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Deloitte’s Comment Letter Backs PCAOB Plan to Modify Small Firm Inspection Process

The SEC issued a proposal to solicit comments on the PCAOB’s rule proposal to inspect annually some small firms that do not regularly issue audit reports but do play a secondary role in some public company audits. Big Four accounting firm Deloitte said in its comment letter that it backed the plan because it would allow the PCAOB to deploy its inspections resources more efficiently.

Big Four accounting firm Deloitte Touche Tohmatsu Ltd. wrote in an April 29, 2016, comment letter to the SEC that the firm supports the PCAOB’s plans to modify its inspection process for some smaller audit firms that do not issue audit reports.

According to proposed changes in Release No. 34-77558, Public Company Accounting Oversight Board; Notice of Filing of Proposed Amendments to Board Rules Relating to Inspections, filed by the PCAOB in March, the board each year would inspect at least 5 percent of the small firms that participate in the audit “substantially” but do not issue audit reports. In 2007, the board initially filed proposed changes with the SEC not to inspect those firms. But since then, PCAOB inspection staff identified audit deficiencies in some of the firms that play a significant role but otherwise do not issue audit reports.

The SEC published the proposal on April 7 with comment deadline of May 4.

“Notwithstanding the discretion afforded to the board to inspect any registered firm at any time, focusing most of the board’s resources on registered firms that have the ultimate responsibility for issuing audit reports on issuer financial statements, would enable the PCAOB to review most efficiently the firms and their associated persons that are of the most relative significance to the board’s mission,” Deloitte wrote.

The Sarbanes-Oxley Act of 2002 requires the SEC to approve all major PCAOB decisions such as rules and the annual budget.

The audit regulator believes that the 5 percent threshold would involve review of “substantial role only” work that is appropriate and sufficient to provide for a useful, ongoing focus on that segment of the population of firms. The board can always inspect more firms in a given year without a rule, the SEC said in Release No. 34-77558.

The board filed the changes to Rule 4003(b), Frequency of Inspections, and Rule 4003(h) for accounting firms that have fewer than 100 public company audit clients. The small firms get inspected at least every three years.

Last year, 571 accounting firms issued audit reports for one to 100 public companies or brokerage firms, and 103 accounting firms reported having played a substantial role in at least one public company audit without having issued an audit report for any issuers. The PCAOB estimated that the 5 percent threshold will be about four to six firms each year.

The PCAOB also wants to add Rule 4003(e) to give it more discretion in deciding when to forego inspection of a particular firm, which will allow for more efficient use of inspection resources.

For example, there may be delays or impediments in inspecting accounting firms located overseas, according to Release No. 34-77558. Further, there may be small firms that issued audit reports for two years but stopped in the third year. There are 19 audit firms overseas awaiting inspections that have not issued audit reports since 2012, and 13 of the firms have not issued reports since 2010.

It is expected that the SEC will approve the small rule change. The PCAOB in practice has already been inspecting some firms that do not audit public companies but have only participated substantially in an audit.

Section 19(b) of the Securities Exchange Act of 1934 requires the SEC to act on pending PCAOB rules within 45 business days. The review can be extended for another 45 days if necessary.