Statement on Proposed Auditing Standard on Auditing Accounting Estimates, Including Fair Value Measurements, and Proposed Amendments to Auditing Standards For Auditor’s Use of the Work of Specialists

I support the proposals before us today to improve auditing standards related to auditing accounting estimates, including fair value measurements, and the auditor's use of the work of specialists.

Both proposals respond to similar needs for changes to PCAOB standards. By addressing these needs, both proposals should enhance audit quality in areas that often involve complex processes and subjectivity and judgment by company management.

Because accounting estimates and the use of specialists have become more prevalent and significant in financial reporting in recent years, higher audit quality in these areas should benefit investors and other users of financial statements across the capital markets. Strong auditing performance or procedural requirements, when appropriately designed, are a key element of audit quality.[1]

With today's action, the Board is taking another step toward finalizing two important and interrelated matters that were on the Board's early standard-setting agenda, when the Board first began to identify emerging issues that required rulemaking while simultaneously beginning its review of interim standards it adopted from the profession.

As the proposing releases explain, the use and complexity of accounting estimates, including fair value measurements, continues to grow and the financial reporting frameworks for them continue to evolve. In this regard, the Board's standards have not evolved to take into account the changing practices related to preparing such estimates, including the use of third-party pricing sources and other specialists by companies, and the related changes to their associated risks.

In addition, the PCAOB standards in both areas, largely adopted from the profession as interim standards in 2003, do not address these matters holistically by taking into account how companies and auditors use specialists in their different and evolving roles.

The primary existing PCAOB standards that apply to estimates and specialists, therefore, do not fully reflect the risk-based approach of auditing under the Board's risk assessment standards. In both areas, the standards address certain matters through different standards that were adopted at different times to address specific objectives; for example, the standards for auditing fair value measurements and auditing derivatives differ from the standard for auditing other estimates; and the standard for auditors' use of employed specialists is different than that applicable to engaged specialists and the use of company specialists.

I agree that the Board's standards in these areas would benefit from enhancements to lead to consistently strong auditing in these areas that involve complex processes, subjectivity, and judgment.

When auditors comply with and properly implement strong auditing standards in their work, investors benefit in that they should be able to form expectations about the audit.

The proposals before us today reflect improvements that address specific performance objectives to guide auditors, taking into account the range of current practices across firms. The proposals reflect the results of significant outreach and analysis by our staff, including monitoring the impact of changes and proposed changes made to the international auditing standards in these areas.

I commend the work of our staff economists for a detailed analysis of the behavioral implications related to these critical financial reporting and auditing areas, which demonstrates a need for specific improvements.

I won't repeat the staff's summary today of the specific improvements being proposed. However, I would like to call attention to how the principal elements of these proposals are designed to respond to specific problems identified by the PCAOB.

Accounting Estimates, Including Fair Value Measurements

The Board's standards related to auditing accounting estimates, including fair value measurements, for example, could be enhanced by improving the requirements related to how auditors apply professional skepticism and respond to potential management bias in subjective areas that often involve significant uncertainty involving a range of assumptions.

By prompting auditors to more specifically focus on the potential for management bias in the development of estimates, auditors should be more likely to identify potential errors in accounts and disclosures involving estimates.

The estimates proposal should also prompt auditors to more consistently evaluate audit evidence by, for example, extending the requirements applicable to evaluating third-party pricing sources in fair value measurements to all estimates. These enhancements should lead to consistently higher audit quality across different types of estimation processes and the related financial statement amounts and disclosures.

The Auditor's Use of the Work of Specialists

The Board's existing standards related to the use of the work of specialists likewise would benefit from the proposed enhancements to promote more effective audit practices and consistently stronger audit evidence. The proposal would provide more specific guidance on how to use the work of a company's specialist as audit evidence.

The proposal would also enhance the requirements for the use of auditor-employed specialists and extend those requirements to auditor-engaged specialists. Both of these enhancements build upon the Board's risk-based supervisory approach to audit engagement management. This should enhance the coordination between the auditor and its specialists, resulting in higher quality audits and consistently stronger audit evidence.

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I welcome input from commenters on key elements of these proposals, including in the following particular areas:

Do the proposed requirements for auditing accounting estimates, including fair value measurements, adequately respond to the relevant risks? Do they impose burdens that are justifiable in light of the benefits? Do you agree with the Board that the alternative requirements considered but not proposed would not adequately address the needs described in the proposing release?

Do the proposed requirements for the use of the auditor's specialist respond effectively to the need for better audit evidence, primarily evidence related to estimates obtained from the company's specialist? Do they provide more effective performance requirements for the supervision of auditor-engaged specialists and would those requirements incentivize appropriate behavior from individual specialists and the organizations that employ them? And, do they impose burdens that are justified?

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In closing, this proposal is a significant step forward in enhancing audit quality in areas that have become more significant in recent years.

I welcome input from commenters on the proposals and the significant matters that the Board will need to decide as we move forward.

I want to thank the staff of the Office of the Chief Auditor, the Office of the General Counsel, and the Office of Economic and Risk Analysis for the hard work put into these proposals.

[1] PCAOB, Release No. 2015-005, Concept Release on Audit Quality Indictors, pps. 10-11 (audit quality can be defined as, among other ways, "full compliance with professional auditing standards and applicable law"); see Public Oversight Board, The Panel on Audit Effectiveness: Report and Recommendations, Aug. 31, 2000, pg. x ("Definitive auditing standards form the starting point for promoting quality audits"); See also, Robert W. Knechel, "Do Auditing Standards Matter," Current Issues in Auditing, vol. 7:2 (2013) (interpreting theoretical and empirical research on the economic role of auditing standards and opining on the conditions under which they have a desirable effect).