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PCAOB Issues Second Proposal to Modernize Rules on Audit Confirmation Process

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

More than a dozen years after the Public Company Accounting Oversight Board (PCAOB) issued a rule proposal on audit confirmations, the board on Dec. 20, 2022, voted unanimously to issue another proposal for comment. Confirmation is a technique that auditors use to obtain or verify information about a company by inquiring a source outside the company. It is intended to make sure that the information in the financial statements is accurate.

The proposal would better reflect today’s business environment and the increasing use of sophisticated technology that was not available when the current standard was written three decades ago. The standard would also strengthen confirmation procedures to better help prevent fraud.

The proposal covers five main areas: auditors would need to confirm a company’s cash and cash equivalents held by third parties; the existing requirement would also cover accounts receivable with some differences; negative confirmation would be insufficient; more illustrative examples when alternative procedures can be performed; and more clarity on the role of internal auditors in the confirmation process.

The standard in question is Auditing Standards (AS) No. 2310, The Confirmation Process, and the PCAOB wants to replace it in its entirety with a new standard, AS 2310, The Auditor’s Use of Confirmation. AS 2310 requires auditors to maintain control over the confirmation requests and responses during the confirmation process.

But AS 2310 is an old AICPA standard that became effective in 1992 when electronic communications were far less advanced than are today. For example, existing AS 2310 references fax, which most businesses have stopped using more than a decade ago. After the PCAOB was established two decades ago, the board on an interim basis adopted AICPA standards that auditors of public companies must use. Over the years, the PCAOB revised some of the interim standards while others have remained unchanged, such as AS 2310.

The PCAOB first issued a concept release in 2009 and followed up with a proposal in 2010 in Release No. 2010-003, Proposed Auditing Standard Related to Confirmation. But there was some pushback by audit firms at the time, saying the proposal was too prescriptive. And the project got set aside, and the PCAOB for a decade focused on other standards until the most recent board took over. Erica Williams, who became PCAOB chair in early 2022, said that it is the board’s priority to update old standards and set an ambitious standard-setting agenda in the spring, which includes this project.

“It is so critical to ensure our confirmation standard is fit for purpose in today’s capital markets to ensure investors receive the protection they deserve,” Williams said. “And that is why I support strengthening and modernizing our requirements for the auditor’s use of confirmation. I look forward to receiving input from all our stakeholders.”

Proposal In Detail

In terms of cash confirmation, the proposal allows the auditor not to confirm every single cash account that the audit client has as it could have hundreds or even thousands of accounts with financial institutions. But the auditor would have to understand the client’s cash management and Treasury function. And as part of risk assessment, the auditor must determine which accounts they believe should be confirmed.

In terms of accounts receivable, the PCAOB is proposing a requirement for confirmation. Board officials said that the proposal would allow an auditor not to send confirmation for accounts receivable under certain situations. This flexibility would be provided when the auditor determines that an alternative procedure would work better. But the auditor must obtain at least as persuasive evidence that they would expect to obtain through confirmation procedures.

PCAOB officials said that they are providing this flexibility because auditors have various tools related to testing. But the new proposed standard would require auditors to communicate the alternative method to the audit committee and explain why they decided to choose another method to confirm the information.

As for negative confirmations, existing standards allow it. This is when the auditor sends out confirmation, and the other party agrees that it is accurate and just does not respond. But the auditor cannot just assume that it is confirmation. Today, there is an overwhelming amount of communication, and the communication could be easily lost. Thus, the auditor would be required to do something else to verify the information.

The proposed standard would also include some examples of alternative procedures that an auditor could perform regarding  accounts receivable, accounts payable and terms of transactions or an agreement with third-parties.

The existing standard has some suggested alternative procedures, but they are largely about receivables and revenue transactions. Thus, other examples of procedures would be illustrated in the proposal.

In addition, the proposed standard would ban certain activities that internal audit could perform: identifying account balances to confirm, sending out and receiving back the confirmation.

But an auditor can get administrative help from internal auditors, such as preparation of the confirmation requests and doing checks to look for differences in confirmation responses.

 

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