Research and Educational Implications of the PCAOB Mission

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Research and Educational Implications of the
PCAOB Mission

• Gary Holstrum
• Associate Chief Auditor Director of Research
• PCAOB
• FSA FACULTY CONSORTIUM
• May 20, 2005

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Caveat

• The views I express are my own and not those of
  the PCAOB, Board members, or other staff
• PCAOB Web Site www.pcaobus.org

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Overview of Research Implications

• PCAOB research plan
• Standards-setting projects for 2005-06
• Teams of academic researchers
• Research syntheses in process for two projects
• Researchers needed for additional projects
• Audits of internal control (an example)
• Illustrates need for continuing research
  feedback
• Recent staff guidance

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Overview of Educational Implications

• Competence requirements for future auditors
• The link to professional education and continuing
  professional development
• Update articles
• Designed to aid researchers, educators, students

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PCAOB Standards Issued to Date

• AS 1 Audit performed in accordance with PCAOB
  standards rather than GAAS
• AS 2 Audits of internal control over financial
  reporting
• AS3 Audit documentation

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PCAOB Proposed Standards

• Independence, Tax Services, and Contingent Fees
• Proposed December 14, 2004. Comment period ended
  February 14, 2005
• 805 comment letters received
• Auditors Report on the Elimination of a Material
  Weakness
• Proposed March 31, 2005. Comment period ended May
  16

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2005 STANDARDS PROJECTS
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Two Standards Projects with Research Teams In
ProcessDeveloping Research Syntheses

• Auditor Risk Assessments
• Dana Hermanson (Kennesaw State U), Robert Allen
  (U of Utah), Robert Ramsey (U of Kentucky), Tom
  Kozloski (Wilfrid Laurier U)
• Auditing fair value
• Roger Martin (U of Virginia), Jay Rich (U of
  Northern Illinois), Jeff Wilks (BYU)

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Other Projects Needing Research Syntheses

• Financial Fraud
• Communications with Audit Committees
• Engagement Quality Review (also known as
  concurring or second partner review)
• Auditing Related Party Transactions
• Consistency of Application of GAAP
• Audit Confirmations
• Audit Firm Quality Control
• Audit Reporting Model

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Auditing Internal ControlIllustrates a Need for
Continuing Research
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Auditing Internal ControlA Perspective A
Century of Auditing Financial Statements versus
a Year of Auditing and Reporting on Internal
Control
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Reporting on Internal Control A Brief
Historical (and Personal) Perspective

• 1977-1982
• Foreign Corrupt Practices Act (1977)
• 1977-78 Accounting firms prepared for reporting
  on internal control
• Evaluating weaknesses How can an auditor judge
  whether a control deficiency is a material
  weakness?

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1979-1982 First Standard for Reporting on
Internal Control is Developed

• IC Attest Standard developed by AICPA Auditing
  Standards Board Task Force
• Chaired by Ken Stringer (Deloitte)
• Contained initial definition of material weakness
  

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1988-1992 Required Reporting on Internal Control
is Considered

• SEC Chief Accountant proposal to require
• Public company management reports on IC
• Auditor attestation on IC
• Appropriate criteria were not available
• COSO Integrated Framework developed
• ASB revises attest standard
• Still no strong demand for reports on IC

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2002 Sarbanes-Oxley Act PassedAfter 3 years,
does consensus exist?

• April 13 2005 PCAOB participates in Roundtable
  hosted by SEC
• Numerous comment letters
• Constructive comments in the Roundtable panels
• Consensus?

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Roundtable Consensus My Personal
Interpretation

• 404 has significant benefits
• Cost is highwe should be able to reduce cost
• 404, SEC rules, and AS2 are not fatally flawed
• Costs driven up by
• Inappropriate interpretation of SEC rules and AS2
• Coupled with fear of litigation and of PCAOB
  inspections

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Potential solution alternatives?

• Official rulemaking (to revise SEC rules or AS2)
  is a lengthy, time-consuming process
• It is most likely not necessary at this time
• Staff guidance can be developed and issued on a
  much more timely basis

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Benefits of 404

• Top management and audit committees pay greater
  attention to
• Fairness in financial reporting
• Controls to ensure fairness
• Most material weaknesses identified during 404
  work were corrected before being reported
• Investor confidence In financial reporting and
  capital markets

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First-Year 404 Costs are High

• Additional staff guidance (FAQs and QAs) may
  help alleviate some problems
• Big-Four survey
• Companies spent average of 7.8 million
• (0.10 of revenue)
• This is less than the 9.8 million average CEO
  compensation
• FEI survey
• Companies spent average of over 4 million

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First-Year High costs

• Much cost is actually deferred maintenance
• Correcting long-time weaknesses
• Much cost is first-year training/learning
• Big-Four survey Companies predict 46 decrease
  next year
• Small company cost likely a much higher of
  revenue

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Primary Issues

• Auditor Professional Judgment
• Top-Down Approach v. Bottom-Up
• Risk-Based Approach Emphasis on High Risk Areas
• Scope of Testing
• Using the Work of Others
• Auditor Communications

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Primary Issues (continued)

• New Systems Delayed
• Evaluations of Control Deficiencies
• Material Weakness
• Significant Deficiency
• Small Business Issues
• Integrating IC and FS audits
• Market Reaction to Material Weaknesses

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Moving forwardNext year and Beyond

• All groups need to
• Learn from first year
• Realize the value of the benefits
• Work to reduce costs while maintaining benefits

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PCAOB A BALANCED APPROACH

• Listen to various groups
• Issuers management
• Auditors
• Investors public interest
• Standing Advisory Group
• Standards and staff guidance
• Principles-based and objectives-oriented
• Require sound professional judgment

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Implications for Education Key Future
Competence Areas

• Internal control and systems evaluations
• Risk assessments
• Fraud detection and prevention
• Audits of fair value
• Information technology
• Ethics and independence

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Auditor Competence

• The link to professional education and continuing
  professional development
• What should be the role of the PCAOB?
• In establishing competence requirements for
  auditors of public companies?
• (See exposure draft of IFAC Education Committee)
• In encouraging the development of required
  competencies through professional education and
  continuing professional development
• Should a separate credentialing be established
  for auditing?

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PCAOB Standards-Setting Update Articles

• Designed to aid researchers, educators, students
  and others
• In The Auditors Report (Audit Section
  Newsletter)
• Spring 2005 and Summer 2005
• Hyperlinked to related PCAOB position papers and
  standards

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Above All Stay Focused on PCAOB Mission

• MISSION To oversee the auditors of public
  companies in order to protect the interests of
  investors and further the public interest in the
  preparation of informative, fair, and independent
  audit reports.
• A MAJOR OBJECTIVE Restore investor and public
  confidence in financial reporting and audited
  financial statements of public companies.

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QUESTIONS