Extra round of comments planned for proposal on lead auditors’ supervision of other auditors

The PCAOB has more work to do before finalizing a rule intended to strengthen the lead auditor’s supervision of other accounting firms working on an audit, according to the board’s updated standard-setting agenda published on July 6, 2017.

After reviewing the feedback on an April 2016 proposal, the board said its next step will be to consider issuing a “supplemental request for comment” in the third quarter of 2017.

The PCAOB issued Release No. 2016-002, Proposed Amendments Relating to the Supervision of Audits Involving Other Auditors and Proposed Auditing Standard—Dividing Responsibility for the Audit With Another Accounting Firm, to improve the way lead auditors supervise the work of another firm as part of an audit of a large or a multinational company. Comments were due in July 2016.

During a Standing Advisory Group (SAG) meeting in May 2017, PCAOB Chief Auditor Martin Baumann said the staff has been addressing issues raised in comment letters. Major accounting firms asked for changes to the rule before the board adopts the final version. The supplemental document is likely to ask for detailed comments on the specific issues raised.

As more companies in the U.S. and overseas expand their international operations, regulators have paid more attention to the accounting firms hired to handle portions of large audits. A lead auditor hired by a company often recruits other firms to examine financial reports prepared in foreign offices, which may be prone to a higher risk of misstatement.

Auditors asked the PCAOB to clarify situations when other auditors are part of the same global network or when they are not part of the same network. Baumann said firms also asked for more clarity about the proposed requirement that audit firms determine the sufficiency or participation of the lead auditor.

Comment letters from accounting firms said the proposed requirements were too prescriptive, and the firms asked the PCAOB to use a more risk-based approach. Accounting firms also said they wanted more clarity about the supervision of “multi-tiered” audit structures. This is, for example, when a U.S. multinational’s lead auditor based in the U.S. supervises a U.K. auditor which deals with the company’s European operations, while another accounting firm audits a business unit in Italy whose results are consolidated into the European operations.

The PCAOB believes audit quality will improve if lead auditors are required to take more responsibility for the work of other auditors. The board wants lead auditors to have more access to a participating firm’s work papers and extensively evaluate the other auditors. Lead auditors will have to set minimum requirements for the other firms they hire.

In a separate project, the board has also been considering whether Auditing Standard (AS) 2415, Consideration of an Entity's Ability to Continue as a Going Concern, formerly AU Section 341, needs to be revised. But the audit regulator has yet to decide whether drafting a proposed rule will be its next step.

Companies did not have to make similar disclosures until the FASB issued Accounting Standards Update (ASU) No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern. The standard became effective for annual periods ending after Dec. 15, 2016.

The FASB defines substantial doubt using a threshold of “probable” that a company will not be able to pay debts as they come due during the next 12 months. The PCAOB, on the other hand, incorporates a more qualitative assessment in the definition of substantial doubt, which could cover a broader set of issues.

Because management and auditors now have different thresholds for evaluating a company’s ability to stay afloat, the PCAOB staff, among other things, has been monitoring how companies and auditors are applying the different guidance and evaluating whether changes are needed to audit standards.

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