Current Developments at the PCAOB

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Current Developments at the PCAOB

• Moore Stephens North America Audit and Accounting
  Conference
• October 3, 2008
• Atlanta, Georgia

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Caveat

• The views expressed are my views and do not
  necessarily reflect the views of the Board,
  individual Board members, or the staff of the
  PCAOB.

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What We Will Cover

• Registration and Inspections Activities
• Status of Registration and Inspections Program
• Observations on Inspections of Domestic
  Triennially Inspected Firms
• Standards Activities
• Recent Standards/Rules Adopted by the Board
  Other Activities
• Future Standards-Setting Projects
• Enforcement Activities

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Registration and Inspections Activities
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Registration

• There are approximately 1,000 domestic small
  firms registered with the PCAOB
• Geographically dispersed and diverse in size,
  number of issuers and number of offices
• Approximately 65 of these firms are subject to
  triennial inspection
• There are approximately 870 foreign small firms
  registered with the PCAOB
• Spanning 86 countries, with largest concentration
  in China, Canada, the United Kingdom and India
• Approximately 27 of these firms are subject to
  triennial inspection
• PCAOB Form 4 and related rules adopted by the
  Board on July 29, 2008

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Rules on Periodic Reporting by Registered Public
Accounting Firms

• Section 102(d) Periodic Reporting
• Adopted June 10, 2008
• Effective 60 days after SEC approval
• Require firms to report certain information
  annually
• Require special reporting for certain specified
  events within 30 days of the event

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Rules on Periodic Reporting by Registered Public
Accounting Firms

• Annual Reporting
• General information concerning the firm
• Audit clients and audit reports
• Offices and affiliations
• Personnel
• Certain relationships
• Acquisitions
• Affirmation of consent

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Rules on Periodic Reporting by Registered Public
Accounting Firms

• Special Reporting
• Audit reports
• Certain legal proceedings
• Certain relationships
• Licenses and certifications
• Changes in the firm or the firms Board contact
  person

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Inspections Milestones DomesticAs of August 1,
2008

• Conduct annual inspections of 10 large firms (9
  domestic and 1 international)
• Conducted engagement file reviews of over 1,700
  issuer audits in large firm inspections
• Performed over 780 inspections of small firms to
  date
• Over 60 of these firms had five or fewer issuer
  audit clients
• Only 10 of these firms had greater than 26
  issuer audit clients
• Conducted engagement file reviews of over 2,400
  issuer audits
• During 2007, we began second inspections of small
  firms

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Inspections Milestones InternationalAs of
August 1, 2008

• Internationally conducted inspections of over 90
  firms
• International inspections have been successfully
  conducted jointly with home country audit
  oversight bodies in four countries to date
• Proposed Guidance Regarding Implementation of
  PCAOB Rule 4012 put out for comment on December
  5, 2007

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Inspections Milestones ReportingAs of August
1, 2008

• All of the large firm inspection reports related
  to the 2003 through 2006 inspections have been
  issued as final
• 8 of the 10 large firm reports related to 2007
  have been issued as final
• There have been 639 domestic small firm reports
  have been issued as final to date
• There have been 21 international small firm
  reports issued as final to date

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Remediation

• Final inspection report triggers 12-month
  remediation cycle for quality control
  deficiencies
• These criticisms or potential defects are made
  public only if they are not satisfactorily
  addressed by the firm before the 12-month period
  deadline
• The criticisms or potential defects will remain
  nonpublic if the quality control criticisms are
  satisfactorily addressed
• Firms are not required to address the quality
  control criticisms
• Non-response will result in Board making the
  quality control criticisms public
• The Board has made the quality control
  criticisms, or relevant portions thereof, public
  for 23 firms to date

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Rule 4010 Report

• Issued October 22, 2007
• Discussed 11 audit areas where significant or
  frequent auditing or quality control deficiencies
  were observed
• Reports for-
• 248 firms (approximately 57) identified at least
  one audit performance deficiency in one or more
  audits, as well as criticisms of, or concerns
  about potential defects in, the firms quality
  control system
• 124 firms (approximately 28) were clean
• 67 firms (approximately 15) contained only
  criticisms of the firms quality control system
• Observations are illustrative and do not
  represent a complete summary of the results of
  all small firm inspections
• See www.pcaobus.org/Inspections/Other/2007/10-22_
  4010_Report.pdf

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Audit Areas

• Significant or frequent auditing or
  quality-control deficiencies were observed in -
• Revenue
• Related-Party Transactions
• Equity Transactions
• Business Combinations and Impairment of Assets
• Going-Concern Considerations
• Loans and Accounts Receivable (including
  allowance accounts)
• Service Organizations
• Use of Other Auditors
• Use of the Work of Specialists
• Independence
• Concurring Partner Review

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Revenue

• General responsibilities of the auditor
• Perform substantive procedures to test existence,
  completeness, and valuation of revenue
• Review revenue contracts for terms and conditions
  that can impact revenue recognition
• Test whether revenue was recorded in the
  appropriate period
• Common inspection observations
• Inappropriate use of testing A/R or inventory as
  a proxy for testing revenue recognition
• Inappropriate reliance on management
  representations without corroboration regarding
  appropriateness of revenue recognition
• Over-reliance on poorly designed analytical
  procedures
• Complex or specialized revenue-recognition
  principles not adequately addressed

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Equity Transactions

• General responsibilities of the auditor
• Evaluate compliance with applicable accounting
  principles in accounting for equity transactions,
  including adequacy of disclosures
• Common inspection observations
• No evaluation of the reasonableness of fair value
  assigned to equity-based transactions for
  goods/services (employees or nonemployees)
• No testing of assumptions used to value options
  or warrants (e.g., volatility factor)
• Inappropriate reliance upon managements decision
  to determine fair value based on other sources
  besides market value

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Business Combinations

• General responsibilities of the auditor
• Determine whether the transaction was accounted
  for in accordance with GAAP (e.g., valuation,
  purchase price allocation and disclosure)
• Common inspection observations
• Inadequate testing of estimate of fair values
  assigned to assets acquired
• Inadequate testing of allocation of the purchase
  price to the assets acquired and liabilities
  assumed
• Inappropriate evaluation of client's accounting
  for and reporting of a business combination
  (e.g., common control merger, asset acquisition
  as business combination)
• Unaware of certain terms contained in the merger
  agreement (e.g., contingent considerations)

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Use of Other Auditors

• General responsibilities of the auditor
• Determine whether firm can serve as principal
  auditor
• If taking responsibility for other auditors work
  (e.g., out-sourced staff), determine
  involvement in planning, supervision, and review
  of work of other auditor
• Common inspection observations
• Materiality of portion of financial statements
  audited by firm not sufficient to allow firm to
  report as principal auditor
• Insufficient planning, supervision, review and
  addressing of significant audit areas in audits
  where firm assumed complete responsibility for
  the work of other auditing firm and does not
  refer to the report of the other firm

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Independence

• Prohibited Non-Audit Services
• The auditor is prohibited from providing
  bookkeeping and other services related to the
  accounting records or financial statements of the
  audit client
• Indemnification
• Firms entered into agreements which impaired
  their independence
• Firms did not comply with quality control
  standards related to independence policies and
  procedures as required by PCAOB Rule 3400T(b)
• Firms did not provide audit committee with
  written confirmation of its independence of the
  issuer within the meaning of the security laws

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Standards-Setting Activities
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Auditing Standard No. 5, An Audit Of Internal
Control Over Financial Reporting That Is
Integrated With An Audit Of Financial Statements

• Focuses the internal control audit on the most
  important matters
• Eliminates procedures that are unnecessary to
  achieve the intended benefits
• Makes the audit scalable to fit any company's
  size and complexity
• Simplifies the standard

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Smaller Company Considerations

• The size and complexity of the company, its
  business processes, and business units, may
  affect the way in which the company achieves many
  of its control objectives the risks of
  misstatement and the controls necessary to
  address those risks.
• Six example areas where tailoring based on size
  and complexity may be necessary
• Assessing entity-level controls
• Evaluating risk of management override and
  mitigating actions
• Evaluating controls implemented in lieu of
  segregation of duties
• Evaluating information technology ("IT") controls
• Evaluating financial reporting competencies
• Obtaining sufficient evidence with limited
  company documentation

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Auditing Standard No. 6, Evaluating Consistency
of Financial Statements

• Aligns auditing standards with FASB Statement No.
  154, Accounting Changes and Error Corrections
• Specific direction for auditor reporting on
  restatements
• Provides additional direction regarding
  evaluation of reclassifications
• Remove GAAP hierarchy from the auditing standards
  (when it is added to the accounting standards

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PCAOB Rule 3523 - Tax Services for Persons in
Financial Reporting Oversight Roles (FROR)

• A registered public accounting firm is not
  independent of its audit client if the firm, or
  any affiliate of the firm, during the audit
  and professional engagement period, provides
  any tax service to a person in a FROR at the
  audit client or their immediate family member
• Deleted

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PCAOB Rule 3526 - Communication with Audit
Committees Concerning Independence

• Prior to accepting an initial engagement pursuant
  to the standards of the PCAOB
• Describe, in writing, to the audit committee, all
  relationships between the firm or any affiliates
  of the firm and the potential audit client or
  persons in a FROR at the potential audit client
  that, as of the date of the communication, may
  reasonably be thought to bear on independence
• Discuss with the audit committee the potential
  effects of the relationships on the independence
  of the firm and
• Document the substance of its discussion with the
  audit committee.
• At least annually thereafter
• All of the above, and
• Affirm to the audit committee, in writing, that,
  as of the date of the communication, the firm is
  independent in compliance with Rule 3520

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Proposed Auditing Standard - Engagement Quality
Review

• Issued by the Board on 2/26/08 for a 75-day
  comment period
• Comment period expired on May 12, 2008
• Required for all engagements performed pursuant
  to PCAOB standards
• Supersedes Appendix E SECPS concurring partner
  review requirement

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Proposed Auditing Standard - Engagement Quality
Review (contd)

• Key Elements
• Qualifications of the reviewer
• EQR Process
• Evaluate significant judgments and conclusions
• Higher-risk areas of the engagement
• Evaluate engagement documentation
• Reviewer must not provide concurring approval of
  issuance if
• Failed to obtain sufficient competent evidence
• Reached an inappropriate overall conclusion
• Firms report is not appropriate
• Firm is not independent
• Documentation of the EQR

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Staff Audit Practice Alert No. 2, Matters Related
to Auditing Fair Value Measurements of Financial
Instruments and the Use of Specialists

• Practice Alert issued on 12/10/07
• Highlights aspects of auditing standards
  principally AU sec. 328, Auditing Fair Value
  Measurements and Disclosures
• Specific risks related to auditing fair value,
  including risks related to SFAS No. 157
• Specific risks related to use of pricing services
• Highlights key aspects when using the work of
  specialists

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Future Standards Setting Projects

• Risk Assessment, including Fraud Risk Assessment
• Fair Value
• Specialists
• Related Parties
• Confirmations
• Action Plan for Review of Interim Standards

Activities subject to change based on emerging
issues
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Enforcement Activities
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Sources of Investigations

• Issuer disclosures
• Auditor changes
• Restatements
• Public news sources
• Tips
• Other regulators
• Other PCAOB divisions and offices
• Office of Research Analysis
• Division of Registration and Inspections

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Common Types of Investigations

• Violations of professional standards
• "Audit failure" issuer's financial statements
  are not in accordance with GAAP and the auditor
  should have detected the misstatement
• Not limited to matters involving GAAP departures
  
• Independence violations
• Illegal acts
• Failure to cooperate with an inspection or
  investigation

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Audit Execution

• Failure to obtain sufficient audit evidence
• Confirmations
• Revenue recognition
• Existence and valuation of assets
• Related party transactions
• Consideration of fraud
• Principal auditor
• Audit documentation

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Keeping Current with PCAOB

• Our Web site - www.pcaobus.org
• List of registered firms
• Inspection reports
• PCAOB standards, including interim standards
• Enforcement disciplinary proceedings
• Contact us at info_at_pcaobus.org
• Sign up for the PCAOB Updates service to receive
  a notification via e-mail that briefly describes
  significant new postings to our Web site
• www.pcaobus.org/News_and_Events/Updates/subscribe
  .aspx

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Questions?