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In Response to Investor Demand, PCAOB to Consider Adding Audit Quality Indicator Project to Agenda

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

Following requests by several heavy-hitters in the financial reporting ecosphere, the PCAOB is finally considering picking back up an old project that got shelved several years ago because of resistance by audit firms and to a lesser extent by audit committees.

The project in question is the development of audit quality indicators (AQIs) as part of a broader effort to improve audit quality.

“I really appreciate this question from Lynn [Turner]. Many of our stakeholders, as you know, have indicated that audit quality indicator is of great interest to them, and we are looking into options for adding a standard-setting project or research project related to AQIs to our agenda, and I hope to provide an update very soon,” PCAOB Chair Erica Williams said on July 28, 2022, at an event commemorating the 20th anniversary of the Sarbanes-Oxley Act of 2002, which created the audit regulatory board to better oversee the auditing profession following accounting scandals at Enron, WorldCom, and others at the time.

Over the years, the board’s Investor Advisory Group members had pressed the PCAOB to move ahead with the stalled project to no avail.

Now more recently, with new leadership at the board, who is putting a big emphasis on carrying its responsibilities to protect investors, AQIs might become a reality.

AQI was one of the several recommendations in a report issued by the Treasury Department’s Advisory Committee on the Auditing Profession (ACAP) in 2008. The PCAOB has implemented some other recommended reforms from the report, such as expanded auditor’s report, but others such as AQIs and fraud prevention, have had little progress.

With the leadership change at the board in January, the standard-setting and research agendas got refreshed in May, with many projects on them, including one on fraud on the mid-term standard-setting agenda. However, AQI was nowhere to be seen.

During recent advisory group meetings, advisers such as Turner, who is a former SEC chief accountant, Jack Ciesielski, Sandra Peters, and Jeffrey Mahoney, said they need more relevant information to be able to assess audit quality.

Peters is senior head for global advocacy of the CFA Institute, and she also serves on the SEC’s Investor Advisory Committee. Mahoney is general counsel of the Council of Institutional Investors, who moderated the July 28 Sarbanes-Oxley event. Ciesielski is president of R.G. Associates, Inc. and also serves on the FASB’s Emerging Issues Task Force.

At the July 28 event, Williams said that she wants “to reiterate that our focus is on performance standards such as quality control standards, and that will also directly affect the body of work performed by the auditor as well as the firm’s quality control system.”

Currently, the PCAOB is working to issue a proposal later in the year on quality control. In December 2019, the board issued a preliminary rulemaking document to solicit the public’s input about ways to improve the quality control standards.

A firm’s quality control deals with its system of employee training and compliance with professional standards and its standards of quality. The regulatory board believes that strong quality controls are important to audit quality, but the inspections staff has continued to find deficiencies in audit engagements as well as problems in firms’ quality control systems in certain areas.

Currently, the PCAOB uses the AICPA’s quality control standards issued in 1997 when the board did not exist. The audit environment has changed dramatically since then, especially with advances in technology.

“And of course, while focusing on those areas are important for the benefit of investors because they directly drive audit quality, we are … actively considering what additional information investors may need for them to be able to assess the quality of audit,” Williams added. “So, as many of you have heard me say before, and I know Lynn has heard me say, our standard-setting agenda is dynamic. And as we advance these projects, we will continue to evaluate our approach, including related to audit quality indicators.”

AQI: A Long-Stalled Project

The PCAOB first put out a preliminary rulemaking document on AQIs in July 2015. Shortly afterward, however, the board shifted to monitoring audit firms’ voluntary actions in the area because of opposition in the auditing industry, to the disappointment of investor advocates.

The comment letters by the audit firms tended to question why the indicators were needed through a regulatory initiative if accountants could address them through firm-wide policies. In their view, indicators should be tailored and customized to particular audits to be useful. In particular, they said quantitative measures mean little without qualitative discussions of a particular audit.

They also said some indicators, in particular the measures that deal with specific audit engagements, should not be mandated or made public.

Auditors and audit committees were concerned that the public might overreact to the information without the proper context. But Investors said they are fully capable of evaluating the measures. They also viewed the indicators as an important piece of a more far-reaching plan to use regulations to strengthen auditors’ independence from their clients. Some large investor groups believe the indicators could give them meaningful information when considering their votes to ratify the external auditor and elect the chair of the audit committee.

The 2015 release laid out 28 indicators, covering three broad categories dealing with audit professionalism, process, and results.

Some indicators are straightforward and sometimes measured or described by audit firms. They include employee workload, length of time spent examining a client’s books, staff expertise and experience, independence, and inspection results. Others may be more difficult to gauge, such as tone at the top, which tends to apply to a firm’s management practices and integrity, leadership, fraud detection, and financial reporting quality.

 

This article originally appeared in the August 4, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.

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