• Also, as part of furthering relationships with audit oversight counterparts outside the United States, PCAOB board member Lew Ferguson is serving as the vice chairman of the International Forum of Independent Audit Regulators (IFIAR)⁶ and PCAOB board member Steve Harris is chairing IFIAR’s Investor Working Group (which is responsible for organizing IFIAR’s dialogue with investor representatives). In addition, during the first week of November, the PCAOB hosted its sixth annual International Auditor Regulatory Institute, which was attended by 37 auditor oversight organizations from around the world.

Standard-Setting Agenda

Chief Auditor Marty Baumann provided an update on the PCAOB’s various standard-setting activities and reviewed its future standard-setting agenda. Mr. Baumann explained that the PCAOB’s planned standard-setting activities for 2012 have been affected by new requirements under the JOBS Act.⁷ He further explained that while the Board’s rulemaking process has always involved certain elements of economic analysis, the JOBS Act now requires the SEC to perform a specific economic analysis when considering whether PCAOB rules should apply to emerging growth companies (see Deloitte’s April 2, 2012, Heads Up for more information). As a result, the PCAOB has been working with the SEC to develop the additional data and analysis necessary to help the SEC meet the new requirements, which will be applied for the first time in connection with the passage of Auditing Standard 16. The PCAOB expects to be able to meet its standard-setting goals in 2013 and provided an update on its agenda for the first half of 2013. On the basis of this updated agenda, the PCAOB expects to complete the following during the first six months of 2013:

In addition, the PCAOB explained that the projects in the table below remain on its agenda but that it does not expect action on these items in the first half of 2013; the Board did not provide any timetable or indication of priority:

Auditor’s Reporting Model

Jennifer Rand, deputy division director and deputy chief auditor, and Jessica Watts, associate chief auditor, presented an overview of the PCAOB’s auditor’s reporting model project. (For more information on this project, see Deloitte’s June 28, 2011, Heads Up.) In addition, Dan Montgomery, deputy chairman of the International Auditing and Assurance Standards Board (IAASB) and chairman of the IAASB’s Auditor Reporting Task Force, discussed the status of the IAASB’s similar project. He provided a preliminary analysis of the comment letters the IAASB has received in connection with its invitation to comment¹¹ on improving the auditor’s report. On the basis of this preliminary analysis, the IAASB’s Auditor Reporting Task Force believes that there is generally broad support for changing the auditor’s reporting model to enhance the informative nature of the report; however, views differ on how best to proceed. Mr. Montgomery acknowledged that the IAASB’s challenge will be to reconcile these views and develop a proposal on this topic, which it expects to issue in June 2013 for public comment. The IAASB then expects to issue a final standard in mid-2014.

SAG members discussed the following issues related to the PCAOB’s auditor’s reporting model project during a nonpublic breakout session of the meeting:

• Whether certain matters communicated to the audit committee under Auditing Standard 16 should also be communicated in the auditor’s report through emphasis paragraphs.
• Whether to consider special reporting requirements for audits of smaller and less complex companies, brokers and dealers, and emerging growth companies.
• Whether the PCAOB should consider specific elements of the projects of other regulators or standard setters for its project on the auditor’s reporting model.

The PCAOB staff presented a summary of the breakout discussions, which indicated that various views were voiced regarding the direction the PCAOB should take in expanding the auditor’s reporting model. Those views include the following:

• Many SAG members seem to believe that certain matters should be communicated through required emphasis paragraphs in the auditor’s report. However, there is little consensus on what the emphasis paragraphs should include.
• Generally, members did not support using Auditing Standard 16 as a basis for developing emphasis paragraphs, although some noted that investors want to know more about some of the issues addressed in Auditing Standard 16.
• Some agreed that an expanded auditor’s report should focus on:
  • The significant risks of material misstatement of the financial statements.
  • Significant management judgments, estimates, and areas with significant uncertainty.
  • Significant changes or events affecting the financial statements, including unusual transactions.
  • The comparability of an entity’s accounting policies and practices.
• Although others believe that it is management’s responsibility to describe risk areas, significant judgments, estimates, unusual transactions, and areas of uncertainty, several SAG members believe that because management already discloses these matters in Management’s Discussion and Analysis (MD&A) within Form 10-K, the auditor should be required to provide some sort of assurance on MD&A, non-GAAP measures, or both. Some believe that requiring the auditor to provide assurance, particularly on MD&A or portions thereof, would improve management’s disclosures. However, others were against such a requirement and explained that in response to prior PCAOB outreach, investors had said that they did not want additional assurance on information outside the financial statements.
• Many thought that the emphasis paragraph should not include a discussion of audit procedures performed, a description of the audit strategy, or qualitative statements regarding matters outside the financial statements. Others strongly believed that the emphasis paragraph should not be an index or a roadmap of items to read in the financial statements.
• One SAG member suggested that rather than requiring the auditor to emphasize certain matters, the audit committee could be responsible for pointing out the most important issues in the financial statements. Another SAG member suggested that perhaps internal auditors should play a role and that a compromise might be for internal auditors to provide some sort of assurance on matters outside the financial statements by using guidance or a framework developed by the Institute of Internal Auditors.
• Some suggested that any new expanded reporting requirements should be scalable to companies of all sizes and that the requirements should not differ on the basis of a company’s size or market capitalization.
• Information in the IAASB’s invitation to comment on improving the auditor’s report was discussed, and questions arose regarding whether it is necessary to consider the international view as the PCAOB considers its proposals.
• SAG members encouraged the Board to identify a target audience for the proposed expanded auditor reporting (e.g., develop a definition of “investor” that is similar to the FASB’s definition and consider whether this is the same view of “investor” that the IAASB is considering) so that it is clear what type of user the expanded auditor reporting is intended to assist.
• In addition, to allow for smoother implementation of changes, many recommended that the PCAOB conduct field testing before adoption, consider making changes gradually, and perform a post-implementation review to assess the effectiveness of enhanced reporting after adoption and the impact on audit quality (e.g., one SAG member cautioned that expanded auditor reporting requirements could remove some focus from the audit itself).

We encourage all stakeholders to look for the PCAOB’s proposal on how to expand the auditor’s report (which, as discussed previously, is expected in the first half of 2013) and to provide input to the PCAOB during the comment period. In addition, we encourage interested parties to provide comments to the IAASB on its similar proposal, which is expected to be released in June 2013.

Auditor’s Approach to Detecting Fraud

Keith Wilson, deputy chief auditor, and Brian Degano, associate chief auditor, presented details regarding the PCAOB’s consideration of outreach or research related to the auditor’s approach to detecting fraud. This discussion was a follow-up to a discussion at the May 2012 SAG meeting, in which some SAG members suggested that the PCAOB continue to pursue the development of a fraud center, fraud task force, or both, to focus on fraud prevention and detection. (For more information on the May 2012 SAG meeting, see Deloitte’s June 13, 2012, Heads Up.)

The following topics related to the auditor’s approach to detecting fraud were discussed during a nonpublic breakout session of the meeting:

• Whether the Board should conduct outreach regarding the auditor’s approach to the detection of financial statement fraud.
• Whether there are particular types of organizations and individuals the Board should consider reaching out to.
• Whether research is needed regarding the auditor’s approach to the detection of financial statement fraud.
• What the Board should focus on when conducting outreach and research activities.
• Whether the outreach and research should apply to broker-dealer audits or whether the Board should conduct separate outreach for such audits.

PCAOB staff members reported a summary of the breakout discussions regarding the Board’s possible direction in conducting outreach and research related to the detection of fraud. The views expressed include the following:

• Generally, SAG members supported outreach and research related to the auditor’s approach to detecting fraud but stressed that the PCAOB needs to establish a clear objective and scope for the project. Others suggested that the PCAOB’s outreach and research not be limited to the prevention and detection of fraud but should focus on improving audit quality (e.g., perhaps by also focusing on determining root causes related to audit deficiencies noted in PCAOB inspections and identifying audit procedures that were used to successfully detect frauds). Such research, it was suggested, would help the PCAOB focus on areas that could have the greatest impact on audit quality.
• Some SAG members suggested that there should be a connection between outreach and research conducted and the recommendation by the U.S. Department of Treasury Advisory Committee on the Audit Profession that the PCAOB, in coordination with the SEC, create a national center “to facilitate auditing firms’ and other market participants’ sharing of fraud prevention and detection experiences, practices, and data and innovation in fraud prevention and detection methodologies and technologies, and commission research and other fact-finding regarding fraud prevention and detection, and further, the development of best practices regarding fraud prevention and detection.”¹² Chairman Doty commented that he believes that any outreach related to this issue will help inform the PCAOB as it considers such a center.
• Some also discussed the need to view the prevention and detection of financial statement fraud more holistically by considering all participants in financial reporting, including company management, audit committees, internal auditors, and external auditors. Several recommendations were made regarding the groups that the PCAOB should be working with in coordinating efforts to help prevent and detect fraud.
• The issue of considering costs and benefits of requiring additional forensic or fraud detection procedures was raised, along with the need to collect statistical data for, and perform analysis of, financial statement frauds that have occurred (prevalence, magnitude, and types) to make informed recommendations and decisions about whether and, if so, how the PCAOB should proceed.
• Most suggested that, while broker-dealer audits have unique aspects that would need to be considered separately, the information gathered could potentially also be applied in the context of broker-dealers.

While no consensus was reached during the discussion and no clear direction was provided regarding how the PCAOB will proceed, the PCAOB and its staff were appreciative of the feedback provided and indicated that they will be taking the comments into consideration.

Audit Committee Practices

The SAG meeting concluded with PCAOB board member Jay Hanson asking one of the SAG members, Michael Cook,¹³ to share his feedback on a practice that he has implemented as an audit committee chairman. Mr. Cook shared with the group that, at the suggestion of board member Hanson, he has undertaken a process whereby he, as the audit committee chairman, meets with the entire audit team at the beginning of the audit to share his insights regarding the importance of the audit, the role of the audit committee in overseeing the audit, and his expectation that the auditors bring important issues to his attention. To make the meeting both cost-effective and practical, some audit team members attended the meeting in person while others in various locations joined by video or teleconference. Mr. Cook explained that having such a meeting and using the various available technologies to enable all audit team members to attend the meeting allowed all audit team members, including the youngest and newest members of the audit team, to ask questions and communicate directly with him, which he found very helpful and insightful. Mr. Cook believes holding these types of meetings may be a best practice to effectively emphasize the role of the audit committee and further enhance communication between auditors and audit committees. He also suggested that the PCAOB consider providing audit committees with additional best practices that may help promote audit quality.

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1 The SAG meeting included a presentation by the PCAOB as well as breakout sessions on these topics during the afternoon of November 15, which were closed to the public. A summary of the nonpublic breakout discussions was presented to the entire SAG on November 16.

2 PCAOB Release No. 2012-003, Information for Audit Committees About the PCAOB Inspection Process.

3 PCAOB Release No. 2012-004, Auditing Standard No. 16 — Communications With Audit Committees; Related Amendments to PCAOB Standards; and Transitional Amendments to AU Sec. 380.

4 PCAOB Release No. 2012-006, Concept Release on Auditor Independence and Audit Firm Rotation; Notice of Roundtable.

5 PCAOB Release No. 2012-005, Report on the Progress of the Interim Inspection Program Related to Audits of Brokers and Dealers.

6 IFIAR was established in 2006 and concentrates on sharing knowledge and experiences of auditor oversight bodies, focusing on inspections, promoting collaboration, and providing a platform for dialogue.

7 The Jumpstart Our Business Startups Act.

8 This project was originally combined with transparency of other public accounting firms or persons involved in the audit. These are now two separate projects.

9 The PCAOB explained that the timing of this project depends on the SEC’s adoption of amendments to Rule 17a-5.
Mr. Baumann commented that the Board plans to act quickly once the SEC completes its rulemaking.

01 The PCAOB explained that the timing of this project depends on the timing of the FASB’s going-concern project.

1 IAASB Invitation to Comment, Improving the Auditor’s Report.

12 Recommendation 1 of the Final Report of the Advisory Committee on the Auditing Profession, issued on October 6, 2008.

13 Michael Cook is the retired chairman and chief executive officer of Deloitte & Touche LLP. Mr. Cook is a member of the board of directors and chairs the audit committee of Comcast Corporation and is a board member of International Flavors & Fragrances, where he chairs the Compensation Committee. In addition, Mr. Cook is chairman of the Government Accountability Office’s Accountability Advisory Panel.

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