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Staff Paper on Specialists Planned for Year-End Release

The PCAOB’s staff is working on a consultation paper about an audit firm’s use of specialists to improve audit performance.The project is closely linked to the board’s effort to improve audits of accounting estimates.

The PCAOB is planning to issue a staff consultation paper by the end of 2014 or in early 2015 on the auditor’s use of specialists.

The project is closely linked to the board’s effort to improve audits of accounting estimates.

It’s far from clear how the board will use its findings from the paper, but it may develop a single auditing standard on accounting estimates, which is generally regarded as one of the most complex areas of financial reporting.

With the increasing number of accounting estimates, including fair value measurements, in financial statements, auditors’ reliance upon specialists to test clients’ valuations has grown significantly.At the same time, PCAOB officials have been frustrated by inspection findings that regularly uncover audit firms mishandling their dealings with specialists.

In 2010, the regulatory board published Release No. 2010-004,Auditing Standards Related to the Auditor’s Assessment of and Response to Risk and Related Amendments to PCAOB Standards,which established a series of eight risk assessment standards firms have to use, particularly when employing specialized skills or knowledge.The standards range from Auditing Standard (AS 8) No. 8,Audit Risk,to AS 15,Audit Evidence.

“We’ve seen execution problems through inspections,” PCAOB Chief Auditor Martin Baumann said during the board’s Investor Advisory Group meeting in Washington on October 20, 2014. “They don’t always recognize when they need those skills, but the requirement is there.”

The PCAOB has a separate standard on the use of specialists, AU Section 336, “Using the Work of a Specialist,” (AU-C Section 620).

If the audit firm has an in-house specialist, the firm must supervise the specialist and make sure its conclusions are supported with the necessary documents.If the auditor hires a third-party firm, the work still needs to be reviewed.Auditors also need to review specialists used by the client’s management.

The “standard is weaker.We think it needs to be improved,” Baumann said.Inspections have uncovered instances when firms are doing little more than taken the specialist’s work without question and adding it to the file for audit’s work papers.

“The engagement partner on the job is supposed to have sufficient knowledge of the industry he or she is in so that they can understand what a specialist has done,” Baumann said. “So all of these things are being addressed.”

To gather more information on the related issue of valuation, the PCAOB in August issued theStaff Consultation Paper:Auditing Accounting Estimates and Fair Value Measurements.It also held a special Standing Advisory Group meeting on the topic in early October.

Sandra Peters, head of the financial reporting policy group of the CFA Institute, said auditors don’t always have the expertise to engage a specialist or evaluate its work.

“You can’t really audit what you may not understand,” she said.

“I can look back at my younger audit self and say I wish I understood that better,” Peters said. “But I think it’s really hard to do the work if you don’t understand valuation concepts, you don’t understand how cash flows are derived, you don’t understand discount rates, and you don’t understand in doing the goodwill impairment tests the difference between a relative and a fundamental valuation approach.I think it’s challenging.”

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