By John Filar Atwood
In more than 240 conversations with audit committee chairs in 2021, the PCAOB discovered that outside of financial statement issues, audit committees view ESG issues as a hot topic and indicated that it is an area where companies are feeling pressure from investors. In a report on the takeaways from those conversations, the PCAOB found that audit committee chairs also frequently look to auditors for insight on business trends, regulatory developments in financial reporting, and management’s tone at the top.
PCAOB staff conducted the conversations as part of its ongoing outreach program and in the course of its inspection cycle. Participation by audit committee chairs is voluntary, and the staff noted that in 2021 it inspected 477 audits and held 244 conversations with audit committee chairs.
According to the report, audit committee chairs said that financial statement issues were the most common topics, but that outside of financials ESG was cited as a key area of discussion. The staff said that about 70 percent of committee chairs with whom it spoke cited ESG as a hot topic, with one indicting that she would be shocked if boards were not thinking about environmental and other ESG issues. In 2021, conversations mostly centered around the accuracy of data and the potential need for new ESG processes or controls, the report indicated.
A second area outside of the financial statements that generated a lot of discussion is non-GAAP measures, the staff noted. Audit committee chairs rely on their auditors for perspective on the use of non-GAAP information, the PCAOB found, with earnings before interest, taxes, depreciation, and amortization being a key metric for discussion.
Required communications. PCAOB Auditing Standard AS 1301 requires auditors to communicate with audit committees regarding certain matters related to the conduct of the audit. Committee chairs told the PCAOB staff that the required topics most commonly discussed were accounting matters, including impairments and goodwill accounting issues, revenue recognition, and the accounting implications of the COVID-19 crisis. The committee chairs said that COVID-19 discussions tended to focus on the impact on company liquidity, going concern assessments, relevant disclosures, and management of the audit in a remote environment.
Critical accounting matters (CAMs) were another topic frequently mentioned by committee chairs, according to the report, with conversations focusing on how CAMs are identified and disclosed. A third commonly discussed topic was the audit process itself. Committee chairs told the PCAOB staff that they regularly review with their auditors issues surrounding the conduct of the audit, including planning, scope, procedures, auditor needs, levels of cooperation, and new standards.
The report states that many committee chairs discussed the auditor’s evaluation of the quality of the company’s financial reporting, usually in the context of cybersecurity incidents, the implementation of information technology, and the impact of spin-offs and other restructuring transactions. In addition, committee chairs frequently discussed risks with auditors, including possible high-risk areas, risks related to fraud, changes in accounting practices, and management override of controls.
Non-required communications. The report identifies three primary areas outside of those required by AS 1301 that committee chairs discussed with auditors: management tone at the top, big picture considerations, and regulatory issues.
Regarding tone at the top, audit committee chairs often told PCAOB staff that they use the auditor as a sounding board to enhance their understanding of management. Some chairs look to the auditor to provide a view on whether management is setting the right tone at the top of the company. They also view the auditor as a resource in gauging the strength of key management positions and departments, notably in accounting and finance, the report states.
Big picture conversations between auditors and committee chairs tended to cover economic conditions broadly and for particular industries. PCAOB staff noted that discussions focused on industry trends and background, challenges in the current operating environment, and views on what might be coming next.
According to the report, committee chairs see their auditors as resources on gaining an understanding of the regulatory environment, particularly regarding accounting and auditing matters. Chairs said they rely on auditors to provide the audit committee with a view on developments at regulators and standard setters such as FASB, the PCAOB, and the SEC.
Inspection reports. The conversations with audit committee chairs also provided the PCAOB with some feedback on its inspection reports. About 70 percent of the chairs with whom the PCAOB staff spoke said that they review PCAOB inspection reports independently and/or discuss them with their auditors.
Committee chairs said they use the inspection reports to check for warning signs and to understand the number or nature of findings, trends in findings over the years, and how the firm responds to the report. In addition, chairs find the reports helpful as a means to understand how one firm is doing relative to its peers, particularly in terms of numbers of findings identified.
The report indicates that committee chairs also use the inspection reports as a catalyst for discussions with the auditors. Committee chairs go through the report with the audit partner to probe findings and to get a better sense of what the firm is doing to remediate deficiencies.
Committee chairs also were critical of PCAOB inspection reports in a couple of areas, the report states. First, some committee chairs shared concerns about the timeliness of the inspection reports. They said that the gap in time between the inspection period and the issuance of the report led some to doubt whether the report was still useful or actionable. The PCAOB indicated that it is focused on accelerating the issuance of its inspection reports going forward.
In addition, committee chairs called into question the level of detail provided in inspection reports. The PCAOB staff found that committee chairs want additional types of information in the inspection reports, such as findings broken down by industry or more information on good practices observed.