SEC Chief Accountant Urges Profession to Explore Blockchain Impact on Financial Reporting within Current SEC Regulatory Framework


In a November 14 speech before the Financial Executives International (FEI) 36th Annual Financial Reporting Issues Conference, SEC Chief Accountant Wesley Bricker, called on the accounting profession to "light a lamp" to understand distributed ledger, i.e., blockchain, technology, and its impact on financial reporting.  He noted that the SEC's Office of the Chief Accountant (OCA) is doing similarly, and "with a compass; namely the Commission's existing accounting and auditing requirements, books and records requirements, auditor independence rules, and the federal securities laws more generally".  Referring to these things collectively as a "framework," Bricker urged the profession to invest the time to understand the impact of new technologies on commerce and financial reporting within the current framework, even though those rules predate the development of recent technologies such as blockchain.   

PCAOB 2016 Inspection Preview Cites Old and New Independence Deficiencies


The Public Company Accounting Oversight Board (PCAOB), in its Staff Inspection Brief - Preview of Observations from 2016 Inspections of Auditors of Issuers, reported lingering concerns about recurring deficiencies in three areas (audit risk assessments, and auditing internal control and accounting estimates), and other areas of inspection focus, including independence.  As to independence, the PCAOB cited repeated, and even one new (to me anyway) concerns regarding firms' compliance with SEC (Securities and Exchange Commission) and/or PCAOB independence rules. The observation that was new to me was this one: 

  •  Firms are misapplying Rule 2-01(d) of SEC Regulation S-X and wrongly concluding that a covered member's financial relationship with the audit client (or an affiliate) did not impair the firm's independence. Rule 2-01(d) is entitled Quality Controls and follows part (c) of the rule, which describes various interests and relationships that are considered to impair independence.  I don't recall seeing this type of observation in previous reports (unlikely, but maybe I missed it) but this observation implies that firms that discovered a covered person's financial relationship (e.g. stock interest) with an audit client wrongly concluding that the interest did not impair the firm's independence. Firms have traditionally viewed 2-01(d) as a "safe harbor" provision that would not penalize a firm that experienced a covered person's lack of compliance if certain conditions were met (e.g., the  covered member was not aware of the circumstance that put them out of compliance, and the firm corrected the matter swiftly once discovered and had an adequate quality control system in place).  It would be interesting to know more details about this observation, but my hunch is (perhaps?) the firms could not demonstrate that the covered person lacked awareness or that the firm acted as quickly as the PCAOB inspectors would expect... Hard to say, and I would love more facts. 

Other observations were more in line with what I think we've seen before, which were: 

  • Insufficient communication with the audit committee about the scope of the firm's tax consulting services, and their potential impact on the firm's independence. 
  • Indemnification agreements included in audit engagement letters protecting the auditor against liabilities or expenses related to the audit (strictly prohibited). 
  • Impermissible bookkeeping or management functions performed during the period under audit, but prior to engagement. (Independence restrictions apply to both.)
  • Failure to make required communications to the audit committee about independence (required prior to appointment and annually thereafter).
  • Inadequate quality control over the independence of outside auditors or firms involved in group audits. 

The report also cited frequent deficiencies in firms' performance of engagement quality reviews (EQRs), including that in certain instances individuals were not qualified to perform the EQR because they had served as the audit partner during one of the prior 2 years, which violates PCAOB Auditing Standard 1220, Engagement Quality Review(par. .08). 

The report was based on 2016 inspections of portions of more than 780 public company audits and quality control systems reviews performed on more than 190 firms.  


CAQ Report Says Audit Committee Transparency Continues to Increase in 2017


The Center for Audit Quality (CAQ), with Audit Analytics (AA), published the 2017 Audit Committee Transparency Barometer indicating that audit committees are, in many ways, becoming more transparent in disclosing how they oversee and evaluate their companies' external auditors. The CAQ/AA initiative, performed annually since 2014, measures the robustness of proxy disclosures of companies in the S&P 500, S&P MidCap (top 400) and S&P SmallCap (top 600) groupings ("S&P 1500," collectively).   The 2017 report is based on proxy statements filed between July 1, 2016 and June 30, 2017. 

According to the CAQ/AA, notable findings include: 

Enhanced disclosures re: recommending the appointment of the auditor: 

  • Thirty-seven (37) percent of S&P 500 companies (vs. 13 percent in 2014).  
  • Twenty-four (24) percent of mid-cap companies (vs. 10 percent in 2014)
  • Seventeen (17) percent of small-cap companies (vs. 8 percent in 2014)

Disclosures of the committee's criteria when evaluating the auditor: 

  • Thirty-eight (38) percent of S&P 500 companies (vs. 8 percent in 2014).
  • Twenty-eight (28) percent of mid-cap companies (vs. 7 percent in 2014)
  • Twenty-seven (27) percent of small-cap companies (vs. 15 percent in 2014).

Other proxy disclosure increases related to: 

  • auditor tenure, especially in the S&P 500
  • involvement in auditor fee negotiations, especially in the S&P 500
  • audit firm evaluation and supervision, most notably among the S&P 500
  • audit engagement partner selection (more so in the larger companies)

The report also noted that many of its findings were consistent with two other reports; Trends in Audit Committee Reporting (Jan 17) - Deloitte's Center for Board Effectiveness, and Audit Committee Reporting to Shareholders in 2017 - EY Center for Board Matters.