Statement on Proposed Amendments Relating to the Supervision of Audits Involving Other Auditors and Proposed Auditing Standard—Dividing Responsibility for the Audit with Another Accounting Firm

Mr. Chairman, I support the proposal before us today regarding audits involving other auditors. I view the proposal as an important step forward in addressing the audit quality concerns noted through our inspection and enforcement activities.

The audits implicated here are those where portions of the audit are performed by auditors other than the firm signing the audit report. The other auditors are often located in different jurisdictions and may be affiliates of the signing firm. If the signing firm takes responsibility for the work performed by the other auditors involved, it does not identify the participation of the other firms or individuals in its report.[1] However, if the signing firm does not take responsibility, it identifies the portion of the work performed by the other auditor and that auditor provides a separate audit report for its work.

Most investors in today's capital markets own shares in companies with foreign operations. As noted in the release, approximately 40 percent of total assets and revenues of publicly listed companies are outside of the country of the signing auditor.[2]

The increasing globalization by public companies has led to the expanded use of other auditors in the audits for those companies. Based on PCAOB staff analysis of inspections data as of March 31, 2013, about 80 percent of Fortune 500 issuer audits performed by the top six U.S. firms involved other auditors.[3] In addition, other auditors are now playing a more significant role in such audits.

The signing auditor may enlist assistance from another auditor to, among other things, manage costs or use personnel who are familiar with local practices and culture. Engaging other auditors may also enable a firm to accept engagements that it may have had to otherwise decline due to jurisdictional hindrances.[4]

Audits that involve other auditors, though, face certain challenges. Differences between auditors' business practices, languages, cultural norms, market conditions, and professional training, just to name a few, may adversely affect the quality of the audit.

It is important that the signing auditor ensures that the work done by the other auditors is of high caliber. Our inspections have noted a generally higher rate of deficiencies for foreign-affiliated firms than for U.S.-affiliated firms between 2011 and 2013.[5] This indicates that there are real differences in the quality of work performed by firms in the U.S. and their affiliates abroad.

The nature of the deficiencies that our inspectors have observed cover a wide range, from the other auditor not performing procedures requested by the lead auditor or required under our standards to failing to communicate significant accounting and auditing issues to the lead auditor.

Inspectors have also noted issues with the lead auditor's work as it relates to the other auditor. These include the lead auditor failing to (i) assess the qualifications of other auditors participating in the audit, (ii) review the results of the other auditor's procedures relating to fraud risk factors,[6] and (iii) provide specific instructions to the other auditors.[7]

Today's proposal, which calls for increased lead auditor involvement in, and evaluation of, the work of other auditors, is a positive step in addressing these deficiencies and increasing investor protection. This is especially important as inadequate lead auditor supervision has led to deficient audits. It is also consistent with what our Investor Advisory Group recommended in 2011.[8]

The amendments proposed appropriately direct the lead auditor's attention to the areas of greatest risk and include specific lead auditor supervisory responsibilities. For example, the proposal includes a requirement for the lead auditor to (i) provide the other auditor with specific information in writing, (ii) have discussions about potential risks of material misstatements with the other auditor, and (iii) obtain and review the other auditor's description of audit procedures it plans to perform. The signing firm will also need to maintain a list of work papers of the other auditor that were reviewed but not retained.

Today's proposal requires the lead auditor to be better informed about the qualifications and performance of the other auditor as well. For example, we are proposing that the lead auditor assess the other auditor's qualifications and compliance with pertinent independence, ethics and registration requirements.

The proposal also includes a separate standard for those situations in which two or more firms divide responsibility for an audit.

We are not alone in taking action in this area. The International Auditing and Assurance Standards Board (IAASB) is currently assessing the need for change following persistent deficiencies in group audits reported by the International Forum of Independent Audit Regulators.[9]

Certain aspects of this proposal are also consistent with what a number of the largest firms already require under their methodologies. As noted in the release, some firms now require the lead auditor to have frequent, comprehensive communications with other auditors and review the other auditors' work papers in areas of significant risk.

The Board recognizes that imposing new requirements may result in some additional costs. Such costs, however, will not be significant for those firms that already require heightened supervision by the lead auditor and are justified for those that have not adopted such methodologies for the protection of investors. In my opinion, alternatives to rulemaking, such as issuing interpretive guidance, would not address the audit quality issues noted.

I believe improving the relevant performance requirements in this area is consistent with the Board's investor protection mission by promoting high quality audits. There are indications that firms with enhanced supervision methodologies have already experienced a reduction in audit deficiencies.[10] For these reasons, I support the amendments being proposed today.

Finally, Mr. Chairman, today's proposal deals with the supervision of other auditors. However, I believe that appropriate supervision of firm personnel at all levels within a firm is an essential ingredient for an audit practice to perform high quality audits. Such a supervision standard regarding all such firm personnel was contemplated by Section 105(c)(6), the Failure to Supervise section, of the Sarbanes-Oxley Act. The Board previously issued a concept release in this area in August 2010 noting "[t]he quality of a firm's audit practice is directly affected by the quality of supervision within the firm"[11], and I would hope that we might revisit and move ahead soon on that proposal as well.

In conclusion, I would like to thank Marty Baumann, Keith Wilson, Dima Andriyenko, Lillian Ceynowa, Stephanie Hunter, Denise Muschett Wray, Robert Ravas, and Hunter Jones, from our Chief Auditor's office, Andres Vinelli, John Powers and Joon-Suk Lee from our Center of Economic Analysis, and Gordon Seymour and Matt Goldin from our Office of General Counsel. I would also like to thank Greg Scates who worked on this project prior to joining our Division of Registration and Inspections.

[1] On December 15, 2015, the Board adopted new rules and related amendments to auditing standards to require accounting firms to disclose, in audits of issuers, (i) the name of the audit engagement partner, (ii) the name, location, and extent of participation of each other accounting firm participating in the audit whose work constituted at least 5 percent of total audit hours, and (iii) the number and aggregate extent of participation of all other accounting firms participating in the audit whose individual participation was less than 5 percent of total audit hours. See Improving the Transparency of Audits: Rules to Require Disclosure of Certain Audit Participants on a New PCAOB Form and Related Amendments to Auditing Standards, PCAOB Release No. 2015-008 (Dec. 15, 2015). The final rules adopted by the Board in that rulemaking were intended to improve the transparency and accountability of issuer audits by adding to the mix of information available to investors. The Board also acknowledged that disclosure of accounting firm participation could allow financial statement users to understand how much of the audit was performed by the firm issuing the audit report and how much was performed by other accounting firms, including those in jurisdictions where the PCAOB has been unable to conduct inspections.

[2] Information from the most recent audited financial statements of public companies filed as of November 15, 2015, indicates that, among the publicly listed companies sourced from Standard & Poor's that reported segment assets or revenues in geographic areas outside the country or region of the lead auditor, such assets and revenues comprised approximately 38 percent and 45 percent of the total assets and revenues, respectively.

[3] The Fortune 500 includes 451 issuers that are audited by BDO USA LLP, Deloitte & Touche, LLP, Ernst & Young LLP, Grant Thornton LLP, KPMG LLP, and PricewaterhouseCoopers LLP, and 364 of the audits of those issuers involve other auditors

[4]       See, e.g., Hansrudi Lenz and Marianne L. James, International Audit Firms as Strategic Networks—The Evolution of Global Professional Service Firms, in Economics and Management of Networks: Franchising, Strategic Alliances, and Cooperatives 367, 369 (Gérard Cliquet, George Hendrikse, Mika Tuunanen, and Josef Windsperger eds., 2007) ("In most countries the right to practice as a certified audit firm is granted only to national firms in which locally qualified professionals have majority or full ownership. Therefore, member firms of an accounting network are locally owned and managed. …. Furthermore, the detailed national rules concerning corporate law and accounting require a high degree of local knowledge, which creates a natural barrier of entry for foreign audit firms without local knowledge.").

[5]       From 2011 to 2013, the percentage of deficiencies in the inspected work performed by non-U.S. Global Network Firms for lead auditors went from 32 percent to 42. See Audit Committee Dialogue, PCAOB Release No. 2015-003, at 9 (May 7, 2015) (graph entitled "Deficiencies in Non-U.S. Referred Work"). The issuer audit engagements and aspects of the work inspected are selected based on a number of risk-related and other factors. Due to the selection process, the deficiencies included in inspections reports are not necessarily representative of the inspected firms' issuer audit engagement practice.

[6]      See Ron Freund, CPA, PCAOB File No. 105-2009-007, at 1 (Jan. 26, 2015).

[7]      See, e.g., Child, Van Wagoner & Bradshaw, PLLC, Russell E. Anderson, CPA, and Marty Van Wagoner, CPA, SEC AAER No. 3637 (Feb. 11, 2015); Sherb & Co., LLP, Steven J. Sherb, CPA, Christopher A. Valleau, CPA, Mark Mycio, CPA, and Steven N. Epstein, CPA, SEC AAER No. 3512 (Nov. 6, 2013).

[8]     See Report from the Investor Advisory Group Working Group on "The Global Networks and Audit Firm Governance" (March 16, 2011), located at:

[9] See paragraph of 7 of IAASB, Invitation to Comment, Enhancing Audit Quality in the Public Interest: A Focus on Professional Skepticism, Quality Control and Group Audits (Dec. 2015). See also IAASB, Work Plan for 2015–2016: Enhancing Audit Quality and Preparing for the Future (Dec. 2014), 7 ("Concern [with ISA 600] has been expressed about: [t]he extent of the group auditor's involvement in the work of the component auditor ...; [c]ommunication between the group auditor and the component auditor; [a]pplication of the concept of component materiality; [i]dentifying a component in complex situations; and [w]ork effort of the component auditor.").

[10] In 2014, PCAOB inspections staff observed a decrease in the number of significant audit deficiencies in work performed by other auditors.

[11] See Concept Release on the Application of the "Failure to Supervise" Provision of the Sarbanes-Oxley Act of 2002 and Solicitation of Comment on Rulemaking Concepts, PCAOB Release No. 2010-005 (August 5, 2010). See also Statement by Steven B. Harris on the Application of the "Failure to Supervise" Provision of the Sarbanes-Oxley Act of 2002 and Solicitation of Comment on Rulemaking Concepts (August 5, 2010).