INFORMATION FOR AUDIT COMMITTEES ABOUT THE
1666 K Street, N.W.Washington, DC 20006Telephone: (202) 207-9100Facsimile: (202) 862-8430www.pcaobus.orgINFORMATION FOR AUDIT COMMITTEESABOUT THE PCAOB INSPECTION PROCESSPCAOB Release No. 2012-003August 1, 2012
Executive SummaryThe Public Company Accounting Oversight Board ("PCAOB or the "Board") isissuing this document to assist audit committees in (1) understanding the PCAOB'sinspections of their audit firms and (2) gathering useful information from their audit firmsabout those inspections. Some audit committees have told the Board that their auditfirms provide helpful information to them about their inspection, but others have saidthat their auditors decline to discuss their PCAOB inspection results with them ordownplay the results of any adverse findings that may be included in the report.Information about the results of a PCAOB inspection of a company's audit, aswell as more general inspection results, can help an audit committee in carrying out itsoversight role. Inspection reports can help inform an audit committee about how itsauditor performed on specific audits and in high-risk areas across audits.This is a high-level summary of matters that are discussed in more detail in therelease. Audit committee members are urged to read the entire release for moreinformation on each summarized topic.The Nature of a PCAOB Inspection of an Audit FirmPCAOB inspections assess compliance with certain laws, rules, and professionalstandards in connection with firms' audits of issuers. A PCAOB inspection of an auditfirm examines in depth (1) certain aspects of a limited number of audits performed bythe audit firm and (2) certain elements of the firm's system of quality control over itsaudit processes. Individual audits and areas of inspection focus are most often selectedon a risk-weighted basis and not randomly. Areas of focus vary among selected audits,but often involve audit work on the most difficult or inherently uncertain areas offinancial statements. A PCAOB inspection report – regardless of whether it identifies adeficiency – does not mean that the firm's unreviewed audit work was, or was not,deficient. Thus, results reported in a PCAOB inspection report should not necessarilybe understood to mean that the unreviewed audit work of the firm was deficient.PCAOB inspection findings are contained in two of the four parts of an inspection report:1. Part I – describes audit deficiencies where inspection staff found that theauditor failed to gather sufficient audit evidence to support an audit opinion. This mayrelate to the opinion that the financial statements are fairly stated or the opinion that thecompany's internal control is effective. Part I findings are made public and are availableon the PCAOB's web site.
Executive SummaryInformation for Audit CommitteesAbout the PCAOB Inspection ProcessAugust 1, 2012Page ii2. Part II – typically describes deficiencies in the firm's overall system of qualitycontrol such that the Board has doubts that the system provides reasonable assurancethat professional standards are met. The Board is prohibited by law from publiclyreleasing these Part II findings unless the firm fails to remediate these findings to theBoard's satisfaction within twelve months of issuance of the inspection report. The auditfirms themselves have copies of this part of the report and are not prohibited by lawfrom releasing this information at any time, though there may be other reasons theydecline to do so.Possible Questions Audit Committees May Wish to Ask Their Audit Firms aboutPCAOB Inspections1. Was the company's audit selected for PCAOB inspection? Committees maywant real time updates about whether their audit has been selected, what is beinglooked at, and any deficiencies identified by the PCAOB in the audit. The releaseprovides additional information about specific areas for possible further inquiry in thisregard.2. Did the PCAOB identify deficiencies in other audits that involved auditing oraccounting issues similar to issues presented in the company's audit? Committees maywish to understand whether similar deficiencies exist in the company's audit and, if so,what has been done in response.3. What were the audit firm’s responses to the PCAOB findings? Committeesmay want to understand whether the audit firm agreed with the PCAOB’s findings and, ifnot, why not. If the firm agreed, what did the firm do in response? The PCAOB is awareof certain audit firm responses that should be viewed with skepticism, such as:A. "It was just a documentation problem." The PCAOB bases deficiencyfindings on an absence of available evidence in the audit files or elsewhere tosupport that adequate work was done to support an audit opinion, not just afailure to document work that was in fact done. Audit firms are provided anopportunity to describe the details of work that was done but not documented.B. "There was a difference in professional judgment." The PCAOB basesdeficiency findings only on failures to obtain sufficient audit evidence, not ondisagreements when reasonable judgments appear to have been made aboutsuch matters.C. "The firm has addressed the criticisms in accordance with PCAOBstandards." Professional standards require that when a required auditingprocedure was omitted, certain remedial steps must be taken. Ask whether
Executive SummaryInformation for Audit CommitteesAbout the PCAOB Inspection ProcessAugust 1, 2012Page iiithe firm performed more work in response to the finding or in subsequentaudits, or whether the firm concluded that no additional steps were required –in other words, that the firm disagrees with PCAOB inspection conclusions.4. What topics are included in Part II findings? Firms may be reluctant to sharethe details of Part II findings in an inspection report for a number of reasons, but even inthat case, audit committees may want to ask for certain generic information about thefindings such as:A. what changes the firm is making to address any quality controldeficiencies;B. what is the progress of the quality control remediation process, includinga discussion of any submissions the audit firm made to the PCAOB as part ofthat process;C. the inspected years about which the PCAOB has made a finaldetermination about the firm's remediation efforts and the nature of thatdetermination; andD. whether the PCAOB has provided initial indications that the audit firmmay not have sufficiently remediated any items.****
1666 K Street, N.W.Washington, DC 20006Telephone: (202) 207-9100Facsimile: (202) 862-8430www.pcaobus.orgRELEASEINFORMATION FOR AUDIT COMMITTEESABOUT THE PCAOB INSPECTIONPROCESS)))))))PCAOB Release No. 2012-003August 1, 2012The Sarbanes-Oxley Act of 2002 ("the Act") changed oversight of publiccompany auditing in two fundamental respects: it created the PCAOB to regulate theauditors, and it amended the Securities Exchange Act of 1934 to rest responsibility forthe appointment, compensation, and oversight of any listed public company's auditorwith a committee of independent directors. Both the role of the Board and the role ofthe audit committee are critical to protecting the interests of investors.In carrying out its role, the Board collects and generates information that could beuseful to audit committees in carrying out their role. Some of that information is publiclyavailable on the Board's web site. This information includes, among other things,annual and special reports filed by audit firms under Board reporting requirements,disciplinary sanctions imposed by the Board along with detailed descriptions of thereasons for those sanctions, and information about the results of the Board's regular,periodic inspections of registered public accounting firms. The publicly availableinspection information includes individual reports on each inspection of a firm andgeneral reports that are not firm-specific but that provide information and analysisconcerning specific audit issues or a summary and analysis of results from inspectionsof a specified category of firms over a particular period.The Act does not, however, permit the Board to make public, or otherwise toshare with an audit committee, all of the information obtained by the Board that couldassist an audit committee in carrying out its role. Because of restrictions in the Act,many PCAOB inspection reports include a portion that is nonpublic. By law, the Boardcannot disclose to an audit committee the nonpublic portion of an inspection report orother nonpublic inspection information – including whether the inspection identifieddeficiencies in the audit that the audit committee oversees – and the Board cannotcompel an audit firm to disclose such information to an audit committee. Beyond thepublic portion of an inspection report, voluntary disclosure by the inspected audit firm isan audit committee's only means of obtaining information concerning a PCAOBinspection.
PCAOB Release No. 2012-003August 1, 2012Page 2RELEASEIt is the Board's understanding that the nature and amount of inspection-relatedinformation that audit firms provide to audit committees vary. The Board has heard fromaudit committee members about some instances in which they received from their auditfirm nonpublic inspection information that was significant to the audit committee in itsoversight role, and the Board has also heard, from those and other audit committeemembers, that audit committees would benefit from access to more inspectioninformation.1/Although the Board cannot provide audit committees with nonpublic informationabout specific inspections, this release provides information about the inspectionprocess, and the meaning of reported results, in a way that may better equip auditcommittees to engage in meaningful discussion with audit firms about the results ofinspections. Part I of the release discusses the meaning and significance of auditdeficiencies described in the public portion of an inspection report. Part II provides abasic description of the way that quality control criticisms are framed in portions ofreports that are, at least initially, nonpublic. Part III of the release suggests somespecific approaches that an audit committee might consider for initiating or enhancinginspection-related discussions with an audit firm. The appendix to this release providesadditional detailed background concerning the PCAOB inspection process andadditional details on other related matters.I.The Public Portions of Inspection Reports and Firms' ResponsesFor every inspection, the Act requires the Board to prepare a written report, toallow the inspected firm an opportunity to respond in writing to a draft of the report, andto include the firm's written response as part of the final report. As required by the Act,the Board makes a portion of each inspection report publicly available. If a firm submitsa response to the draft report, the Board makes public, as part of the final report, anyportion of the response that the firm chooses to have made public.PCAOB inspections are designed to identify and address weaknesses anddeficiencies related to how a firm conducts audits. To achieve that goal, Boardinspections include, among other things, reviews of certain aspects of selected auditsperformed by the firm. It is not the purpose of an inspection, however, to review all of a1/Examples of the views of audit committee members on these points canbe found in recent panel discussions at PCAOB Public Meetings on Firm Independenceand Rotation, including Session Four of the Board's June 28, 2012 public meeting (seehttp://pcaobus.org/News/Events/Pages/06282012 PublicMeeting.aspx for archivedwebcast and transcript), and Session Nine of the Board's March 21-22, 2012 publicmeeting (see http://pcaobus.org/News/Events/Pages/03212012 PublicMeeting.aspx forarchived webcast and transcript).
PCAOB Release No. 2012-003August 1, 2012Page 3RELEASEfirm's audits or to identify every respect in which a reviewed audit is deficient. Asdescribed in more detail in the appendix, audit work is selected for inspection largely onthe basis of an analysis of factors that, in the PCAOB inspection staff's view, heightenthe possibility that auditing deficiencies are present, rather than through a processintended to identify a representative sample of the audit firm's work.Accordingly, the Board cautions against extrapolating from the results presentedin the public portion of the report to broader conclusions about the frequency ofdeficiencies throughout a firm's practice. The Board also cautions against judging therelative quality of firms' audit practices solely on the basis of the number of deficienciesdescribed in the public portions of inspection reports. Nevertheless, the public portionof a report can be a useful starting point for discussion between an audit committee andthe audit firm it oversees about the inspection. For a report to be most useful for thatpurpose, the meaning of the published criticisms should be properly understood.A.Criticisms in the Public Portion of a PCAOB Inspection ReportThe public portion of a PCAOB inspection report does not describe every auditdeficiency observed in an inspection. Nor does it describe concerns that relate solely tothe adequacy of documentation of audit procedures. If the public portion of aninspection report describes a deficiency in a firm's audit of financial statements, it isbecause the inspection staff considered all available evidence regarding the auditprocedures performed by the firm and found that the deficiency had a specific andsignificant consequence: the firm did not satisfy its fundamental responsibility to obtainreasonable assurance about whether the financial statements are free of materialmisstatement.2/In other words, in the inspection staff's view the audit firm did not have asufficient basis for an audit opinion and, absent obtaining additional audit evidence,could not have such a basis. That finding does not mean that the financial statementsare misstated, and it is usually not possible for the inspection staff, based only on theinformation available from the firm, to reach a conclusion about whether the financial2/An inspection might also identify deficiencies in a firm's audit of an issuer'sinternal control over financial reporting ("ICFR"), in which case the significancethreshold for inclusion in the public report relates to the firm not having obtainedreasonable assurance about whether effective ICFR was maintained in all materialrespects. In some cases, inspections identify deficiencies in audit work that a firmperformed for an audit in which it played a role but was not the firm that issued the auditreport. In those cases, the significance threshold for inclusion in the public reportrelates to the firm not having obtained sufficient audit evidence to fulfill the objectives ofits role in the audit.
PCAOB Release No. 2012-003August 1, 2012Page 4RELEASEstatements are misstated. Auditors that have performed additional procedures inresponse to such criticisms, however, have sometimes discovered that there was amaterial misstatement that they had not detected before issuing the audit report, andthose discoveries have led to restatements.In some cases, the available information is sufficient for the inspection staff toform a view that there is an apparent material misstatement that, due to insufficientaudit work or improper assessment of the application of the relevant accountingframework, went undetected or unaddressed by the auditor. In cases where theinspection staff reaches that conclusion, the public portion of the inspection reportsummarizes the criticism of the auditing in terms that reflect the inspection staff's viewthat the financial statements are misstated.3/With respect to every deficiency described in the public portion of a report, theinspection staff will have formed its conclusion after a rigorous process. As describedmore fully in the appendix, that process involves opportunities for the firm to respond indetail to the initial assessment made by the team that performed the inspectionprocedures. That inspection team and other inspection staff carefully consider allevidence presented by the firm that may bear on the matter. Depending upon the issue,the inspection staff might also consult with staff in the Board's Office of the ChiefAuditor.4/3/The authority to prescribe the form or content of a public company'sfinancial statements rests with the Securities and Exchange Commission ("Commission"or "SEC"), not the Board. Any description in a PCAOB inspection report of a financialreporting error that the auditor did not appropriately address is a criticism of the auditingbased on information in the audit documentation, public information such as thecompany's SEC filings, and the inspection staff's understanding of financial reportingrequirements. The inspection staff does not engage with a company's managementabout financial reporting matters, and an inspection report's description of such an auditdeficiency is not an indication that the Commission has made or necessarily will makeany determination concerning the financial reporting in question.4/An inspection report's description of audit deficiencies reflects findings ofthe PCAOB inspection staff as reported to the Board, as distinct from Board findings ofthe type that may be grounds for the imposition of disciplinary sanctions. Findings ofthat nature would be made only in the context of an adjudicative process in which thefirm is afforded procedural rights that do not apply in the inspection context.
PCAOB Release No. 2012-003August 1, 2012Page 5RELEASEB.The Public Portions of Firms' ResponsesThe public portion of a report describes audit deficiencies in terms intended tomake clear the significance described above. The public portion of a report alsoincludes, however, any portion of a firm's response to the draft report that the firmchooses to have made public, and those responses sometimes describe the firm'sperspective on the inspection results or the firm's actions in response to the results. Insome cases, those public portions of firms' responses make assertions that may createuncertainty or confusion in the reader's mind concerning the nature and significance ofthe reported deficiencies. Although not all audit firms make such assertions in theirresponses, variations on three such assertions occur with sufficient frequency in firms'written responses – and possibly in discussions with audit committees – that auditcommittees may benefit from the Board's perspective on them.1. Assertions that Characterize Criticisms as Documentation DeficienciesRather than as Deficiencies in the Performance of Procedures toObtain Audit EvidenceIn addressing inspection report criticisms, firms' responses sometimescharacterize the deficiency in terms of audit documentation. That is, firms sometimesassert or imply that the firm performed procedures to obtain the necessary auditevidence and that the criticism arises only because the firm did not sufficientlydocument its procedures.In the Board's view, such assertions should be viewed with skepticism.5/ Inreaching its conclusions, the inspection staff considers whether audit documentation orany persuasive other evidence that a firm might provide to the inspection team supportsa firm's contention that it performed a procedure, obtained evidence, or reached anappropriate conclusion. In the case of every matter cited in the public portion of a final5/The Audit Inspection Unit ("AIU") of the Professional Oversight Board inthe United Kingdom publicly addressed a similar point in a 2011 report. Noting thatcomments received by the AIU from audit committee chairs indicated that they"sometimes had difficulty in assessing the significance" of AIU inspection issuescommunicated to the audit committee by the firm, the AIU observed that "[t]his difficultycould be caused by firms characterising some of the AIU's findings as relating to thesuffici
compel an audit firm to disclose such information to an audit committee. Beyond the public portion of an inspection report, voluntary disclosure by the inspected audit firm is an audit committee's only means of obtaining
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