March 22, 2023

Audit Committees: Questions to Ask When Your Lead Auditor Outsources Work

On Friday, the SEC’s Chief Accountant, Paul Munter, issued a statement on the responsibilities of lead auditors to conduct high-quality audits when involving other auditors. He notes this has become a prevalent practice:

The increasing integration of world economies and the resultant globalization of multinational public companies has led to increased use of, and more significant roles for, accounting firms and individual accountants other than the lead auditor (“other auditors”) on many issuer audit engagements.

In 2021, for example, 26 percent of all issuer audit engagements and 57 percent of large accelerated filer audits involved the use of other auditors by the lead auditor. In some cases, engagements include the use of other auditors that may not even be registered with the Public Company Accounting Oversight Board (“PCAOB”) and that work in countries with different business cultures and languages from those of the lead auditor.

Here’s the part that’s most relevant to audit committees & companies – and those of us who advise them:

Audit committees make significant contributions to financial reporting through their critical oversight of the independent auditors. With respect to the use of other auditors, audit committees should be actively engaging with the lead auditor to consider the sufficiency of their quality control system, specifically those policies and procedures around supervision and evaluation of the audit work performed by other auditors. This also includes giving careful consideration to the lead auditor’s use of other auditors, especially in areas of significant risk, and engaging in related dialogue in response to communication requirements. Potential questions that audit committees could be asking their auditors include, but are not limited to the following:

– Are there other participating accounting firms that play a substantial role in the audit?

– If so, are they registered with the PCAOB and subject to PCAOB inspections?

– How does the lead auditor supervise the audit work performed by other auditors?

– How does the lead auditor assure that the work is being performed by other auditors that understand the requirements of the applicable financial reporting framework and the PCAOB’s auditing and related professional standards?

We also remind issuers and audit committees that if an unregistered firm plays a substantial role in the audit, the issuer’s financial statements are considered to be “not audited.” Any accompanying annual report, proxy statement, or registration statement containing or incorporating by reference such financial statements creates potential liabilities for the issuer and others, and may result in time consuming and costly remediation efforts. Therefore, management and audit committees should engage with the auditors regarding the PCAOB registration status of other auditors.

The statement also covers lead auditor’s responsibilities in these situations and how those responsibilities are incorporated in PCAOB standards. Paul has been preaching the need to pay attention to audit quality in a series of speeches over the past several years – including this one focused on engagement structures specific to China-based audits, commentary on auditor independence, and this 2021 year-end statement that flags “audit quality” as a key focus area.

Liz Dunshee