PCAOB Inspections Outlook for 2019

As part of the overall strategic plan and reevaluation of how inspections of public company audits are planned, conducted, and reported on, the PCAOB has released its objectives and potential focus areas for planned 2019 inspections of issuers and brokers and dealers. We encourage audit committees, management and auditors to review this alert.

Background

In early December 2018, the PCAOB issued an Outlook on its objectives and potential focus areas for planned 2019 inspections of audits of issuers and brokers and dealers. This Outlook outlines ongoing inspections transformation efforts and provides an overview of various areas of inspection focus for 2019 to be aware of in consideration of ever enhancing audit quality initiatives to bolster the capital markets.

PCAOB Transformation of Inspection Approach

The PCAOB recently approved and announced its five year strategic plan and further outlined its approach to evaluating and transforming its audit inspection process. The PCAOB has placed significant emphasis on driving finding rates down through the cultivation of strong preventative controls within firms’ systems of quality controls. As such, the 2019 inspection process will include the PCAOB’s consideration of topics such as the procedures inspection teams perform on the review of specific audit engagements and a deeper focus on audit firm systems of quality control, the approach to selecting engagements for inspection and areas of inspection focus, and how and what the PCAOB communicates about such inspections. The PCAOB is further considering how to make the process forward-looking and how to more effectively consider evolving risks, environmental factors, and the changing needs of stakeholders. Many of these projects are noted as being long-term in nature, with the expectation that certain other projects are to have an effect on the 2019 inspections cycle.

Key Areas of Inspection Focus

The PCAOB has indicated the following potential areas of focus for inspections performed in 2019 which we shall explore further:

  • Audit Firms’ Systems of Quality Control
  • Independence
  • Recurring Inspection Deficiencies
  • External Considerations
  • Cybersecurity Risks
  • Software Audit Tools
  • Digital Assets
  • Audit Quality Indicators
  • Changes in the Auditor’s Report
  • Implementation of New Accounting Standards

Audit Firms’ Systems of Quality Control – The PCAOB intends to perform a deep dive into the design and operating effectiveness of such systems and how these promote an audit firm’s culture of audit quality and responsiveness to risks, scoping in the organization’s structure, complexity of firm practices, and the knowledge and experience of its professionals. Critical processes to be reviewed in depth include engagement acceptance and continuance decisions, firms’ internal audit monitoring programs, engagement performance and management of staff. Additionally, this area of focus will expand understanding of whether or not firms design policies and perform audit procedures to evaluate whether their issuer clients are establishing and maintaining appropriate codes of conduct and compliance programs related to fraud, bribery, corruption, and other violations of law, including inadvertent violations that may have a direct and material effect on financial statements.

Independence – Recognizing that independence contributes to public trust in the quality of audit services, the PCAOB intends to assess audit firm independence preventative controls, compliance with and knowledge of independence rules, and the impact on independence of non-audit services.

Recurring Inspection Deficiencies – Review of the remedial actions that firms are taking in response to previous inspection findings and consideration of the timing and progress of audit firm work, tools and techniques used to identify and define root causes of deficiency findings and the action steps and monitoring mechanisms firms deploy to address and prevent recurring deficiencies. Audit finding themes continue to include deficiencies in auditing internal control over financial reporting, revenue recognition, allowance for loan losses, and other accounting estimates, including fair value measurements (e.g., goodwill and intangible assets) along with deficiencies related to assessing and responding to identified risks of material misstatement.

External Considerations – External factors that impact the risk of material misstatements stem from a variety of sources and may emerge during the course of the period under audit. As such, the PCAOB reminds us that an auditor’s risk assessment procedures should be continuous throughout the audit. Inspection procedures will consider evaluating firms’ responses to elevated risks of material misstatement due to external considerations, including assessing how firms adjust the nature, timing, and extent of their audit procedures. Additionally, the PCAOB will assess firms’ evaluation of audit evidence, including consideration of evidence obtained through external sources, such as industry or economic data that potentially contradicts management assertions.

Cybersecurity Risks – Cyber risk and the evolving complexity relative to incidents and breaches of information systems remain at the forefront of risk assessment and the potential for material misstatement to companies’ financial statements.

Software Audit Tools – As firms continue to develop and use software audit tools, including the increasing incorporation of analytical tools, artificial intelligence, etc., the PCAOB intends to monitor whether the firms are effectively using these tools and applying appropriate due care and professional skepticism when they do. 

Digital Assets – Similar to the monitoring of software audit tools, the PCAOB will evaluate auditors’ responses to risks associated with digital assets (e.g., cryptocurrencies, initial coin offerings, and uses of distributed ledger technology such as blockchain). This includes consideration of audit firm independence, client acceptance and retention decisions, resource management, and planned audit procedures.

Audit Quality Indicators (AQIs) – As indicated above, the PCAOB plans to consider how firms may be using AQIs to monitor their audit work and assignment of staff and whether such AQIs are being discussed with audit committees. The PCAOB has further signaled it is looking to collaborate further with those who collect data and conduct research on the quality of audits to develop more thought leadership around AQIs.

Changes in the Auditor’s Report – In addition to changes to basic elements of the auditor’s report effective in 2017, the PCAOB Auditing Standard 3101 (AS 3101) will feature adoption of the disclosure of critical audit matters (CAM) within the auditor’s report for issuers beginning with larger accelerated filers for audits of fiscal years ending on or after June 30, 2019 and for other issuers for audits of fiscal years ending on or after December 15, 2020.6 The PCAOB, along with the SEC, is particularly interested in monitoring the results from “dry runs” the firms and their issuer clients are engaged in currently to aid in the implementation of this new and comprehensive standard and understanding unintended consequences or challenges that may result from adoption of this standard.

Implementation of New Accounting Standards – With the implementation of significant accounting standards that are effective (revenue recognition), are soon to be effective (leases), or will be effective in the near future (financial instrument accounting and expected credit losses), the PCAOB is focused on changes in firms’ auditing processes and procedures including both the implementation and disclosures of these new and significant standards. Emphasis will be placed on areas that require management judgment and how auditors have addressed related internal controls for both the implementation period and the post-implementation accounting and disclosure periods. This further includes review of auditors’ independence processes with respect to providing assistance to companies as they implement the standards. Additionally, the PCAOB is mindful and will continue to monitor impacts on evolving auditing standards – for example the pending PCAOB standard on Auditing Accounting Estimates, including Fair Value Measurements.

Next Steps 

We encourage audit committees, management and our audit professionals to remain abreast of the PCAOB’s focus and communications. 

For information on audit preparation or other audit services, please contact Michael Davis, CPA at 703.652.1124 or please feel free to leave us a message below.

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Material discussed in this article is meant to provide general information and should not be acted on without professional advice tailored to your firm’s individual needs.



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