July 27, 2022
Audit Committees: PCAOB Inspection Priorities Preview Challenging Audit Issues
Recently, the PCAOB published its anticipated focus areas for auditor inspections. Being familiar with the inspection priorities can help audit committees understand auditor work plans and areas of sensitivity – and can also give advance notice of which areas could present accounting or reporting challenges in the upcoming year. I blogged last October about the findings from the 2021 inspection cycle.
This blog from Dan Goelzer summarizes the 10 topics that the PCAOB plans to scrutinize. Here’s info from Dan (who is a SASB member, retired Baker McKenzie partner, former Acting Chair of the PCAOB, and former GC at the SEC):
The staff discusses ten areas on which 2022 inspections will focus:
Fraud and Other Risks. The inspection staff will emphasize audit procedures that address risks of material misstatement, including fraud. Some specific risk areas are IPOs or significant M&A activities, including SPAC transactions; the effects of supply chain disruption; and volatility due to fluctuations in interest rates and inflationary trends. Industries prone to supply chain disruption risks include electronic components and equipment, automobile, retail, and materials. Industries prone to COVID-19 related risks include airlines, hospitality, and entertainment. Inspectors will also review the auditor’s assessment of fraud risk, including whether the company’s controls sufficiently address identified risks, such as the risk of management override of controls.
The Spotlight lists five specific accounting and auditing risks:
o Unreasonable assumptions affecting revenue recognition due to the negative effects of the COVID-19 pandemic and supply chain disruptions.
o Unreasonable assumptions used in projections to account for business combinations or in testing goodwill or other intangibles for impairment.
o Earnings manipulation as a reaction to margin pressures driven by rising costs.
o Inventory existence and valuation (e.g., challenges in observing in-transit inventory and in valuation due to supply chain disruptions and rising costs).
o Financial, economic, and business uncertainties that impact the assessment of the company’s ability to continue as a going concern.
IPOs and M&A Activity. IPOs and M&A, including SPAC transactions, present reporting and audit risks due to transaction complexity and variations in company readiness to comply with public company financial reporting and internal control requirements. For SPAC and de-SPAC transactions, inspectors will focus on the auditor’s work in the areas of financial instrument valuation; determination of whether a business combination should be accounted for as a reverse merger; internal controls; financial statement presentation and disclosures; and restatements.
Audit Firms’ Execution Challenges. Inspectors will review firm policies and procedures for assigning professionals with appropriate qualifications to audit engagements and whether firms are modifying their supervision and review procedures appropriately. The Board also plans to select engagements for review where the lead engagement partner is new to the engagement, including those resulting from partner turnover.
Broker-Dealer-Specific Considerations. In inspections of securities broker-dealer audits, the staff will examine how auditors addressed the risk of misappropriation of customer assets at broker-dealers that hold customer funds.
Independence. Independence will remain a focus area in 2022. In particular, inspectors may:
o Analyze audit firm independence assessments, including relationships that present threats to objectivity and impartiality, and firm-identified violations of independence rules.
o Evaluate compliance with the independence rules related to permissible non-audit services and their preapproval.
o Review audit firm communications with audit committees concerning independence.
o Review audit firm responses to independence-related quality control concerns identified in past inspections (e.g., high rates of exceptions in independence compliance testing).
Use of Service Providers in the Confirmation Process. Inspectors will review procedures for maintaining control over confirmation requests and responses, particularly in cases where the auditor arranges for service providers to assist in the confirmation process by electronically sending and receiving confirmations.
Critical Audit Matters (CAMs). Inspection procedures will include: (1) engaging in discussions about CAMs with engagement teams and certain audit committees; (2) reviewing CAMs in the auditor’s report; (3) reviewing whether certain matters communicated to the audit committee were included in the audit firm’s procedures to determine CAMs; and (4) reviewing the engagement team’s determination of whether a matter was a CAM.
Audit Areas With Continued Deficiencies. Inspectors will focus on areas in which audit deficiencies commonly recur, including revenue recognition and related risk assessment; allowance for loan losses and other accounting estimates; and internal control over financial reporting, particularly controls with a review element.
Firms’ Quality Control Systems. Inspectors will assess audit firms’ compliance with the PCAOB’s quality control standards. Among other things, they will consider the impact of the COVID-19 pandemic and of the current economic environment in gaining an understanding of firm quality control systems.
Technology. Inspectors will focus on three technology-related areas:
o Auditing digital assets. Companies with material digital asset holdings and transactions will be selected for inspection, where appropriate, with an emphasis on assertions related to existence, valuation, rights and obligations, and financial statement disclosures.
o Responding to cyber threats. Inspection procedures will evaluate the auditor’s response to identified cybersecurity breaches and known security vulnerabilities.
o Use of data and technology in the audit. Inspectors may inquire about changes in the use of technology and seek to obtain an in-depth understanding of how auditors are using technology in identifying and responding to risks of material misstatement.
Visit our “Audit Committees” Practice Area for more PCAOB commentary, checklists, and other practical guidance for committee practices & emerging challenges.
– Liz Dunshee