The Public Company Accounting Oversight Board (PCAOB) announced Monday that their inspections of audit firms, which began this week, will focus on progress made by the firms toward efficient implementation of the Board’s Accounting Standard No. 2, An Audit of Internal Control over Financial Reporting Performed in Conjunction with an Audit of Financial Statements (AS-2). Internal Control over Financial Reporting (ICFR) audits “should be conducted in a manner that is integrated with, and complementary to, the financial statement audit, and that devotes attention to higher risk areas and away from those with less potential to have a material impact on the financials,” the PCAOB’s statement said.
“A key emphasis of the 2006 inspections will be the efficiency of the firms’ performance of audits of internal control over financial reporting,” said PCAOB Acting Chairman Bill Gradison.
The PCAOB issued guidance in May and November of 2005 on efficient implementation of AS 2 to auditors after corporate executives complained at a roundtable conducted by the PCAOB and the Securities and Exchange Commission (SEC) about “rigid and overreaching audits,” CFO.com reports. A second roundtable hosted jointly by the PCAOB and the SEC will be held on May 10 at the SEC’s headquarters in Washington DC.
PCAOB inspections in 2006 will focus on four areas, according to their statement:
- the degree of integration between the audit of ICFR and the audit of the financial statements;
- the use of a top-down approach to the audit;
- the proper assessment of and response to identified risks; and
- firms’ use of the work of others.
Internal control and financial statement audits were often performed separately in the first year of implementation of Sarbanes-Oxley 404, CFO.com says. The PCAOB, which in the past had employed separate teams of inspectors for their review of ICFR auditing and their review of financial statement audit procedures, will combine these reviews in 2006, the PCAOB statement says.
Focusing on the top-down approach will lead to concentrating on controls that are relevant to the company’s business, according to CFO.com. Executives had complained at the 2005 roundtable that auditors arrived with checklists of controls that did not focus on controls that were significant to the company’s business.
The PCAOB inspection will determine whether internal controls testing is based on proper risk assessment and the risk that a control would lead to a misstatement. Finally, CFO says, the Board will be checking to see if auditors took advantage of work already done by the company’s internal auditors. Companies and auditors were both uncertain in the 2004 audits about whether the work of internal auditors could be relied on.
The PCAOB has emphasized the importance of communication with the audit firms in 2006. Before beginning their inspections of the eight U.S. firms and one Canadian firm that audit more than 100 public companies, the PCAOB Division leadership, inspection team leaders and staff from the Office of Chief Audit will meet with senior leadership of these firms. “The objective of this meeting will be to hear the firm’s perspective on whether, and how, it has achieved efficiencies in the four areas identified above.” After making a preliminary assessment, the team will summarize “any useful or innovative practices, opportunities for improvement and items for follow up at the national office,” the PCAOB statement says.”
At the national level, the inspection team will assess each firm’s efforts to achieve efficiency. They will meet with the firm’s technical leadership, review the firm’s communication of its policies and procedures and the training provided to the firm’s auditors. One of the four areas will be inspected at each engagement reviewed.