PCAOB Proposes New Rules on Auditing Estimates, Use of Specialistsby
The Public Company Accounting Oversight Board (PCAOB) proposed two new standards on June 1 that would strengthen the requirements for auditing accounting estimates and the auditor’s use of specialists in an audit.
“Estimates help investors understand value and expected future value,” PCAOB Chairman James Doty said in a prepared statement. “But because they necessarily involve judgment, they are a particularly challenging area for auditors, as evidenced by inspections findings.”
That’s why the two proposals were developed together, as both are intended to make an auditor’s opinion more reliable, he said.
Here are the key takeaways of each proposed standard.
Auditing Accounting Estimates (Including Fair Value Measurements)
The proposal combines three existing standards into one and emphasizes that auditors must apply “professional skepticism” and more attention to possible management bias when auditing accounting estimates.
The proposal is open for public comment through Aug. 30.
Under the proposal, Auditing Accounting Estimates (AS 2501) would be updated and retitled, Auditing Accounting Estimates, Including Fair Value Measurements (AS 2501).
The following standards would be superseded:
- Auditing Fair Value Measurements and Disclosures (AS 2502)
- Auditing Derivative Instruments, Hedging Activities, Investments in Securities (AS 2503)
The proposed single standard would include a special topics appendix that addresses auditing the fair value of financial instruments, including the use of information from pricing sources.
It also strengthens existing requirements by building on common approaches in AS 2501, AS 2502, and AS 2503 by:
- Devoting more attention to possible management bias.
- Giving certain requirements in the existing standard on auditing fair value measurements to all accounting estimates to better reflect a uniform approach to substantive testing.
- Increasing the focus of auditors on estimates with a bigger risk of material misstatement.
- Offering key requirements and direction to address certain issues unique to auditing fair values of financial instruments (including the use of information from pricing sources).
- Making other updates to the requirements for auditing accounting estimates to provide additional clarity and specificity.
Why do this? Because most financial statements include amounts in accounts and disclosures that aren’t directly measurable and instead require estimates. This would include:
- Certain valuations of financial and nonfinancial assets.
- Impairments of long-lived assets.
- Allowances for credit losses.
- Contingent liabilities.
- Revenues from contracts with customers.
Management bias is a threat because such estimates generally involve subjective assumptions and uncertain measurements. Accounting estimates are among the greatest risk areas in audits.
What’s more, PCAOB inspectors continue to identify deficiencies at large and small firms in auditing accounting estimates. That also has raised concerns about professional skepticism and possible management bias.
Use of Specialists
The proposal calls for auditors to pay more attention to audit areas in which the work of an outside specialist, such as a valuation specialist, engineer, or legal specialist, is used and aligns the use of specialists with PCAOB risk assessment standards.
Companies often use specialists to assist in developing accounting estimates in their financial statements, as well as to interpret laws, regulations, and contracts, or to evaluate the characteristics of certain physical assets, according to the PCAOB.
Auditors often use the work of these companies’ specialists as audit evidence. In addition, auditors might use the work of auditors’ specialists to assist in their evaluation of significant accounts and disclosures, including accounting estimates in those accounts and disclosures.
The PCAOB proposes amending two existing standards – Audit Evidence (AS 1105) and Supervision of the Audit Engagement (AS 1201). The proposal also would replace Using the Work of a Specialist (AS 1210) and retitle it, Using the Work of an Auditor-Engaged Specialist (AS 1210).
According to the PCAOB, the proposed standard would further protect investors by:
- Strengthening requirements for evaluating the work of a company specialist.
- Applying a risk-based approach to supervising and evaluating auditor-employed and auditor-engaged specialists.
The proposal “could improve the auditor’s ability to detect material misstatements in the financial statements,” the PCAOB said, and promote an improved, uniform approach to supervision of an auditor’s specialist.
For changes involving a company’s specialist, the proposal:
- Supplements current requirements in AS 1105 to address situations when the auditor uses the work of a company’s specialist as audit evidence.
- Aligns requirements with those in the companion proposal on auditing accounting estimates, including fair value measurements.
- Removes requirements for using the work of a company’s specialist as audit evidence from the scope of AS 1210.
For changes involving an auditor’s specialist, the proposal:
- Enhances the requirements for applying a risk-based supervisory approach to auditor-employed specialists and extends those requirements to auditor-engaged specialists.
- Adds requirements for informing the auditor’s specialist of the work to be performed and for reviewing and evaluating that specialist’s work.
- Amends the requirements for assessing the knowledge, skill, and ability of an auditor’s specialist.
- Describes objectivity as “the ability to exercise impartial judgment on all issues encompassed by the specialist’s work related to the audit” and expands the list of matters that the auditor would consider when assessing whether the specialist has the necessary objectivity.
The proposal is open for public comment through Aug. 30.
Terry Sheridan is an award-winning journalist who has covered real estate, mortgage finance, health care, insurance, personal finance, and accounting and taxation issues for newspapers, magazines, and websites. A Chicago native and former South Florida resident, she now lives in New England.