By John Filar Atwood
The PCAOB released its annual report on the interim inspection program related to audits of brokers and dealers in which it revealed that in 105 of the audit engagements it inspected it found 55 with audit and attestation deficiencies. An additional 25 engagements had audit deficiencies but no attestation deficiencies. The PCAOB acknowledged that the percentage of deficiencies remains high, and hopes the issues identified in the report will help drive future improvements.
The report states that the PCAOB inspected 67 firms in 2018 and found only three with no deficiencies. In addition to the 105 audit engagements, the board inspected 24 examination engagements and 79 review engagements. It found deficiencies in 18 of the examination engagements and in 43 of the review engagements.
The report states that in selecting the firms to inspect and the engagements for review, the PCAOB used both risk-based and random selection methods. Moreover, the staff did not review every aspect of the selected engagements, but focused on the more complex, challenging, or subjective areas, or other areas that presented greater risk. The PCAOB noted that its observations are specific to the particular portions of the engagements reviewed and are not representative of the entirety of the specific engagements.
Quality control observations. The PCAOB requires firms to have a system of quality control that provides reasonable assurance that their personnel comply with applicable professional standards and a firm’s standards of quality. During the 2018 inspections, the PCAOB identified defects and potential defects related to engagement performance and monitoring, which are two required elements of a system of quality control.
With regard to the engagement performance and monitoring aspects of the system of quality control for certain firms, the PCAOB found that some firms’ audit methodology was not effective. Specifically, engagement teams established materiality levels that were too high to plan and perform audit procedures to detect misstatements that could be material to the financial statements because the firm’s audit methodology did not require appropriate consideration of certain relevant factors. The methodology also did not sufficiently instruct engagement teams to evaluate whether a lower materiality level was needed for particular accounts, according to the report.
In some cases, engagement teams determined sample sizes that were too small to provide sufficient, appropriate audit evidence. The firm’s audit methodology allowed engagement teams to determine samples for substantive tests of details that did not take into consideration tolerable misstatement and the allowable risk of incorrect acceptance.
Engagement quality. The PCAOB also found problems with the engagement quality review, including instances where reviews were not performed. In other instances, reviewers had served as the engagement partner for the audit of the broker-dealer’s financial statements for one or more of the previous two years and, therefore, did not meet the objectivity qualifications of an engagement quality reviewer. Further, some reviews did not include an evaluation of the engagement team’s significant judgments and the related conclusions reached that formed the overall conclusion in the engagement report.
The PCAOB reported the following numbers with respect to audit and attestation engagements with deficiencies in the engagement quality review: 83 audit engagements reviewed, and 54 with deficiencies; 19 examination engagements reviewed, and 5 with deficiencies; and 51 review engagements inspected, and 22 with deficiencies.
Auditor’s report and documentation. The 2018 inspections found that in some instances audit reports were not prepared under the applicable auditing standard. Others did not accurately describe the financial reporting framework under which the broker-dealer’s financial statements were prepared.
In other cases, a complete and final set of audit documentation was not assembled for retention as of the documentation completion date. Documentation added to the audit work papers subsequent to the report release date did not indicate the date the information was added, the name of the person who prepared the additional documentation, and the reasons for adding it, according to the report.
Examination engagements. An auditor is expected to perform an examination of statements made by the broker-dealer in its compliance report, which should include obtaining evidence about whether one or more material weaknesses existed in the broker-dealer’s internal control over compliance (ICOC) with the broker-dealer financial responsibility rules. The examination also includes performing tests of the broker-dealer’s compliance with the net capital rule and paragraph (e) of the customer protection rule (the reserve requirements rule) as of the end of the broker-dealer’s fiscal year.
In the 2018 examination engagements, the PCAOB found that in some cases planning was not sufficient because the firms did not obtain a sufficient understanding of certain of the financial responsibility rules or of the broker-dealer’s processes, including relevant controls, regarding compliance with the financial responsibility rules. In other engagements, testing of ICOC with the financial responsibility rules was not performed, or was not sufficient, including examinations in which no testing was performed of any ICOC related to one or more of the financial responsibility rules.
Other deficiencies. The report discusses numerous other areas where deficiencies were identified, including performing compliance tests, evaluating the results of examination procedures, performing review procedures, evaluating the results of the review procedures, reporting on the review engagement, auditing financial statements, the auditor’s report, auditor communications, and auditor independence.
The report also provides multiple examples of effective procedures employed by various firms. The PCAOB said that its goal in identifying both deficiencies and effective practices is to assist audit firms as they assess and refine their audit practices to prevent the deficiencies from occurring in the future.