SEC Approves PCAOB Standard on Engagement Quality Review

The SEC has approved PCAOB Auditing Standard No. 7, which requires an engagement quality reviewer to evaluate the significant judgments made and related conclusions reached by the audit engagement team in forming the overall conclusion on the engagement and in preparing the engagement report. AS 7 also requires the engagement quality reviewer to perform procedures designed to focus the reviewer on those judgments and conclusions. In its approval order, the SEC encouraged the PCAOB to issue guidance on the standard’s documentation requirements. In response, the PCAOB said that it would publish a staff Q&A on implementation of the standard in the near future. Release No. 34-61363

The standard is effective for engagement quality reviews of audits and interim reviews for fiscal years that began on or after Dec. 15, 2009. Thus, for interim reviews of public companies that file financial reports on a calendar-year basis, AS 7 is applicable beginning with the quarter ending March 31, 2010.

According to PCAOB Acting Chairman Dan Goelzer, the standard should improve the reliability of audited financial statements by increasing the likelihood that reviewers will identify significant engagement deficiencies before audit reports are issued to the investors. Martin F. Baumann, Chief Auditor and Director of Professional Standards, emphasized that a well-performed engagement quality review can serve as an important safeguard against erroneous or insufficiently supported audit opinions and, in this way, contribute to audit quality.

The procedures required of an engagement quality reviewer are different in nature from the procedures required of the engagement team. Unlike the engagement team, a reviewer does not perform substantive procedures or obtain sufficient evidence to support an opinion on the financial statements or internal control over financial reporting. If more audit work is necessary before the reviewer may provide concurring approval of issuance, the engagement team, not the reviewer, is responsible under PCAOB standards for performing the work. In contrast, the reviewer fulfills the obligation to perform an a quality review by holding discussions with the engagement team, reviewing documentation, and determining whether to provide concurring approval of issuance.

A number of commenters were concerned about an example in the PCAOB’s adopting release describing the documentation requirement for significant engagement deficiencies identified by the engagement quality reviewer. The release states that the documentation should contain sufficient information to enable an experienced auditor, having no previous connection with the engagement, to understand, for example, the significant deficiency identified, how the reviewer communicated the deficiency to the engagement team, why such matter was important, and how the reviewer evaluated the engagement team’s response.

Commenters were concerned that the example in the release could be read to be inconsistent with the requirement in the standard and could result in unintended consequences in terms of performance. The primary concern was that the engagement quality reviewer may be compelled to document every interaction with the engagement team, not knowing whether a matter will ultimately be identified as a significant engagement deficiency. This was viewed as a documentation requirement incremental to the requirements of Auditing Standard No. 3 on audit documentation, which does not require the auditor to document each discussion and preliminary conclusion.

But the SEC does not believe that there is any inconsistency between the example in the adopting release and the requirements of AS 7. The SEC said that the documentation suggested in the example from the adopting release is appropriate after the engagement quality reviewer has concluded that he or she has identified a significant engagement deficiency. However, in light of commenter concern, the SEC asked the PCAOB to provide further implementation guidance on the documentation requirement.

Some global audit firms expressed concern with language in the adopting release indicating that a qualified reviewer who has performed the required review with due professional care will, necessarily, have discovered any significant engagement deficiencies that could reasonably have been discovered under the circumstances. The firms said that this language could be read as requiring absolute assurance or a flawless review.

But the SEC did not find any inconsistency between the PCAOB’s adopting release and the requirement to conduct the review with due professional care. The SEC emphasized that the adopting release specifies that the Board is not redefining due professional care in the context AS 7.

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