Starting last month, audit firms must now disclose the names and locations of other auditors—including shared service centers and foreign firms—participating over a certain percentage of the audit of public companies. The disclosure of this new information may require changes in practice for audit firms and audit committees.
The New Standard
In 2017, a new PCAOB standard will require PCAOB-registered audit firms to file Form AP (Auditor Reporting of Certain Audit Participants), which the PCAOB has referred to as the “transparency report.” Under this rule, firms have already started disclosing the name of their engagement partner on each audit. This requirement of the standard has received significant media attention. However, the second part of this standard may be far more interesting as a source of information as it unfolds because it will contain new information about multinational audits that has heretofore been unavailable to the general public. Since the participating firms whose names will be disclosed will likely be subject to PCAOB inspections, there will be information available about those firms in PCAOB inspection reports and enforcement actions.
Disclosure of the Lead Engagement Partner
The new form AP became effective for issuers with Dec. 31, 2016 year ends, with a phased implementation approach. For the first six months the rule is in place, only the name of the lead engagement partner needs to be disclosed on Form AP.
So far thousands of engagement partners’ names and associated audits have been publicized. The forms containing this information can be searched through the PCAOB’s “auditor search” function on our website. For the first cycle of public disclosure, it is unlikely that the public will derive significant benefits from the information in the Form AP because only a single year’s experience will be shown. As time passes and data accumulates, the public will be able to trace the various engagements that a partner has worked on and will have a better picture of an engagement partner’s work history.
There are aspects of this disclosure that may need refinement. For example, it recently came to our attention that a lead engagement partner may not be disclosed on the form if that partner is not licensed in the jurisdiction where the audit is performed (for example, in a non-U.S. country). In those instances, the true lead partner who coordinates and oversees the audit will likely not be the person signing the audit opinion. It is the partner who is licensed in the jurisdiction and signs the opinion whose name would be disclosed. This may not be a common occurrence, but it does occur, including with some very sizable issuers.
Disclosure of Other Auditors
Starting with Form AP reports filed in June of 2017, the firm which signs an audit opinion will be required to disclose the name and location of other accounting firms participating in an audit if the work of such firms constitutes more than five percent of the total audit hours. In addition, the signing firm must also disclose the aggregate audit hours (as a percentage of the total) of those other firms that participated in the audit but whose individual participation was less than 5 percent of the total. For firms performing more than 5 percent of the audit, the firm must be named and the percentage of the total hours disclosed in a range or as a percentage. The 5 percent threshold was selected based on the Board’s belief that this threshold would generally result in the disclosure of the names of the firms that make up most of the audit effort, without imposing the undue reporting burden of a lower threshold.
The PCAOB has previously publicized that 80 percent of Fortune 500 companies have a multinational audit (an audit involving several affiliates of a global auditing network or other unrelated auditors in various countries), and 55 percent of all public companies in the United States have multinational operations. Thus, most companies have foreign operations, but we do not yet know how those operations are being audited. The PCAOB staff has estimated that there will be one or two additional participants disclosed, on average, in multi-national audits. For the first time in the United States, we are about to see how much of an audit is being performed by foreign affiliates of the lead auditor.
Today, the PCAOB conducts inspections of all PCAOB-registered audit firms that audit issuers and that play a substantial role in the audits of issuers, so long as those firms are in jurisdictions to which we can secure access for inspections. The PCAOB publishes the engagement-level findings in those inspections without naming the specific issuers.
Quality Issues and Foreign Auditors
In 2016, in an opinion piece in MarketWatch, I raised concerns about the lack of uniformity of audit quality around the world. The article tried to point out that if a firm can boast improving results in their inspections findings in the United States, that alone would not show the whole picture about either the performance of the global audit group or a complete picture of the relevant inspection results for the firms that participated in audits of multinational clients.
At the end of 2016, PCAOB announced a large settlement with Deloitte Brazil, and the settlement disclosed significant quality and leadership issues. The settlement with Deloitte is a strong step forward in the PCAOB’s efforts to draw attention to the importance of the quality of non-U.S. auditors that may be component auditors on multinational audits. In addition, the PCAOB has announced some other significant settlements that our Division of Enforcement and Investigations has reached with foreign affiliates of the largest firms in the United States. The descriptions in those settlements of the conduct that led to the enforcement actions make it clear that there were fundamental quality issues in the audits to which the settlements pertain. The cases should draw even greater attention to what our inspection reports have been making public for some time—there are foreign affiliates of the United States audit firms that are struggling to comply with PCAOB auditing standards.
In conversations with audit committee members in the United States, I have observed that committee members are often not focused on, or in some cases even very aware of, the component parts of the audit conducted by the “other auditor.” Many audit committee members were not aware that they could find our inspection reports for the affiliates performing significant components of their audits around the world. Audit committee members should be asking their auditors about these global inspections and whether there are findings in the inspections of their lead auditor’s affiliates. If they are not asking that question already, I believe this new disclosure will draw audit committee attention to the magnitude of the percentage of the audits performed by affiliates or other component auditors rather than by the United States firm and therefore to the significance of their participation.
Change in Practices this New Disclosure May Drive
In my work as the Chair of the International Forum of Independent Audit Regulator’s Global Audit Quality Working Group, member regulators and I meet regularly with the audit leadership of the six largest global audit networks. The networks are making great improvements in giving the group auditor the information that the lead auditor needs to evaluate the competency of their component auditors. If the clients and investors join the regulators in calling for this step to be considered critical to the audit, we can hope to see continued improvements. The networks face challenges of data privacy within certain jurisdictions, and a lack of central control over their affiliates, and in some instances, the lack of a path for information to flow regarding regulators’ findings from one jurisdiction to another.
As greater focus is trained on group audits, we expect that both firms’ and audit committee processes will evolve so that greater focus will be placed on inspection results, by both the firms’ own internal inspections as well as those of outside regulators in evaluating component auditors.
Interplay of Other Auditors with Rotation
Several years ago, the European Union put in place regulations that require member countries to mandate that public companies start rotating their auditors. The law allowed the various member states to adopt the mandatory tendering or rotation requirements in a variety of forms. A consequence of this is that rotation or tendering is required at various intervals within the European Union.
The new rules are already raising some very complex issues. For example, for a U.S. issuer that has a separately incorporated but non-listed wholly owned subsidiaries in the European Union, rotation of the European subsidiary’s statutory auditor may be required, but the auditor of the U.S. consolidated audit would not necessarily be required to change. Will issuers and audit firms have the two audits conducted by separate firms—one for the statutory audit in Europe and another for reporting to the U.S. auditor of the consolidated accounts —or will the U.S. auditor work with the affiliate of another network for the component audit? This leads to the question: how will a global multinational company’s auditor continue to conduct a group audit? Will the group auditor have to become more comfortable working with the affiliates of a competitor network? Will this be positive or negative for audit quality? At a minimum, it would pose challenges for the auditors in reaching a sufficient common understanding around the proprietary network methodology of competing networks.
The information to be released as a result of the new requirement that firms file Form AP will be interesting for scholars, investors and audit regulators to monitor. The new information will likely lead to further attention to audit quality around the globe, and hopefully, related improvements.
The authors are speaking for themselves and their views do not necessarily represent those of the PCAOB, its board members or staff.