The Public Company Accounting Oversight Board’s (PCAOB) Investor Advisory Group (IAG) once again pressed the board to complete a slow-moving rulemaking project that would provide information that investors could use to gauge the quality of a public company financial statement audit: audit quality indicators (AQIs).
This time, members of the IAG are requesting the board to work on AQIs in response to a proposal the board issued in November 2022 that would revise the PCAOB’s quality control standards that audit firms must follow. The advisory panel wants the PCAOB to work on both AQIs and quality control standards at the same time, and it did not mince words in urging the board to do so.
“The process of establishing a quality control standard naturally fits simultaneously with the establishment of audit quality indicators,” IAG wrote. “How else can consistent audit quality be maintained if it is not measured and quantified? The proposal fails to establish even a few audit quality indicators.”
Members of IAG wrote their views in a comment letter submitted in response to Release No. 2022-006, A Firm’s System of Quality Control and Other Proposed Amendments to PCAOB Standards, Rules, and Forms.
“We believe that the development of audit quality indicators should not be done in a vacuum, but as an adjunct project to the other auditing standards that the PCAOB is establishing,” IAG wrote. “The replacement of the quality control standards is a logical place to start this approach.”
Quality control is foundational to audit quality because it deals with a firm’s system of employee training and compliance with professional standards and its standards of quality. And the board first issued a preliminary document to solicit comment more than three years ago after the inspections staff continued to find deficiencies in audit engagements as well as problems in firms’ quality control systems in certain areas.
For a long time, the development of AQIs has been one of the top requests by investors—including by IAG— and it has been discussed during advisory group meetings, including by the current members of the IAG which was reconstituted last year under the new leadership of the PCAOB.
The board under the leadership of James Doty issued a concept release on AQI in 2015 but quickly shifted to monitoring mode because of pushback by audit firms and audit committee members. Doty’s successor, William Duhnke, followed a more auditor-friendly agenda, and AQIs were set aside.
Now with Chair Erica Williams, who has been emphasizing investor protection, the board added it onto its research project under a newly-branded name called firm and engagement performance metrics in October 2022, even if it disappointed some advisory members as it was not put on the standard-setting agenda.
“While we understand that audit quality indicators are a separate research project on the Board’s docket, that should not prevent the inclusion of a minimum number of such indicators in the quality control standard,” IAG wrote. “More indicators can be added as progress is made on the research project.”
The panel recommended a minimum of eight AQIs, which were drawn from the 2015 concept release: staffing leverage; partner workload; manager and staff workload; audit hours and risk areas; quality ratings and compensation; audit fees, effort, and client risk; audit firms’ internal quality review results; and PCAOB audit inspection results.
“While we would prefer a more complete set of audit quality indicators, we believe that these would be an effective starting set for integration into the design of a quality control system,” the comment letter noted.
Rationale Behind Request for AQIs on Quality Control Project
In their comment letter on the quality control proposal, members of IAG said that their views were formulated based on how well the proposal would meet investors’ needs as provided by the auditor’s opinion on financial statements.
“A standard for a quality control management system for independent auditors should establish and include objectives for the system and discuss the benefit for investors,” IAG wrote.
Today, auditors opine on whether financial statements were fairly presented or not. They also disclose critical audit matters on auditor’s reports. But IAG noted that investors need more than that. They must have information to figure out whether the audit was performed “capably” so that they can better make decisions about whether the current auditor should continue or not during a company’s annual meeting votes. IAG said that having more information about the capability of auditors is also important for the election of audit committee chairs or members.
“Most importantly, such information provides investors with a level of confidence in the financial statements of companies in which they invest,” IAG wrote. “Their level of confidence in the financial statements has a bearing on the prices they will be willing to pay or demand for investments.”
The advisory panel believes a robust system of quality control can help provide information about engagement-specific audit quality to investors if the information is quantified and communicated publicly.
“We see no evidence of this in the Proposal,” IAG stated. In particular, its members want AQIs at audited company level, audit firm office level and the audit firm level.
“Perhaps because there are no required quantified audit quality indicators, we see no new information in the Proposal that would be transmitted to investors,” IAG noted. “In fulfilling their duty to oversee audit committees and vote on the ratification of their appointment of auditors, investors should be provided with information about the quality of audits at the engagement level.”
PCAOB Gets Failing Grade on Proposal?
In the meantime, the group had several other criticisms about the proposal, and it did not hold back in expressing its disappointment.
For example, the panel wrote that the “proposal has been formulated without any apparent assessment of current practice. It seems to have been developed in a vacuum. Without an assessment of what is working or not working effectively in current practice, we believe the proposal may miss quality control attributes that need attention.”
And IAG was not alone in sharing criticisms with the audit regulatory board. While comment letters from the auditing profession used more tempered language, they also had plenty of suggestions, which obviously do not always align with what investors want.
The Center for Audit Quality (CAQ), an affiliate of the AICPA, wrote that the proposal is too prescriptive without providing commensurate benefit to audit quality. The views expressed by the CAQ largely reflect what audit firms believe as it represents accounting firms that have public company audit clients.
“The volume of prescriptive requirements, such as specified quality responses, make the standard inherently less scalable,” the CAQ wrote.
This article originally appeared in the Feb. 22, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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