PCAOB and Audit Committees – An Important Partnership

Good afternoon.

Thank you for that kind introduction and for inviting me to speak here today at your annual meeting. I am pleased to see the interest of not only audit committee members, but many other who advise and support their important work.

One of my priorities since joining the Board has been to ensure a robust dialog between the PCAOB and audit committee members, because, in my view, audit committees are an indispensable complement to the PCAOB's work. While the PCAOB's regulatory activities, such as inspections, enforcement and standard setting, have driven improvements in audit quality in the last decade, audit committees are a powerful market force that can help maintain and further enhance audit quality by diligently discharging their responsibilities and creating appropriate incentives for auditors to do their best work. Ultimately, audit committees hire and fire the auditors and, like the PCAOB, their work is intended to benefit investors.

Audit committee roles and activities have expanded substantially in recent years. Cybersecurity, the regulatory landscape, demands for sustainability reporting and concerns about non-GAAP measures are but a few of the many important topics consuming board and audit committee time. I appreciate that the time to devote to oversight of the auditor must be balanced with all the other roles of the audit committee. However, in recognition of the important role audit committees play in driving audit quality, I would like to discuss today some of our efforts in recent years to establish robust interactions with audit committees and to tell you about some of the PCAOB's current activities that may be relevant to your work. The three main subjects I will address are the PCAOB's outreach to audit committees, inspection activities and our efforts around audit quality indicators and the related quality control standards.

But before I go further, I should tell you that the views I express today are my personal views and do not necessarily reflect the views of the Board, any other Board member, or the staff of the PCAOB.


By way of background, as you all know, the Public Company Accounting Oversight Board was created by Congress through the passage of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Act) to oversee the audits of public companies in order to protect investors and the public interest by promoting informative, accurate, and independent audit reports.

I joined the full-time five-member Board in February 2011 after spending over thirty years in public accounting. I am one of two Board members who are (and must be) Certified Public Accountants. The other current CPA Board member is Jeanette Franzel, a former senior official from the U.S. Government Accountability Office, while the other three Board members, Chairman James Doty and Board Members Steven Harris and Lewis Ferguson all have legal backgrounds.

In 2012, as we began to look back over the PCAOB's first decade of work, we recognized the importance of the work of audit committees, and we took a number of steps intended to assist audit committee members in their work (mindful of the fact that we regulate auditors but not audit committees). First, after several years of study and public consultation, the Board adopted in 2012 a new standard on auditor communications with audit committees. The standard was intended to enhance the relevance, timeliness, and quality of communications between auditors and audit committees, in order to facilitate audit committee oversight over the financial reporting process and the external audit. In August 2012, we issued a document, Information for Audit Committees about the PCAOB Inspection Process, in order to help audit committees understand the context and content of PCAOB inspection reports. And, in late 2012, we included in the Board's Strategic Plan a near-term priority to enhance our outreach to audit committees

Audit Committee Outreach

In the past four years, I and several of my colleagues on the Board have made regular appearances at audit committee events, ranging from meeting with individual audit committees, to small gatherings of audit committee chairs, to large conferences for audit committee members from companies of all sizes and industries. In addition to providing information about PCAOB inspections, standard setting, international oversight and other areas of our work, we have benefitted from these discussions by gaining a more nuanced perspective on the work of audit committees, including their interactions with and evaluation of their auditors. We found that many audit committees are thoroughly informed about our work and regularly discuss PCAOB inspection findings and other activities with their auditors. Others have indicated they are interested in learning more about the PCAOB, and we are taking steps to increase our communications to satisfy this demand. We continue to struggle, however, in reaching some audit committees, particularly those that know the least about PCAOB activities.

In order to make information as accessible as possible, the PCAOB included on its website a page directed at audit committees to provide information about our inspection program, the objective and progress of current standard setting projects and other useful information. If you have not done so, take a look at this page[1] and provide us with feedback on how we can improve it and what else you want to know.

Of course, audit committee members also provide important feedback through our Standing Advisory Group (SAG), which is composed of auditors, investors, public company executives, audit committee members and others. The SAG advises the Board on the development of auditing and related professional standards. And we have held several sessions at SAG meetings in recent years that were focused, at least in part, on issues relevant to audit committees, including audit committee communications, audit quality indicators, emerging audit risks and issues, root cause analysis and firm quality control, among other topics.

We continue to look for more input from audit committees about how we can best help them oversee auditors and enhance audit quality, and we are always open to new ideas!

Inspection Activities

Let me turn now to the substance of some of our recent discussions with audit committees. Audit committee members have shown particular interest in our inspection program and its results. We have responded to this demand for information in part by making changes to our firm-specific inspection reports. For example, our reports now include a number of charts and other references to provide an overview of the nature of our findings, as well as the auditing standards and auditing and financial reporting areas involved. Our general reports, which are designed to summarize inspection results over a period of time or across a certain population of firms, now include executive summaries to provide a plain-English and high level explanation of our findings and their relevance, as well as suggested actions or ideas directed specifically at audit committee members.

In an effort to respond to requests from audit committee members for timely information, our staff began in 2015 to issue so-called "Inspection Briefs," intended to provide the public with high level summaries of our findings on a preliminary basis. In addition, we began to release briefs that preview our inspection plans for the upcoming inspection season, including the number of audits we plan to inspect and the financial reporting and audit areas on which we plan to focus, generally based on where we believe we will encounter the greatest audit and financial reporting risks. Among other things, these previews may assist audit committees in determining important issues to discuss with their auditors.

Currently our inspections for 2016 are still ongoing, focusing on audit areas where we have observed frequent deficiencies, such as internal control over financial reporting; assessing and responding to risks of material misstatement; and auditing accounting estimates, including fair value measurements. In addition, we are taking into consideration certain economic factors including the effect on multinational public companies of the recent significant appreciation in the strength of the U.S. dollar; increased merger and acquisition activity; and continued fluctuations in oil and natural gas prices.

In 2015, we inspected over two hundred firms that audited issuers, including ten firms that are subject to annual inspections because they audited more than 100 issuers. Frequent inspection findings in 2015 continued to be observed in the areas of ICFR and auditing accounting estimates, including fair value measurements, particularly in connection with the valuation of assets and liabilities acquired in a business combination and evaluating impairment analyses for goodwill and other long-lived assets.

Deficiencies also were identified in the areas of revenue-related estimates and reserves, allowance for loan losses, inventory reserves, and tax-related estimates. And in some instances auditors did not fully understand how estimates were developed or did not sufficiently test significant inputs and evaluate the significant assumptions used by management. Some auditors also did not perform testing beyond inquiry of management in both tests of controls and substantive tests. This topic would be a good one to ask your auditors about, including the extent of their testing and evaluation of significant estimates.

Some of these findings suggest that auditors are failing to challenge management sufficiently or lack an appropriate level of skepticism. Many factors could contribute to this, including whether an auditor has the competency to challenge a management estimate, the confidence or authority to do so, and sufficient time to follow up. Some firms are increasing the involvement of the more senior members of the engagement team, encouraging the frequent use of firm experts, and requiring more robust project management to ensure there is enough time to deal with the most difficult areas. While is it too early to tell whether these efforts will be effective, there are encouraging signs. Audit committees can bolster these efforts by showing particular interest in their discussions with auditors about audit strategy, timing and significant risks.

As you may be aware, our findings in the areas of ICFR, in particular, recently have attracted the attention of audit committees and management. There seems to be broad consensus that the requirements of the Sarbanes-Oxley Act and the PCAOB auditing standard governing audits of internal control,[2] have contributed to improvements in the effectiveness of internal controls and a decline in the number and severity of restatements. However, some companies question whether the pendulum has swung too far, resulting in excessive auditing of internal controls and undue burdens on management to increase documentation of the operation of some controls. For example, we have heard complaints that some auditors request too much information in immaterial or low risk areas and perform unnecessary procedures to review internal controls. Some auditors justified this work to the clients only by explaining that it is required by the PCAOB or as a result of PCAOB inspections. This is another area where an audit committee may want to ask more questions to better understand the issue. An auditor should be able to explain why they are doing a particular procedure.

In response to these concerns, PCAOB Board members and staff, along with representatives of the SEC, have participated in several meetings with companies and audit firms to better understand the issues being raised. Our discussions at these meetings suggest that there continues to be an expectation gap between preparers, auditors, and the PCAOB and SEC with regard to the appropriate level of scrutiny, testing and documentation by auditors of internal controls.

We are comfortable that our inspectors are not imposing new auditing requirements through inspections. Firms' guidance and training materials tend to establish an appropriate approach. However, it is possible that concerns about the frequency of our inspection findings in the area of ICFR audits have caused some audit engagement teams to do more work and request more information from their clients. In some cases, their work may be focused on the wrong areas, resulting in unnecessary burdens on management. We at the PCAOB, in coordination with SEC staff, will continue to focus on this issue in order to make sure we have an appropriate balance between auditors' doing sufficient and meaningful audit work to gather the right amount and the right type of audit evidence, while not imposing unnecessary burdens on management or causing needless delays in the financial reporting process.

Audit Quality Indicators

A second topic in which audit committees have shown strong interest is our project on audit quality indicators. In late 2012, we announced our intention to study the feasibility of establishing quantitative measures of audit quality, and we have conducted extensive formal and informal outreach on this topic for the past several years. In July 2015, we issued a concept release to seek public comment on the content and possible uses of a group of 28 potential audit quality indicators.

The feedback in response to our concept release was mixed. Some commenters supported the project but advocated that we should let practice develop on a voluntary basis. Other commenters supported the project and urged us to act quickly to mandate public disclosure of certain audit quality indicators.

Several firms, as well as the Center for Audit Quality, also have been studying potential ways to measure audit quality, and some firms have begun to publish a series of firm-level metrics that they believe may be helpful, especially to audit committees, in evaluating audit quality.

We continue to digest the feedback we have received and to discuss with firms their experiences with the quality indicators they have begun to identify and track. While the Board has yet to make a formal determination about next steps, we are not likely to impose in the near future any new requirements to mandate audit quality indicators. Rather, we will continue to gather data about promising indicators, encourage academic study in this area, and urge firms to monitor and report publicly on some of the most informative measures. I believe it would also be useful to gather more input on whether to establish standardized definitions for certain indicators, even if their use is voluntary, in order to allow for comparability between firms. We continue to be interested in the use by audit committees of indicators that they believe are useful in their evaluation of their auditor. If your committee does so, we would be interested in hearing about your experiences.

Firm Quality Control

Related to the topic of measuring audit quality is our standard setting project on firm quality controls. Current standards require a firm to design and implement a system of quality control to provide reasonable assurance that its personnel comply with applicable professional standards and the firm's standards of quality.[3] PCAOB quality control standards also set forth the elements of a system of quality control and establish certain requirements for firms' quality control policies and procedures.

A project to review and enhance the standards applicable to quality control has long been on the Board's list of priorities, given the importance of such standards to audit quality and the specific mandate in the Sarbanes-Oxley Act for the Board to establish such standards and to inspect firms' quality control systems.

The Board's outreach to date suggests that firm-wide quality control systems may benefit from stronger requirements in certain areas, such as firm culture and tone at the top; firm risk assessment; and monitoring of the quality control system.

Currently, our staff is conducting research to identify areas where these important standards should be strengthened, and how. One important aspect of the staff's outreach on this topic is its coordination with the staff of the International Auditing and Assurance Standards Board ("IAASB"), which is also considering changes to quality control standards. Our collaboration with the IAASB may be more important on this issue than on any other, given that differences in the PCAOB and international standards governing firms' systems of quality control may be difficult for firms to implement and could result in inconsistencies and confusion, potentially decreasing audit quality rather than increasing it.

In addition, our staff is reviewing data from our oversight activities, including inspections and the related root cause analyses to identify the underlying causes for instances of poor or high quality audits. We will be conducting additional outreach to seek input on current practice, including areas where firms' quality control systems exceed the requirements of existing standards, and we will carefully consider the potential impacts of any changes on large and small public accounting firms.

With that, I'm happy to take any questions.

[1] This page on the PCAOB website may be found at: https://pcaobus.org/Information/Pages/AuditCommitteeMembers.aspx

[2] Auditing Standard No. 5 (now AS 2201), An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements.

[3] See paragraph .03 of QC sec. 20, System of Quality Control for a CPA Firm's Accounting and Auditing Practice.