PCAOB Warns of Deficiencies in Audit Firms' Risk Assessment

The Public Company Accounting Oversight Board issued a report Thursday warning about significant deficiencies it is seeing in auditing firms’ assessment of risks in their clients.

The report details concerns about registered audit firms’ implementation of and compliance with certain auditing standards related to the auditor's assessment of and response to risk in an audit as observed during 2012-2014 inspections.

Auditing Standards No. 8 through No. 15, known collectively as the risk assessment standards, were adopted in 2010 and are designed to address the auditor’s assessment of and response to risk of material misstatements and the auditor's evaluation of the results of procedures performed in an audit.

The report discusses findings under the eight standards for inspections conducted in 2012, 2013 and 2014.

The PCAOB said it is concerned with the number and significance of deficiencies in compliance with these auditing standards.

“Because risk assessment underlies the entire audit process, it is critical that audit firms address these findings of weaknesses in compliance with the risk assessment standards,” said PCAOB Chairman James R. Doty in a statement.

The eight auditing standards address procedures performed in all stages of the audit, from initial planning through the evaluation of audit results to support an opinion.

The risk assessment standards include:

•    AS  No. 8, Audit Risk
•    AS  No. 9, Audit Planning
•    AS  No. 10, Supervision of the Audit Engagement
•    AS  No. 11, Consideration of Materiality in Planning and Performing an Audit
•    AS  No. 12, Identifying and Assessing Risks of Material Misstatement
•    AS  No. 13, The Auditor's Responses to the Risks of Material Misstatement
•    AS  No. 14, Evaluating Audit Results
•    AS  No. 15, Audit Evidence

In 26 percent of the 632 engagements inspected in 2012 where the risk assessment standards were applicable, inspections staff found an audit deficiency related to one or more of those standards that contributed to an insufficiently supported audit opinion. That rate increased to 27 percent for the 848 engagements inspected in 2013.

A preliminary analysis of 2014 inspection data indicates that a high rate of audit deficiencies related to the risk assessment standards continued to be identified in 2014 inspections.

Audit deficiencies related to the risk assessment standards spanned a wide variety of issuers and firms and most frequently related to AS No. 13, AS No. 14 and AS No. 15.

Examples of common deficiencies under those auditing standards include failing to perform substantive procedures specifically responsive to fraud risks and other significant risks identified, not evaluating the accuracy and completeness of financial statement disclosures, and not testing the accuracy and completeness of information produced by the company.

The report also explores the potential root causes of noncompliance with the risk assessment standards and potential remedial actions firms can take to remain in compliance with the auditing standards.

Audit deficiencies are occurring other areas as well. Separately, the Atlanta-based valuation and litigation consultancy firm Acuitas released an analysis Thursday of recent PCAOB inspections and found that 43 percent of all audits inspected by the PCAOB in 2013 had deficiencies, compared to 16 percent in 2009. The number of fair value measurement and impairment deficiencies as a percentage of the total continued to be significant in 2013, representing 31 percent of all audit deficiencies in 2013.

As in a similar survey last year, the fair value measurement audit deficiencies attributable to mergers and acquisitions activity increased to 49 percent in 2013, up from 45 percent in 2012 and an average of 9 percent from 2008 to 2011. The number of deficiencies caused solely by failures to assess risk and test internal controls remained high in 2013, at 45 percent of all deficiencies for the top 25 firms. In comparison, such failures were present in 22 percent of fair value measurement deficiencies between 2008 and 2012.

“We have seen a significant shift from the years where FVM deficiencies were largely the result of financial instruments to the current trend of business combinations and a failure to test or understand financial assumptions,” said Acuitas managing director Mark Zyla. “This shift has likely been caused by audit improvements for financial instruments that resulted from the PCAOB inspection process and by increased merger activity in recent years. The auditing community should certainly be concerned about the continuing increase in deficiencies caused by a failure to assess risk and internal controls, and the PCAOB’s assessment that they are caused by ‘a lack of due professional care.’”

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