Statement on Adoption of Auditing Standards Related to the Auditor's Assessment of and Response to Risk

Thank you, Mr. Chairman. I support the Board’s adoption of these eight standards and the related amendments, which clarify and strengthen the requirements for auditors to assess and respond to the risks of material misstatements in financial statements.

As others have mentioned this morning, these standards were initially proposed almost two years ago on October 21, 2008. After making important revisions in response to comments received from 33 letters, the standards were re-proposed on December 17, 2009. Since that time, the staff has made further refinements in response to comments from an additional 23 comment letters.

I would again like to thank those who took the time to review the proposed standards and provide their comments to the Board. As I have said before, this feedback is most helpful in ensuring that the Board consider the concerns of all interested parties.  It also results in standards that better align with the needs of investors.

As stated by Anne Simpson, Senior Portfolio Manager at CalPERS, in her March 1, 2010 comment letter:

"The financial interests of [investors] are most effectively served in an environment where investors can confidently utilize financial statements to evaluate the risk and reward of an investment. Auditors play a key role in decreasing the risk of material misstatements in financial reports. An effective audit process provides the investor with assurance that the financial statements present reliable and valid information which conform to the Generally Accepted Accounting Principles."

Protecting Investors

By adopting these standards the Board furthers its mission "…to protect the interest of investors" in several important ways.

These standards replace requirements developed in the 1980's with audit procedures that more effectively respond to today's complex financial reporting environment.

They help to protect investors by providing a clear articulation of the auditor's responsibilities to assess and respond to the risk of material misstatement in financial statements.

They address the concept of materiality and the need for the auditor to consider both quantitative and qualitative factors in establishing materiality levels. The standards further articulate that both quantitative and qualitative factors should include, among other things, consideration of circumstances that "would influence the judgment of a reasonable investor."

Clarifying the auditor's responsibility to consider the risk of financial reporting fraud during an audit has long been a priority for investors and these standards recognize the need to elevate and integrate the auditor's consideration of fraud in every aspect of planning, conducting and evaluating the results of an audit. Incorporating these requirements makes clear that the auditor's responsibilities for assessing and responding to fraud risks are an integral part of the audit process rather than a separate, parallel process.

As I stated when the standards were re-proposed last year, these standards directly and effectively address the requirement for auditors to evaluate the adequacy of financial statement disclosures. The PCAOB's interim standards addressed this area to a limited extent, but our inspections process has continued to raise concerns about the effectiveness of the auditor's review of disclosures. Given the feedback from our inspectors, I believe that clarifying the auditor's requirement to evaluate the adequacy of financial statement disclosures serves the needs and expectations of investors.

Another important issue for investors in these standards is the heightened focus on executive compensation. Auditing Standard No. 12 – "Identifying and Assessing Risks of Material Misstatement" – states that the auditor is to obtain an understanding of a company and the activities that might have an effect on the risk of a misstatement in the company's financial statements. The standard also says that this means, when necessary, the auditor is to "obtain an understanding of compensation arrangements with senior management, including incentive compensation arrangements, changes or adjustments to those arrangements, and special bonuses." The standard includes examples of performance measures that might affect the risks of material misstatement, such as "measures that form the basis for contractual commitments or incentive compensation arrangements." Taken together, these statements indicate that auditors need to be aware of situations in which compensation arrangements for senior management pose risks of material misstatement of the financial statements.

As with the emphasis on fraud, investor groups have supported such a heightened focus on executive compensation.

Additional Supervision Standard

In response to recommendations from commenters, this set of standards divides the audit planning and supervision standard into two standards. This change, however, does not affect the auditor's responsibilities for planning the audit or for supervising the work of the engagement team members.

The separate standard on supervision describes the responsibilities of the engagement partner and engagement team members who assist in supervising the audit to ensure that "the work performed is as directed and supports the conclusions reached." As others have mentioned, this supervision standard may very well need further refinement as the Board continues its evaluation of the existing interim auditing standards and completes other standard-setting activities.

Comparison with Other Standards

I commend the staff on providing a comparison of these risk assessment standards to analogous standards of other standard-setters. While this comparison helps identify differences between the standards, I strongly encourage the staff to improve the value of this comparison by more clearly describing how the Board's requirements protect the interests of U.S. investors as compared to similar standards issued by other standard-setting bodies.

Summary

With the adoption of these risk assessment standards, the Board is making essential improvements over the current PCAOB interim standards. These eight standards describe the Board's expectations of what the auditor needs to do to incorporate risk assessment principles into the planning and performance of an audit. In short, these standards focus the auditor's efforts on those areas that have the greatest risk of creating an audit failure and, with their adoption, the Board significantly furthers its goal "…to protect the interest of investors… in the preparation of informative, accurate, and independent audit reports."

I also join you, Mr. Chairman and the other Board members, in acknowledging the fine work done by Keith Wilson and his team, including Jessica Watts, Diane Jules, Hasnat Ahmad, and Hong Zhao, under the direction of Marty Baumann, as well as Bob Burns, and Nina Mojiri-Azad, from the General Counsel's office, under the direction of Gordon Seymour, in developing these risk assessment standards.