The PCAOB and Research

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The PCAOB and Research

• Gary Holstrum
• Associate Chief Auditor Director of Research
• University of Illinois Auditing Research
  Symposium
• October 8, 2004

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Overview of Presentation

• Comments on the PCAOB and research
• The need for communication and cooperation with
  the academic community
• Operation of the PCAOB
• PCAOB standard-setting activities
• Whats next? Forthcoming PCAOB projects

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Caveat

• The views I express are my own personal views and
  not necessarily those of the PCAOB, Board
  members, or staff.

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TWO PRIMARY QUESTIONS

• What should be the role or research in the PCAOB?
• What should be the role of the PCAOB in research?

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DRIVING FACTORS

• Research can be a powerful force
• To inform and enhance the quality of
  standard-setting decisions.
• Research is a costly endeavor to undertake.
• Research is a valuable resource for those who
  possess it.
• The PCAOB has limited resources
• Although it has the means of acquiring reasonable
  resources that it can justify.

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What is the best way for the PCAOB to use its
resources to

• Utilize the findings of extant research and
• Stimulate new research that is
• Relevant to its mission
• Setting standards
• Registration and inspection
• Investigation and enforcement.

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Towards a Solution

• Academic community and various non-academic
  research organizations have huge research
  resources relative to the PCAOB
• PCAOB can potentially have a significant
  influence on the nature of this research
• PCAOB is central to what makes research relevant
  and meaningfully practical.

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The role of research in the PCAOBWhat should be
done?

• Capture relevant research findings
• Summarize findings in an appropriate form ?
• So that they may be utilized meaningfully in
  PCAOB decisions.
• Cooperation with academic community is essential

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Academicians can help to

• Identify
• Gather
• Summarize
• Synthesize

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The role of the PCAOB in researchWhat should be
done?

• PCAOB should be able to stimulate future research
  that is
• Relevant and suitable for future PCAOB decisions
• Well-designed and robust

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What would I like to see us do at the PCAOB?

• Find effective ways for the staff to signal or
  communicate future standard-setting project areas
  
• While protecting the required PCAOB
  confidentiality
• Making certain we as staff do not purport to
  speak for the Board
• This is a tricky balance

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Overview of the PCAOB

• Established by Sarbanes-Oxley Act of 2002
• A private non-profit organization overseen by the
  SEC
• Independent funding assured
• 5 Board members
• Current staff of over 200 full-time staff
• Ultimately over 300
• See www.pcaobus.org

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Major PCAOB Functions

• Setting standards
• Registration
• Inspections
• Investigation
• Enforcement

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Registrations

• Registered firms
• gt1300 registered accounting firms
• gt850 U.S. auditing firms
• gt450 non-U.S. audit firms
• Mandated Inspection Schedule
• Every year firms that audit over 100 U.S.
  public companies (8 firms)
• Every 3 years firms that audit 100 U.S. public
  companies or less (all others)

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Inspections

• Initial limited inspections of Big 4
• Tone at the top
• Partner Compensation
• Independence
• Client Acceptance/Retention Policies
• Interaction with non-U.S. affiliates
• Regular inspections now in process

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Investigations and Discipline

• Sarbanes-Oxley provides that the Board may
  investigate possible violations
• Board has authority to investigate and impose
  sanctions
• Suspension or permanent revocation of a firms
  registration
• Suspension or permanent barring of individuals
• Civil monetary penalties and other sanctions

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Professional Standards

• Sarbanes-Oxley directs the Board to establish
• Auditing and related attestation standards
• Quality control standards
• Ethical and independence standards

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PCAOB Interim Standards

• Board adopted as interim standards certain
  professional standards of the AICPA (as they
  existed on 4/16/03)
• Auditing Standards (SASs),
• Attestation standards (SSAEs),
• Quality Control Standards,
• Selected Ethical (Independence) Standards
• Interim standards are now on the PCAOB web site
  (www.pcaobus.org )

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Personal observations

• Difference between my experiences on the ASB and
  at the PCAOB
• (Caution This is NOT at all the official or
  unofficial position of the PCAOB)
• Personal Anecdote
• Both groups have a concern for cost-effectiveness
  and balance as they see it

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Auditing standards the public interest

• What would happen if the investing public and
  other public interests wanted and would benefit
  from more demanding auditing standards, even if
  it raised the cost of audits?
• ASB pressures
• Strong concern to limit legal liability
• Management tends to blame them if they raise
  audit standards that warrant increased audit
  fees.
• Concern for expectations gap
• PCAOB--Ultimate mandate is to serve the public
  interest

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Major Constituent Groups with a Strong Interest
in the Quality of Auditing Standards
PUBLIC
ISSUERS
AUDITORS
Should any single constituent group dominate the
setting of auditing standards?
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Due Process Starts with the Standing Advisory
Group

• 30 individuals selected
• Auditors
• Preparers
• Investors
• Others (e.g., professors, current and former
  regulators)
• Five organizations to participate as observers
• FASB, GAO, IAASB, SEC, DOL

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PCAOB Rulemaking Process
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Standards-Setting AgendaOffice of the Chief
Auditor

• Chief Auditor, Doug Carmichael
• Current professional standard-setting staff of 8
• We are looking for more people with a particular
  blend of experience, knowledge, skills,
  attitudes, passion, and willingness to work with
  Board and staff and work full-time, in Washington
  for an extended period of time.
• Sarbanes-Oxley Act established initial agenda
• Audits of Internal Control (Section 404)
• Audit documentation
• Second partner review
• Quality control

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PCAOB Auditing Standard No. 1-The Audit Report

• Change language from
• audited in accordance with generally accepted
  auditing standards to
• audited in accordance with standards of the
  PCAOB
• Reasons for the change
• Implications of the change

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Auditing Standard No. 2 Audits of Internal
ControlKey Issues

• SCOPE--Does the auditor provide an opinion only
  on managements assessment or an opinion on
  internal control?
• USING THE WORK OF OTHERSTo what extent may the
  auditor use the work of internal auditors
  others?
• INDEPENDENCE--What assistance may auditors
  provide to management without impairing
  independence?

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Audits of Internal Control Issues (continued)

• EVALUATION OF THE AUDIT COMMITTEEShould the
  auditor evaluate the effectiveness of the audit
  committee?
• WALKTHROUGHSShould they be required for all
  significant classes of transactions? How many?
• SMALL BUSINESS ISSUESWhat is cost-effective for
  small businesses?

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Audit of Internal Control Issues (continued)

• Definition of a significant deficiency and a
  material weakness
• Requirement for an adverse opinion when a
  material weakness exists
• Mandatory integration with the audit of financial
  statements

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PCAOB Auditing Standard No. 3 -Audit
Documentation

• New threshold requirement Must contain
  sufficient information to enable an experienced
  auditor, having no previous connection with the
  engagement, to understand
• The work performed,
• Who performed it,
• When it was performed
• Conclusions reached

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Language used for ImperativesMust v. Should
v. May

• Unconditional Obligations
• "must," "shall," or "is required" .
• Presumptively Mandatory Obligations
• "should
• Subsidiary Obligations
• "may," "might," "could," or other terms
• professional obligation to consider.

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Second Partner Reviews

• What does the existing professional guidance
  specify?
• Review consists of quite limited specified
  procedures coupled with negative
  assurancenothing came to my attention
• States that the objective is to concur
• Does public interest (the investing public)
  demand more?
• Issues to be addressed in a potential standard
  for an engagement quality control review

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Standard on Firm Quality Control

• What items are covered in interim quality control
  standards and peer review?
• What items are excluded from existing quality
  control standards and peer review?
• Potential items to be addressed in a proposed
  future standard on quality control and in future
  PCAOB inspections

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Whats Next?Planned standards activities in 2004

• Communication with audit committees
• Fraud
• Revenue Recognition
• Related Parties
• AccrualsCookie-Jar Reserves
• Audits of fair value
• Auditor risk assessment
• Confirmations
• GAAS hierarchy and codification
• Independence and tax services
• Continued review of interim standards

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Key Research Areas

• Auditability of fair market accounting
• Fraud
• Revenue recognition
• Expense accruals Cookie jar reserves
• Consolidations and reorganizations

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Key Research Areas (continued)

• Research on re-engineered, strategic, or
  risk-based audit approaches
• Research on the robustness of analytical reviews
  using expectations from in-depth, knowledge-based
  models as substitutes for substantive testing of
  details
• Along the lines of past research on the
  robustness of various analytical review
  approaches by Kinney, Loebbecke and Steinbart,
  Knechel etc.
• Personal opinion Critical need for this research
• Strategic systems audit analysis is essential
• We need to explore its strengths and limitations

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My vision of the PCAOB and research

• The role or research in the PCAOB?
• The role of the PCAOB in research?
• Enhancing the communication and cooperation with
  the academic community

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The PCAOB 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 key related goal Restoring confidence in the
  audited financial information and in capital
  markets through meeting rational expectations

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Questions ????