Last week, the Securities and Exchange Commission (SEC) approved a new standard proposed by the Public Company Accounting Oversight Board (PCAOB), Auditing Standard No. 7, Engagement Quality Review (AS 7). As a result, accounting firms performing audits and interim reviews of financial information for public companies should plan to commit more resources, including partner time, to engagement quality reviews for fiscal years beginning on or after December 15, 2009.
The Board generally agreed that new requirements were necessary to "focus reviewers on the need to perform a robust review, rather than on whether particular matters that had "come to [their] attention."
The Board said that it had proposed this standard",after considering feedback from its Standing Advisory Group (SAG) as well as information from its inspection and enforcement programs." The Board was also charged by the Sarbanes-Oxley Act of 2004 to "provide a concurring or second partner review and approval of [each] audit report (and other related information), and concurring approval in its issuance."
Prior to the adoption of the new standard by the SEC, the Board had relied on an interim standard used by the accounting profession, commonly known as "Appendix E." for SECPS member firms.
Despite the PCAOB's statement at the release of AS 7 that the Board "has been sensitive to commenters' concerns and agrees that the EQR [engagement quality review] should not become, in effect, a second audit", it is clear that meeting the requirements in the more explicit language of the statement will increase the hours partners must devote to a quality review and in the case of large audits, the need for the participation of assistants as well. Accounting firms will be faced with higher costs for the quality review of audits as well as interim quality reviews. Engagement quality review procedures for interim financial information are similar to those for the audit.
Other practical implications of AS 7 for accounting firms include documentation issues and potential liability, according to an analysis by Schulte Ross and Zabel LLP, attorneys in Washington DC and New York.
The new standard focuses on the qualifications of the concurring review partner and lists nine specific tasks that the reviewer must perform, using language that is more explicit than the interim standard. AS 7 also calls for specific documentation of the quality review process.
Qualifications of engagement quality reviewer
Under the new standard the engagement quality reviewer must be associated with a registered public accounting firm and must be a partner or another individual in an equivalent position.
The standard specifically refers to competence. "The engagement quality reviewer must possess the level of knowledge and competence related to accounting, auditing, and financial reporting required to serve as the engagement partner on the engagement under review."
The reviewer must be independent of the company, conduct the review with integrity, and maintain objectivity.
EQR approval is appropriate only if",after performing with professional due care the review required by this standard, [the EQR professional] is not aware of a significant engagement deficiency." The statement defines significant engagement deficiency.
Changes in language
The scope of the changes in engagement quality review procedures is evident in a comparison of the language of the interim statement and AS 7.
The interim statement says that the concurring partner reviewer's responsibility is fulfilled by performing the following procedures:
- Discussing significant accounting, auditing and financial reporting matters with the audit engagement partner;
- Discussing the audit engagement team's identification and audit of high-risk transactions and account balances;
- Reviewing documentation of the resolution of significant accounting, auditing and financial reporting matters, including documentation of consultation with firm personnel or resources external to the firm's organization (such as standard-setters,
- Reviewing a summary of unadjusted audit differences;
- Reading the financial statements and auditors' report; and
- Confirming with the audit engagement partner that there are no significant unresolved matters."
The language of AS 7 explicitly directs the engagement quality reviewer to evaluate risks to the firm and the company, evaluate the severity of deficiencies in control, and determine if there have been "appropriate" consultations on difficult matters. A final requirement calls upon the reviewer to",Based on the procedures required by this standard, evaluate whether appropriate matters have been communicated, or identified for communication, to the audit committee, management, and other parties, such as regulatory bodies."
The nine procedures outlined in AS 7 say that the reviewer should:
a. Evaluate engagement planning, including
- The consideration of the firm's recent engagement experience with the company and risks identified in connection with the firm's client acceptance and retention process,
- The consideration of the company's business, recent significant activities, and related financial reporting issues and risks, and
- The judgments made about materiality and the effect of those judgments on the engagement strategy.
b. Evaluate the risk assessments and audit responses, including the identification of significant risks, including fraud risks, and the engagement procedures performed in response to significant risks.
c. Review the engagement team's evaluation of the firm's independence in relation to the engagement.
d. Evaluate judgments made about (1) the materiality and disposition of corrected and uncorrected identified misstatements and (2) the severity and disposition of identified control deficiencies.
e. Determine if appropriate matters have been communicated, or identified for communication to the audit committee, management, and other parties, such as regulatory bodies.
f. Review the financial statements, management's report on internal control, and the related engagement report.
g. Read other information in documents containing the financial statements to be filed with the Securities and Exchange Commission ("SEC") and evaluate whether the engagement team has taken appropriate action with respect to any material inconsistencies with the financial statements or material misstatements of fact of which the engagement quality reviewer is aware.
h. Based on the procedures required by this standard, evaluate whether appropriate consultations have taken place on difficult or contentious matters. Review the documentation, including conclusions, of such consultations.
i. Based on the procedures required by this standard, evaluate whether appropriate matters have been communicated, or identified for communication, to the audit committee, management, and other parties, such as regulatory bodies.
Documentation of a quality review should provide information that identifies:
- The engagement quality reviewer, and others who assisted the reviewer,
- The documents reviewed by the engagement quality reviewer, and others who assisted the reviewer,
- The date the engagement quality reviewer provided concurring approval of issuance or, if no concurring approval of issuance was provided, the reasons for not providing the approval.
Documentation of an engagement quality review should be included in the engagement documentation.
The SEC, in its order approving the EQR standard, encouraged the PCAOB to issue guidance on the standard's documentation requirements. The PCAOB plans to publish Staff Questions and Answers on implementation of the standard in the near future.