The PCAOB’s inspection staff has released Spotlight: Staff Overview for Planned 2022 Inspections, its annual discussion of focus areas in the current inspection cycle. For audit committees, the Spotlight provides insight into the audit aspects that are likely to be addressed if the company’s audit is inspected. It also highlights accounting and auditing challenges to which the committee may want to direct attention. (For last year’s inspections outlook, see PCAOB Releases 2021 Inspections Outlook and Audit Committee/Auditor Dialogue Tool, March-April 2021 Update.)

Selected Areas of Inspections Focus

The staff discusses ten areas on which 2022 inspections will focus:

• Fraud and Other Risks. The inspection staff will emphasize audit procedures that address risks of material misstatement, including fraud. Some specific risk areas are IPOs or significant M&A activities, including SPAC transactions; the effects of supply chain disruption; and volatility due to fluctuations in interest rates and inflationary trends. Industries prone to supply chain disruption risks include electronic components and equipment, automobile, retail, and materials. Industries prone to COVID-19 related risks include airlines, hospitality, and entertainment. Inspectors will also review the auditor’s assessment of fraud risk, including whether the company’s controls sufficiently address identified risks, such as the risk of management override of controls.

The Spotlight lists five specific accounting and auditing risks:

o Unreasonable assumptions affecting revenue recognition due to the negative effects of the COVID-19 pandemic and supply chain disruptions.

o Unreasonable assumptions used in projections to account for business combinations or in testing goodwill or other intangibles for impairment.

o Earnings manipulation as a reaction to margin pressures driven by rising costs.

o Inventory existence and valuation (e.g., challenges in observing in-transit inventory and in valuation due to supply chain disruptions and rising costs).

o Financial, economic, and business uncertainties that impact the assessment of the company’s ability to continue as a going concern.

• IPOs and M&A Activity. IPOs and M&A, including SPAC transactions, present reporting and audit risks due to transaction complexity and variations in company readiness to comply with public company financial reporting and internal control requirements. For SPAC and de-SPAC transactions, inspectors will focus on the auditor’s work in the areas of financial instrument valuation; determination of whether a business combination should be accounted for as a reverse merger; internal controls; financial statement presentation and disclosures; and restatements.

• Audit Firms' Execution Challenges. Inspectors will review firm policies and procedures for assigning professionals with appropriate qualifications to audit engagements and whether firms are modifying their supervision and review procedures appropriately. The Board also plans to select engagements for review where the lead engagement partner is new to the engagement, including those resulting from partner turnover.

• Broker-Dealer-Specific Considerations. In inspections of securities broker-dealer audits, the staff will examine how auditors addressed the risk of misappropriation of customer assets at broker-dealers that hold customer funds.

• Independence. Independence will remain a focus area in 2022. In particular, inspectors may:

o Analyze audit firm independence assessments, including relationships that present threats to objectivity and impartiality, and firm-identified violations of independence rules.

o Evaluate compliance with the independence rules related to permissible non-audit services and their preapproval.

o Review audit firm communications with audit committees concerning independence.

o Review audit firm responses to independence-related quality control concerns identified in past inspections (e.g., high rates of exceptions in independence compliance testing).

• Use of Service Providers in the Confirmation Process. Inspectors will review procedures for maintaining control over confirmation requests and responses, particularly in cases where the auditor arranges for service providers to assist in the confirmation process by electronically sending and receiving confirmations.

• Critical Audit Matters (CAMs). Inspection procedures will include: (1) engaging in discussions about CAMs with engagement teams and certain audit committees; (2) reviewing CAMs in the auditor’s report; (3) reviewing whether certain matters communicated to the audit committee were included in the audit firm’s procedures to determine CAMs; and (4) reviewing the engagement team’s determination of whether a matter was a CAM.

• Audit Areas With Continued Deficiencies. Inspectors will focus on areas in which audit deficiencies commonly recur, including revenue recognition and related risk assessment; allowance for loan losses and other accounting estimates; and internal control over financial reporting, particularly controls with a review element.

• Firms' Quality Control Systems. Inspectors will assess audit firms’ compliance with the PCAOB’s quality control standards. Among other things, they will consider the impact of the COVID-19 pandemic and of the current economic environment in gaining an understanding of firm quality control systems.

• Technology. Inspectors will focus on three technology-related areas:

o Auditing digital assets. Companies with material digital asset holdings and transactions will be selected for inspection, where appropriate, with an emphasis on assertions related to existence, valuation, rights and obligations, and financial statement disclosures.

o Responding to cyber threats. Inspection procedures will evaluate the auditor’s response to identified cybersecurity breaches and known security vulnerabilities.

o Use of data and technology in the audit. Inspectors may inquire about changes in the use of technology and seek to obtain an in-depth understanding of how auditors are using technology in identifying and responding to risks of material misstatement.

Target Teams

A relatively new facet of PCAOB inspections is the use of “target teams” which review specific issues across all inspected audit firms. The topics assigned to target teams vary from year to year. In 2022, target team will address four issues --- interim financial information (e.g., quarterly reviews); audits of public companies with financial reporting risks related to climate change; IPOs and de-SPAC transactions; and audit firm use of shared service centers.

Reminders for Auditors

The Spotlight also contains a series of key reminders for auditors. These include –

• The need for professional skepticism in evaluating management’s representations, estimates and forecasts, due to the uncertainty and volatility of the economic environment.

• The possibility that remote or hybrid working environments may create new or increased risks of material misstatement.

• The possibility that changes in the audit client’s circumstances could impair auditor independence.

• The implications of the economic environment for acceptance and continuance of clients.

• The need to consider each audit engagement team member’s knowledge, skill, and ability, when assigning work and determining the extent of supervision.

• The potential economic impact of Russia’s invasion of Ukraine on multi-national companies.

Comment: The Spotlight provides audit committees with insight into why a company’s engagement may – or may not – be selected for review this year and why, if selected, the inspectors may concentrate on some aspects of the audit and ignore others. In addition, the Spotlight may be helpful to the audit committee in understanding the auditor’s work plan, since areas of PCAOB inspection emphasis may become areas of auditor focus in anticipation of possible PCAOB scrutiny in subsequent inspections. The Spotlight may also aid committees in their oversight of the company’s financial reporting by providing a catalog of accounting and reporting issues that are challenging in the current environment.