Securities Regulation Daily PCAOB reports observations based on 2015 issuer audits
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Wednesday, April 20, 2016

PCAOB reports observations based on 2015 issuer audits

By Jacquelyn Lumb

The PCAOB inspection staff is encouraged by improvements in audit quality of many of the issuer audit firms it inspected in 2015, but continues to find frequent deficiencies in a number of areas, including internal control over financial reporting, assessing and responding to risks or material misstatement, and accounting estimates. The staff provided an overview of its 2015 inspection findings for auditors of issuers, and issued a separate inspection brief on the audits of broker-dealers. The brief urges auditors to review the staff’s findings and focus on the areas that continue pose problems.

Control testing. The staff advised firms to continue to focus on testing controls and provided a number of examples of frequently recurring deficiencies, including insufficient testing of the design and operating effectiveness of selected controls, particularly where there was a high risk associated with the control. The staff also continued to identify deficiencies related to the testing of controls that contained a review element.

Risk assessment. The number of deficiencies related to non-compliance with the risk assessment standards decreased at some firms compared to the last two years, but still persists. Here too, the brief provided examples of the staff’s findings, including the failure to perform procedures that were specifically responsive to fraud and other significant risks that had been identified, the use of sample sizes that were too small due to deficiencies in evaluating and testing internal control, and the failure to take into account contradictory assertions in the financial statements.

In some instances, the staff said the auditors did not have a sufficient understanding of the revenue recognition process. These deficiencies were most frequently observed at triennially inspected firms. The brief urged auditors to review the PCAOB’s October 15, 2015 report on inspection observations related to the risk assessment auditing standards, which provides insight into potential root causes of these deficiencies and potential remedial actions.

Estimates and valuation. The 2015 inspections included a focus on complex estimates, which typically require more audit attention. The deficiencies frequently related to the valuation of assets and liabilities acquired in a business combination and evaluating impairment analyses for goodwill and other long-lived assets. In some instances, the auditors did not fully understand how estimates were developed or did not sufficiently test the significant inputs and evaluate the significant assumptions used by management. The staff also continued to see instances where auditors did not perform testing beyond inquiry of management.

Economic environment. The staff considered the economic environment when it selected audits and financial accounting areas for inspection, including business combinations given the pace of merger and acquisition activity, the search for higher yielding investment returns, and the fluctuation in oil prices. While the audit deficiencies related to economic risks were not pervasive across the firms that were inspected, the staff urged auditors to continue to evaluate whether their audit plans are designed to address the concerns raised by these risks.

Financial reporting deficiencies. The financial reporting areas in which the staff reported frequent findings included revenue and receivables, non-financial assets, inventory, financial instruments, and the allowance for loan losses. The staff also focused on the statement of cash flows and income taxes in certain issuer audits. While the staff did not identify frequent deficiencies in these areas, they may continue to be a focus in future inspections.

Independence. The majority of the deficiencies relating to auditor independence occurred at triennially inspected firms. While not pervasive across all firms, the staff urged auditors to continue to assess their personal and professional activities to ensure compliance with the independence rules and standards.

Engagement quality reviews. The staff continued to identify deficiencies with engagement quality reviews, including some of the triennially inspected firms where no reviews were performed.

Multinational audits. The number of audit deficiencies in multinational audits were similar to 2014 and decreased from the 2013 inspection cycle, which the staff attributed to targeted actions by the largest firms to address criticisms in this area.

Cybersecurity. The staff also looked at software audit tools and cybersecurity. The inspections did not identify any audit deficiencies in these areas, but the staff intends to continue to evaluate how firm processes are evolving. The brief urged auditors to consider whether there are cybersecurity risks that could lead to a material misstatement and whether any cyber incidents had an impact on the financial statements.

MainStory: TopStory PCAOBNews AccountingAuditing

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