By Amanda Maine, J.D.
The PCAOB has unanimously adopted standards on auditing accounting estimates and the auditor’s use of the work of specialists. The new standards, which were adopted in tandem, were a priority of the new Board and are the first substantive auditing standards finalized since the full Board was seated in April 2018. According to Chairman William Duhnke, the staff engaged in “thoughtful analysis and extensive external engagement” in recognition of these challenging areas of the audit that needed to be addressed.
Estimates. The new standard on the auditing of accounting estimates, including fair value measurements, emphasizes the need to apply professional skepticism when auditing accounting estimates, especially when it comes to potential management bias. Acting Chief Auditor Barbara Vanich noted that by their nature, accounting estimates involve complex judgments that make them susceptible to management bias.
Assistant Chief Auditor Dominika Taraszkiewicz noted that the new estimates standard replaces the existing three overlapping standards relating to accounting estimates with a new streamlined standard. The new standard and related amendments focus on the risk of material misstatement and emphasize professional skepticism. The new standard includes an appendix that provides specific direction to address auditing the fair value of instruments, particularly when the information is provided from third parties such as pricing services and brokers and dealers, Taraszkiewicz explained.
According to Taraszkiewicz, the final standard was modified in several respects from the initial proposal, including clarifying the auditor’s responsibility for identifying significant assumptions and providing additional directions on the auditor’s ability to group financial instruments with similar characteristics when applying substantive procedures to pricing information obtained from third parties.
PCAOB Chairman William Duhnke noted that currently the auditing of accounting estimates relies on three different standards adopted between 1988 and 2003. The result is an inconsistency in the accounting of estimates. He also advised that this approach pre-dates the Board’s priority for risk assessment analysis. The new standard, Duhnke said, is clearer, more consistent, and risk-based.
Board Member Jay Brown commented that determining estimates has been deemed “both an art and a science.” In the past decade, there has been a steep increase in accounting estimates, he noted. In addition, Brown observed that in developing the standard for estimates, the staff, for the first time, considered behavioral economics in rulemaking, which “incorporates a more realistic analysis of how people think and behave when making economic decisions.”
Board Member Duane DesParte said that while the new standard on estimates requires the auditor to consider both corroborating and contradictory audit evidence, auditors do not have to “scour the universe to uncover and consider any and all possible contradictory evidence.”
Work of specialists. The new standard on the auditor’s use of the work of specialists strengthens and clarifies requirements in two areas: (1) the use of the work of a company’s specialists; and (2) the use of the work of an auditor’s specialist. Regarding company specialists, the new standard is aligned with the new accounting estimates standard by incorporating risk assessment. It also sets forth factors for determining the necessary evidence for to support the auditor’s conclusion regarding an assertion when using the work of the company’s specialist.
The standard on the auditor’s use of the work of a specialist adds requirements that the specialist be informed of the work to be performed and amends requirements for assessing the knowledge, skill, and ability of the auditor’s specialist. It also amends the requirements for “objectivity” of an auditor-engaged specialist.
Associate Chief Auditor Lisa Calandriello advised that the final standard included revisions from the proposal that had been seen as unnecessarily complex or burdensome. With respect to the use of company specialists, the final standard removed the word “test” except in relation to company-produced data. For auditor specialists, the final amendments were revised to allow auditors to assess the specialists along a spectrum of objectivity, which would allow them to use the work of a less-objective specialist if the auditor performs additional procedures to evaluate that specialist’s work.
Board Member Kathleen Hamm noted both the accounting estimates standard and the work of specialists’ standards work hand in hand. She praised the staff for its work in making sure any revised standards remain “evergreen” as the use of emerging technology and data analytics evolve for financial reporting and auditing. The new standards are sufficiently principles-based and flexible to appropriately accommodate these new innovations, Hamm added.
Implementation. Board Member Jim Kaiser said he strongly supports the new standards. He noted that the new standards, if approved by the SEC, will become effective for audits of financial statements for fiscal years ending on or after December 15, 2020. While he supports this effective date, he noted that the new standards will increase demands on the financial reporting ecosystem. As such, the Board must be receptive to feedback on the implementation of the new standards and should be open to making changes if necessary, including to the effective date.
Board Member DesParte agreed, advising that while it will improve audit quality if the standards are implemented as expeditiously as possible, he also acknowledged that firms need time to update methodologies, develop tools, provide staff training, and prepare audit committees and management for these changes. In supporting the 2020 effective date, DesParte noted that the PCAOB will be establishing an implementation support program to assist firms of all sizes and other impacted stakeholders in implementing the new standards.
The new standards are subject to the approval of the Securities and Exchange Commission.