Audit Conduct

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PCAOB guidance clarifies auditor communications when violating independence

In May 2019, the Public Company Accounting Oversight Board (PCAOB) issued new guidance on the application of Rule 3526(b) Communications with Audit Committees Concerning Independence (Staff Guidance).  That rule requires the auditor to identify in writing to the audit committee any relationships between the auditor and the client and the client’s key persons that might affect independence and discuss with the committee the potential effects of these relationships on the firm’s independence. The auditor then needs to affirm in writing to the audit committee that the firm is independent in compliance with PCAOB Rule 3520, Independence, and document the substance of its discussion about independence with the audit committee.  

PCAOB inspectors have noted that in certain cases, auditors have affirmed their independence despite the existence of one or more violations of the independence rules. Thus, the Staff guidance addresses how an auditor should communicate such violation(s) to the audit committee once they have each determined that the violation did not impair the auditor’s independence in fact or appearance. The Staff references the following fact pattern as being most prevalent in these cases:  

1) An auditor analyzes the facts and circumstances related to an independence violation and concludes that the firm was capable of exercising objective and impartial judgment in performing the audit;

2) The violation has been or is currently being resolved;

3) The auditor communicates the matter and its analysis to the client’s audit committee;

4) The audit committee evaluates the information and agrees with the auditor’s conclusion; and

5) The audit committee and auditor agree to continue the audit engagement because, despite the violation, a reasonable and informed investor would conclude that the firm remained independent.

The Staff Guidance outlines several additional steps the auditor should perform in these situations. First, the auditor should discuss each violation and its analysis with the audit committee and document the substance of those discussions. If multiple violations occurred during the year, the auditor should provide the audit committee a separate analysis of each violation, stating the firm’s rationale as to why the violations in the aggregate did not impair the firm’s independence either in fact or appearance. Lastly, the auditor should affirm in writing to the audit committee that, except for the violation(s) expressly identified, the auditor would be independent in compliance with Rule 3520. The Staff Guidance suggests language that the auditor may consider.

Prior to issuance of this guidance, in these circumstances, auditors typically would affirm independence without any reference to violating the rule(s). They may or may not have addressed violations in the aggregate (if applicable) or documented the substance of any discussion(s) about the violation(s) with the audit committee. Therefore, for firms performing the steps outlined in 1-5 above, these steps represent additional procedures that auditors should consider when independence violations are identified. If a firm has even less formal means of communicating violations than the description provided in 1–5 above, the firm should carefully consider incorporating the new guidance in its entirety.

An important caveat: following the process outlined in the guidance does not "cure" the violation(s) of Rule 3520. The guidance applies only to the auditor’s communication of the violation(s) to the audit committee; it does not address the violation itself. The firm and the audit committee may wish to consult with the SEC Staff on specific matters.

Other highlights

A violation addressed with the audit committee in a prior year need not be included in a subsequent year's communication with the committee if no new facts have come to light that would change the resolution of the prior violation.  In those cases, the auditor may affirm independence in the current year, if as of the date of the communication, the firm is independent in accordance with Rule 3520. This presumes the auditor has fully resolved the violation and no new instances have occurred in the current period.

Following the process outlined in this guidance allows the auditor to continue to use the title, "Report of Independent Registered Public Accounting Firm" in its audit report, as that title does not constitute a specific assertion about compliance with Rule 3520.

Note: Staff Guidance sets forth the Staff's views on issues related to the implementation of PCAOB standards. The statements contained in Staff Guidance are not rules of the Board, have not been approved by the Board and do not reflect any PCAOB determination or judgment about the conduct of any auditor.