Tuesday, July 13, 2010

EU Groups Find Proposed PCAOB Standard on Auditor-Audit Committee Communications Overly Prescriptive

While applauding the PCAOB’s efforts to align its proposed standard on auditor-audit committee communications with international standards, the Institute of German Chartered Accountants (IDW) said that the standard was overly prescriptive and evinced a check-the-box mentality when compared to IAASB standards. Also, in comments to the Board, the IDW said that the proposed standard did not involve a two-way exchange of information since most of it involves the auditor imparting information to the audit committee. Similarly, in its letter to the Board, the European Federation of Accountants said that the proposed standard appeared to be quite prescriptive and rules-based and, therefore, may limit the auditor’s ability to exercise professional judgment in deciding on the most appropriate and efficient means and content of the communication with the audit committee. Further, this level of detail may serve to detract from the aim of communications, as both parties seek to comply with the letter of the requirements.

In the view of the German Institute, it is counterproductive to construe the role of the audit committee in overseeing the auditor’s work as necessitating a list of specific information designed to provide evidence that the auditor has performed routine quality control measures and routine procedures. Yet the matters identified in the Board’s proposed standard seem to imply a move towards this checklist mentality. The Institute is concerned that this approach will encourage auditors to produce copious reports in an attempt to “cover their backs”.

In contrast, the IDW believes that it is significant matters and audit findings that need to be communicated. There is a danger that auditors and audit committees may become overly focused on adhering to the required informational exchange as set forth in the proposed standard and fail to see the larger picture. As a result, important information may be overshadowed such that its significance is not readily apparent to the recipient.

The proposed standard’s over prescription may also be detrimental to an effective two-way exchange of information since if a matter is not listed in the requirements of the standard it may not be communicated at all. Further, over prescription discourages auditors from properly exercising their professional judgment, which in turn may not be conducive to enhancing audit quality.

The IAASB recently revised ISA 260 “Communication with Those Charged with Governance” and developed a new auditing standard, ISA 265 “Communicating Deficiencies in Internal Control to Those Charged with Governance and Management”, both of which cover communications between the auditor and those charged with governance of the entity subject to audit.

It is reasonable, said the IDW, to expect that the audit committee would posses a detailed knowledge of the company. The PCAOB, however, does not appear to view the propensity for the audit committee to provide information to the auditor as particularly significant in the proposed standard, since other than requiring the auditor to inquire of the audit committee whether it is aware of matters that may be related to the audit and about the risks of material misstatement, this aspect is less prevalent in the standard than is the case of ISA 260.

Other than the two instances mentioned above, the proposed standard concentrates primarily on the auditor imparting specified information to the audit committee, which does not promote a two-way exchange of information. Indeed, the standard would require the auditor to discuss the significant risks identified by the auditor during risk assessment procedures, without suggesting that two-way discussions could be useful, particularly if further information has become available to the audit committee or the committee believes the auditor’s assessment may be incomplete or incorrect.

In addition, the requirement as to the adequacy of the two-way communication appears to revolve around matters communicated to the audit committee and their reactions thereto, rather than any additional information the audit committee may impart to the auditor. This seems incongruent with the requirement that the auditor evaluate the effects of inadequate two-way communication on its assessment of risk and ability to obtain appropriate audit evidence. The Institute questions how an auditor may reach a determination that the two way communication was so inadequate as to warrant the measures such as a modification of the auditor’s opinion on the basis of a scope limitation and withdrawal from the engagement.