PCAOB Votes to Propose New Rules on Audit Firms' Use of Other Firms

The Public Company Accounting Oversight Board has voted to propose amending the auditing standards on an audit firm’s use of other audit firms and to propose a new auditing standard.

The proposals build on earlier work of the board. Last December, the PCAOB adopted a rule to provide more transparency on the extent to which audits involve the work of other auditors beyond the lead auditor who signs the audit opinion. Under that rule, PCAOB-registered audit firms will disclose information that will allow investors to see, for a particular audit, how much of the work was performed by other auditors.

The proposal that the PCAOB approved Tuesday takes a different approach by trying to ensure the appropriate involvement by the lead auditor rather than just providing more transparency on the audit. 

“PCAOB-registered firms around the globe contribute audit work to each other’s audits, and our existing auditing standards prescribe responsibilities for the lead auditor with respect to the work of other auditors,” said PCAOB Chairman James Doty in his opening statement at the meeting. “Investors depend on the lead auditor to provide assurance that there are no material misstatements in audited financial statements or material weaknesses in internal control, no matter where those misstatements or weaknesses may reside.”

The proposal aims to require conduct by lead auditors that should result in a consistent level of quality assurance regarding other auditors’ participation in in the audit, Doty noted. The proposal would direct the lead auditor’s supervisory responsibilities to the areas of greatest risk, consistent with the PCAOB's risk assessment standards. It would also require procedures that would cause the lead auditor to be more involved in the work of other auditors, through more communication, access to the other auditor’s work papers, along with more robust evaluation of the other auditor’s qualifications and work.

“I support today’s proposal to strengthen the auditing standards for the lead auditor’s performance when other auditors participate in an audit,” said PCAOB board member Jeanette Franzel during Tuesday’s meeting. “When more than one audit firm is involved in an audit, it is important for investor protection that the lead auditor assures that the audit is performed in accordance with PCAOB standards and that sufficient appropriate evidence is obtained to support the audit opinion.”

The PCAOB is looking for public comments on the proposal by July 29, including feedback on the economic analysis that underpins the proposal. 

The proposal would enhance the planning and supervision of audit work conducted by so-called “other auditors” participating in audits of the financial statements of U.S. public companies, brokers or dealers, according to PCAOB board member Jay Hanson. In addition, the PCAOB proposing a new standard—while incorporating many of the current requirements—for situations in which an auditor divides responsibility for the audit with another accounting firm.

“The ‘other auditors’ addressed in the proposed amendments include other firms or individuals who participate in the audit but who are not part of the audit firm issuing the audit report,” said Hanson. “Under standards currently in effect, auditors may apply a variety of approaches to the oversight of other auditors involving varying degrees of oversight by the lead auditor over the work of the other auditor. While certain approaches taken by firms work well and result in high quality audits, some of the approaches that are permissible under current standards do not involve enough oversight by the lead auditor to ensure that sufficient appropriate evidence is obtained to support the lead auditor’s opinion in the audit report.”

Another PCAOB board member, Steven Harris, said he supports the proposal. “I view the proposal as an important step forward in addressing the audit quality concerns noted through our inspection and enforcement activities,” he said. “The audits implicated here are those where portions of the audit are performed by auditors other than the firm signing the audit report. The other auditors are often located in different jurisdictions and may be affiliates of the signing firm. If the signing firm takes responsibility for the work performed by the other auditors involved, it does not identify the participation of the other firms or individuals in its report. However, if the signing firm does not take responsibility, it identifies the portion of the work performed by the other auditor and that auditor provides a separate audit report for its work.”

The PCAOB explained the proposal by pointing out that many companies have significant operations around the world. When auditing a multinational company, a lead auditor often needs participation of other firms or individual accountants to complete the audit.  

The use of other auditors is especially prevalent among audits of larger companies performed by larger accounting firms. PCAOB data indicate that other auditors are used in about 55 percent of audits performed by U.S. global network firms and about 30 percent of audits performed by non-U.S. global network affiliate firms. 

Approximately 80 percent of Fortune 500 audits performed by U.S. global network firms involved other auditors, according to a PCAOB analysis of data from Audit Analytics and Standard & Poor's. Work performed by other auditors can account for a significant share of the audit. In audits involving other auditors selected by the PCAOB for inspection, other auditors on average audited between one-third and one-half of the total assets and total revenues of the audited company. Without adequate supervision by a lead auditor, deficiencies in the work of other auditors can result in deficient audits, the PCAOB noted.

While many auditors properly supervise the use of other auditors, PCAOB inspectors have found that other firms need to strengthen their practices. Inspectors have identified audit deficiencies in the work of other auditors that the lead auditors did not identify or address.

"We know from PCAOB oversight activities that the supervision of other auditors is an issue at some firms," said PCAOB Chief Auditor and Director of Professional Standards Martin F. Baumann in a statement. "That, and the fact that a majority of the audits of Fortune 500 companies use other auditors, underscores the importance of this proposal."

The PCAOB’s proposal would make the following changes to existing PCAOB auditing standards:

• Amend AS 1201, Supervision of the Audit Engagement, to provide additional direction to a lead auditor on how to apply AS 1201’s principles-based supervision provisions to supervision of other auditors. The proposed amendments would prescribe certain procedures to be performed by the lead auditor in supervising other auditors’ work.

• Amend AS 2101, Audit Planning, to incorporate and update requirements from AS 1205 to specify that they be performed by a lead auditor in an audit that involves other auditors. For example, the proposal would incorporate and revise requirements for determining a firm's eligibility to serve as lead auditor in an audit that involves other auditors.

• Amend AS 1215, Audit Documentation, to require that a lead auditor properly document which specific work papers of other auditors the lead auditor has reviewed, but not retained.

• Amend AS 1220, Engagement Quality Review, to require explicitly that the engagement quality reviewer evaluate the engagement partner's determination of a firm's eligibility to serve as lead auditor.

The PCAOB is also proposing a new standard: AS 1206, Dividing Responsibility for the Audit with Another Accounting Firm.

• The proposed new standard would retain, with modifications, many of the requirements of a current standard, AS 1205, Part of the Audit Performed by Other Independent Auditors, including the requirement that a lead auditor disclose in its audit report which portion of the financial statements was audited by each other auditor.

• The proposed AS 1206 includes new requirements that a lead auditor:

  o obtain a representation from each other auditor that the other auditor  is duly licensed to practice under the applicable laws of the relevant country or jurisdiction.

  o determine whether each other auditor that would play a substantial role in the preparation or furnishing of the lead auditor’s report is, or is required to be, registered with the PCAOB.

  o disclose the name of the other auditor in the lead auditor's report.

AS 1205, Part of the Audit Performed by Other Independent Auditors, would be superseded by the proposed amendments and proposed standard.