Statement on Concept Release on Audit Quality Indicators

Mr. Chairman, I support the issuance of this concept release on audit quality indicators ("AQIs") and the accompanying Appendix A.

One of our most important duties at the PCAOB is to promote high quality audits for the benefit of investors. One way of doing this is to ensure that firms focus and compete based on audit quality. I view the Board's issuance of this concept release as a significant initiative in advancing this objective.

By exploring possible indicators of audit quality, the Board is taking a positive step to promote a more vibrant market in quality audit services while at the same time helping to counter pressures on audit firms to reduce audit effort or resources inappropriately.

There is wide consensus that audit quality indicators, if developed and utilized appropriately, would benefit multiple parties, including regulators, audit committees, audit firms and investors alike.

Background

The concept of developing indicators of audit quality is not new. The Final Report by the Department of the Treasury's Advisory Committee on the Auditing Profession discussed audit quality indicators in 2008, recommending that the Board, in consultation with other parties, "determine the feasibility of developing key indicators of audit quality and effectiveness and requiring auditing firms to publicly disclose these indicators."^[1]

That Committee, comprised of a wide variety of stakeholders, including, amongst others, representatives from the profession, investors, and preparers, suggested:

[R]equiring firms to disclose indicators of audit quality may enhance not only the quality of audits provided by such firms, but also the ability of smaller auditing firms to compete with larger auditing firms, auditor choice, shareholder decision-making related to ratification of auditor selection, and PCAOB oversight of registered auditing firms.^[2]

Since 2008, the idea of developing audit quality indicators has continued to gain traction and has been mentioned several times at meetings of the PCAOB's Standing Advisory and Investor Advisory Groups.^[3]

AQIs have also been the subject of international debate for many years. As one example, considerable attention was devoted to the subject at the 2014 plenary meeting of the International Forum of Independent Audit Regulators in Washington D.C. where a number of audit regulators confirmed that they have begun to use audit quality indicators to plan and evaluate their inspections.^[4]

Investor's Call for Audit Quality Indicators

Earlier, at the October 16, 2013 meeting of the Board's Investor Advisory Group ("IAG"), investor representatives recommended that the PCAOB develop a set of audit quality indicators that measure the quality of the audit, help establish accountability for audit quality, are forward looking, and have informational or predictive content.^[5] The Board's IAG urged the Board to consider indicators at both the engagement and firm levels and suggested that AQIs take into account that audit firms have varying levels of expertise and market penetration in different industry sectors.

At that meeting, the Report from the IAG's Working Group on Audit Quality Indicators identified specific engagement and firm level indicators for the Board's consideration.^[6] As noted in the concept release, 17 of the Working Group's 27 proposed indicators are included in the 28 potential indicators discussed in the accompanying Appendix A.

The Objectives of AQIs

This project was initiated in order to identify a portfolio of quantitative measures of public company auditing (called "indicators"), whose consistent use may enhance dialogue about and understanding of audits and ways to evaluate their quality, and to explore how and by whom the portfolio of indicators can best be used.

These audit quality indicators are meant to identify and quantify key variables that affect the work of audit professionals and the audit process, and that would serve to assist users in the evaluation of audit results.

The release sets forth and seeks comment on 28 potential indicators which are divided into three groups: indicators that measure aspects related to (i) the audit professionals performing the audit, (ii) the audit process, and (iii) the audit results.

Examples of personnel indicators include such items as staffing leverage, partner workload, specialist personnel, experience of audit personnel and the like.

Audit process indicators include, amongst others, quality ratings and compensation, audit fees, compliance with independence requirements, investment in infrastructure, and internal quality review results.

And under the category of audit results, such indicators include frequency and impact of financial statement restatements for errors, fraud and other financial reporting misconduct, and timely reporting of internal control weaknesses and warning of going concern issues.

Potential Users of AQIs

These indicators are designed to help the Board and other regulators, audit committees, audit firms and investors form a deeper understanding of the audit, the engagement team performing the audit, and the audit firm in order to make more informed decisions. I believe that AQIs will prove useful to these users for the following reasons:

With respect to the Board and regulators globally—as the release makes clear, the data can inform the development of inspection strategies. It can also provide regulators with insights into trends in overall audit quality to form an expanded basis for reports on the state of quality at the firm, network, or profession levels. It can broaden the foundation of regulators' consideration of policy issues. And expanded use and analysis of AQIs could inform analysis of the root causes of inspection findings, evaluation of firms' remediation efforts, and the effort to update auditing standards, including those related to audit firm quality control.

With respect to audit committees—I believe these indicators will assist independent audit committees in selecting their auditors. For instance, their understanding of such indicators as engagement and firm level staffing leverage, partner workload, industry expertise of audit personnel, and experience of audit personnel, should make their audit selection process more informed and meaningful.

Audit firms should benefit from established audit firm indicators by allowing them to distinguish themselves for audit quality, and compete on that basis in the marketplace, which in turn should encourage those firms that are lagging behind to improve their efforts.

And AQI data has the potential to significantly expand information shareholders use in deciding whether to ratify their company's choice of auditor, or at least form a basis for raising questions that could do so. As the release notes, a majority of public companies currently ask their shareholders to ratify the auditor selection annually. Those shareholders, however, have very limited insight into the quality of the audit, other than negative events, such as restatements, or the Board's inspection reports. AQIs should aid them in making those auditor decisions.

In my opinion, the release does an excellent job of explaining how the indicators operate at both the engagement and the firm levels, and the appendix clearly and succinctly explains what each indicator is designed to measure.

The release is meant to elevate the debate on what would amount to the most meaningful audit quality indicators in order to improve audit quality and hence further the interests and protection of investors.

The Board welcomes comment and recognizes that some indicators are more likely to be useful and feasible than others and that the list of 28 indicators is likely to be modified. The Board also welcomes debate regarding which AQIs should be mandatory and which voluntary.

In sum, I believe today's release marks a significant move forward in enabling various stakeholders to better monitor audit quality, and I commend the staff for producing this concept release on a subject that has been a priority for investors and other stakeholders for close to a decade.