As part of its oversight responsibilities, the Public Company Accounting Oversight Board (PCAOB or the Board) inspects registered public accounting firms’ audits and quality control (QC) systems for compliance with applicable laws, rules, and professional standards. This article provides a quick update on recent developments related to the Board’s inspection program, specifically with respect to auditor independence.
PCAOB Staff Announces Priorities for 2023 Inspections
In April 2023, the PCAOB issued Spotlight: Staff Priorities for 2023 Inspections, a document that highlights the inspection staff’s priorities this year. These include, among other things: the risk of fraud, digital assets, critical audit matters (CAMs), financial services, broker-dealers, cybersecurity, and independence. As noted in Staff Update and Preview of 2021 Inspection Observations, independence remains an area for improvement as inspectors have continued to find violations of the independence rules, including those relating to financial relationships with audit clients, communications with audit committees about independence, and audit committee pre-approval of the auditor’s services.
The Board’s inspection teams plan to prioritize the following actions:
• Understand and assess how the audit firm monitors independence throughout the audit and professional engagement period for possible quality control (QC) concerns. This includes the firm’s identification and assessment of violations of the firm’s policies and procedures.
• Evaluate compliance with the independence rules for permissible, significant non-audit services, and their preapproval, including PCAOB Rule 3524, Audit Committee Preapproval of Certain Tax Services.
• Review audit firms’ communications with client audit committees concerning independence.
• Review audit firms’ responses to independence-related QC concerns in previous inspections.
• Increase attention to evaluating an audit firm’s policies and procedures over independence, including with respect to providing non-audit services.
• Monitor the creation of alternative practice structures by certain firms and related private equity investment groups, and how these firms are managing risks related to independence.
Inspection Report Enhancements
On May 2, 2023, the PCAOB introduced enhancements to its inspection reports. A new section on auditor independence and other improvements are intended to increase transparency by providing useful information to investors and other stakeholders. The changes will appear in PCAOB inspection reports completed in 2022, beginning with eight (8) inspection reports released on May 2.
The new section in the reports, Part I.C, Independence, notes instances of noncompliance with PCAOB independence rules, and potential noncompliance with U.S. Securities and Exchange Commission (SEC) independence rules. One disclosure cites violations the Board staff identify in their inspection procedures. The other cites violations the firm has identified and reported to the team. Examples of each follow:
Inspection team-identified violation(s) or none to report:
Example 1:
We identified the following instance of potential non-compliance with SEC rules or instances of noncompliance with PCAOB rules related to maintaining independence:
Under Rule 2-01(c)(7) of Regulation S-X, an accountant is not independent if it does not obtain audit committee pre-approval for audit and non-audit services. We identified two instances across two issuers in two audits reviewed in which this circumstance appears to have occurred related to audit services.
Example 2:
We did not identify any instances of potential non-compliance with SEC rules or instances of noncompliance with PCAOB rules related to maintaining independence.
Firm-identified violation(s) or none to report:
Example 1:
During the inspection, the firm brought to our attention that it had identified, through its independence monitoring activities, one instance for one issuer in which the firm appeared to have impaired its independence because it may not have complied with Rule 2-01(c) of Regulation S-X related to maintaining independence.
The firm reported three instances of potential non-compliance with Rule 2-01(c)(1) of Regulation S-X regarding financial relationships, which occurred at the firm or involved its personnel. Of these instances, one related to an investment managed by an audit client and two related to other financial relationships with an audit client. Two of these instances related to a member of an engagement team.
Example 2:
The firm reported one instance of potential non-compliance with Rule 2-01(c)(7) of Regulation S-X regarding audit committee pre-approval. This instance related to a service provided that the firm determined was permissible.
Example 3:
The firm did not bring to our attention any instances of potential non-compliance with SEC rules or instances of non-compliance with PCAOB rules related to maintaining independence.
Disclosures about firm-reported violations also include the following language:
… the number, large or small, of firm-identified instances of potential non-compliance may be reflective of the size of the firm, including any associated firms; the design and effectiveness of the firm’s independence monitoring activities; and the size and/or complexity of the issuers it audits, including the number of affiliates of those issuers. Therefore, we caution against making any comparison of firm-identified instances of potential non-compliance across firms.
If the firm reports a violation, the following type of language may also appear:
The firm has reported to us that it has evaluated this instance of potential non-compliance and determined that its objectivity and impartiality was not impaired.
Apart from independence, the reports also provide:
• more information related to fraud procedures and the identification and assessment of the risks of material misstatements. Specifically, the reports will expand Part I.B to include deficiencies related to AS 2401, Consideration of Fraud in a Financial Statement Audit, and AS 2110, Identifying and Assessing Risks of Material Misstatement.
• additional commentary in Part I.A for certain situations, such as whether the audit was the firm’s first audit of the issuer or whether the firm had identified significant risks, including fraud, for areas in which PCAOB inspection staff identified deficiencies.
• new graphs, for annually inspected firms, to clearly show firm and engagement partner tenure.
For more information on the Board’s enhancements, click here.
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