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  • Writer's pictureDaniel Goelzer

PCAOB Proposes Engagement Metrics and Audit Firm Operational and Financial Reporting

Updated: May 7

On April 9, the Public Company Accounting Oversight Board issued for public comment two proposals that would significantly expand the disclosures that accounting firms must make regarding their performance of audit engagements and their operational and financial condition.  See Firm and Engagement Metrics and Firm Reporting.  In the press release announcing these two proposals, PCAOB Chair Erica Williams stated: “Sound and consistent information bolsters confidence in our capital markets, and can drive audit quality ***.  Informed by extensive study and stakeholder input, today’s proposals would strengthen PCAOB oversight and equip investors, audit committees, and others with clear, consistent, and actionable dated related to the audit.”

 

Firm and Engagement Metrics Proposal

 

The firm and engagement metrics proposal would require PCAOB-registered public accounting firms that audit large accelerated filers and accelerated filers to publicly report eleven metrics relating to specific audit engagements or to the firm’s overall audit practice.  A primary objective of these disclosures would be to aid audit committees in their oversight.  The PCAOB’s release proposing the new metrics states that “audit committees could benefit from having additional context when deciding whether to select or retain a firm and overseeing the firm’s work.”  In addition, the PCAOB believes that firms themselves would benefit, since “audit firms could use standardized information about themselves and their peers in designing, implementing, monitoring, and remediating their systems of quality control.”

 

Some firms already disclose firm-level performance metrics in their audit quality or transparency reports.  See Four Large Firms Report on How They See Their 2023 Audit Quality, January 2024 Update.  However, in the PCAOB’s view, these existing disclosures are insufficient:

 

“[T]he disclosures are inconsistent across firms, and there are no common definitions or calculations allowing for consistent comparisons. Moreover, most of the disclosures are voluntary, so firms are free to revise or discontinue such reporting any time. In our view, the current voluntary reporting regime does not provide consistent, comparable information that stakeholders can rely on to inform their decisions over time.” Proposing Release at 3.

 

The PCAOB has, for several years, sought to identify “audit quality indicators.”  See PCAOB Adds Audit Quality Indicators to its Short-Term Agenda, May-June 2023 Update.  While this proposal is an outgrowth of that effort, the Board has discarded the phrase “audit quality indicators” in favor of “firm and engagement metrics.”  The Board believes that the new terminology “avoids the potential misimpression that any set of metrics can comprehensively measure audit quality and emphasizes our goal of promoting informed decision making through robust disclosure requirements. Some of the most important elements of a high-quality audit, such as application of due care and professional skepticism, cannot be measured and quantified directly.”

 

The eleven proposed engagement performance metrics are:

 

  1. Partner and Manager Involvement.  Hours worked by senior professionals relative to more junior staff across the firm’s issuer engagements and on the engagement.

  2. Workload.  Average weekly hours worked on a quarterly basis by engagement partners and by other partners, managers, and staff, including time attributable to engagements, administrative duties, and all other matters.

  3. Audit Resources – Use of Auditor’s Specialists and Shared Service Centers.  Percentage of issuer engagements that used specialists and shared service centers at the firm level, and hours provided by specialists and shared service centers at the engagement level.

  4. Experience of Audit Personnel.  Average number of years worked at a public accounting firm (whether or not PCAOB-registered) by senior professionals across the firm and on the engagement.

  5. Industry Experience of Audit Personnel.  Average years of experience of senior professionals in key industries audited by the firm at the firm level and the audited company’s primary industry at the engagement level.

  6. Retention and Tenure.  Continuity of senior professionals (through departures, reassignments, etc.) across the firm and on the engagement.

  7. Audit Hours and Risk Areas (engagement-level only).  Hours spent by senior professionals on significant risks, critical accounting policies, and critical accounting estimates relative to total audit hours.

  8. Allocation of Audit Hours.  Percentage of hours incurred prior to and following an issuer’s year-end across the firm’s issuer engagements and on the engagement. 

  9. Quality Performance Ratings and Compensation (firm-level only).  Relative changes in partner compensation (as a percentage of adjustment for the highest rated group) between groups of partners based on internal quality performance ratings. 

  10.  Audit Firms' Internal Monitoring.  Percentage of issuer engagements subject to internal monitoring and the percentage with engagement deficiencies at the firm level; whether the engagement was selected for monitoring and, if so, whether there were engagement deficiencies and the nature of such engagement deficiencies at the engagement level. 

  11.  Restatement History (firm-level only).  Restatements of financial statements and management reports on ICFR that were audited by the firm over the past five years.

 

The proposal would require firms that serve as the lead auditor for at least one accelerated filer or large accelerated filer to report the firm-level metrics annually on a new Form FM.  (In general, accelerated filers are companies with a public float between $75 and $700 million, while large accelerated filers are companies with a public float of $700 million or more.)  For individual accelerated filer and large accelerated filer engagements, the engagement-level metrics would be included in a revised version of Form AP which must already be filed for each public company engagement.  Form AP would be renamed "Audit Participants and Metrics."  The proposal would allow limited narrative disclosures on both Form FM and Form AP to permit firms to provide context and explanation for the required metrics.

 

The five-member PCAOB voted unanimously to issue the firm and engagement metrics proposal for public comment.  However, Christina Ho, one of the two CPA Board members, stated that she did so “cautiously.”  Her statement raises a variety of issues concerning the costs and utility of the proposed metrics.  She encourages public comments on “the usefulness and feasibility of these proposed metrics as proxies to audit quality.”  She also expresses interest “in hearing from shareholders and audit committees to what extent these metrics would be helpful or harmful to investors” and on “the impact on small and medium firms.”

 

Firm Reporting Proposal

 

The PCAOB has also proposed expanding the information that accounting firms registered with the Board must provide in their public annual reports (PCAOB Form 2) and in special reports (PCAOB Form 3) that must be filed on the occurrence of certain events.  The Board’s April 9 press release states that this proposal seeks “to facilitate more public disclosure that would be informative and useful to investors, audit committees, and other stakeholders” and that “[e]nhanced reporting requirements also have the potential to facilitate the PCAOB’s oversight functions and its ability to protect investors.”

 

The key reporting changes are:

 

  1. Financial Information.  All registered firms would report additional fee information in their annual report on Form 2.  For example, firms would be required to report the dollar amount (not merely percentages, as currently required) of the fees earned from audit services, other accounting services, tax services, and non-audit services. The largest registered firms would also be required to confidentially submit financial statements to the PCAOB. 

  2. Governance Information. All registered firms would report additional information regarding their leadership, legal structure, ownership, and other governance information in their annual report on Form 2.  For example, firms would be required to report the names of their principal executive officer and all direct reports to that officer, of the individuals responsible for various components of the firm’s system of quality control, and of the members of the governing board or management committees. 

  3. Network Information.  The public annual report would also be required to include a detailed description of any network arrangement to which a registered firm is subject, including the legal and ownership structure of the network, network-related financial obligations, information-sharing arrangements between the network and registered firm, and network governing boards or individuals to which the registered firm is accountable. 

  4. Special Reporting. The proposal would shorten the time for filing special reports on Form 3 from 30 days to 14 days (or more promptly as warranted).  Form 3 must be filed when certain events occur, such as a change in the firm’s name or criminal or regulatory proceedings against a partner or principal.  The proposal would also create a new confidential special reporting requirement for events material to a firm's organization, operations, liquidity or financial resources, or provision of audit services.  Examples of such events include (l) a determination that there is substantial doubt about the firm's ability to continue as a going concern; (2) a planned or anticipated acquisition of the firm, change in control, or restructuring, including external investment and planned acquisition or disposition of assets or of an interest in an associated entity; or (3) entering into or disposing of a material financial arrangement that would affect the firm's liquidity or financial resources. 

  5. Cybersecurity.  The proposal would require confidential reporting on Form 3 of significant cybersecurity events within five business days and periodic public reporting of a brief description of the firm's policies and procedures, if any, to identify and manage cybersecurity risks.

 

In addition, the proposal would require firms to report changes to their systems of quality control made in response to the Board’s proposal to expand and enhance its quality control requirements, if that proposal is adopted and approved by the SEC.  See PCAOB QC Proposal Could Impact Auditor/Audit Committee Relationship, November-December 2022 Update.  The release proposing the firm reporting rules states: “We believe it is important that firms update the statement regarding their quality control policies and procedures, originally made in connection with their registration application, to reflect the changes to their policies and procedures made in response to the new quality control standard.”

 

The Board vote to issue the firm reporting proposal was 4-1.  In opposing this proposal, Board Member Ho stated:

 

“I am profoundly worried that the Board’s apparent zeal to impose, in each new proposed standard or rule, new burdens on firms, without sufficient tailoring and without quantifying the estimated burdens, may end up breaking the public company auditing profession’s back, particularly for small firms. If we ‘break’ the profession in the name of investor protection, are we really protecting investors?”

 

Comment:  As the two PCAOB releases proposing these extensive new reporting requirements make clear, they are in part intended to benefit audit committees by providing them with additional information to support their oversight of the company’s auditor.  For example, engagement metrics that assist audit committees in evaluating the work of their auditor, and in comparing the performance of other firms, would unquestionably be a valuable tool.  At the same time, as Board Member Ho points out in her statement, most metrics are only meaningful if the user has a sophisticated understanding of the full context of the audit and how particular metrics relate to that audit.  Applying metrics to a specific audit would be a complex task, and there is a risk that the PCAOB’s proposal would end up creating more confusion and misunderstanding about audit quality, rather than less.

 

Audit committees should consider whether they would find the engagement performance metrics and firm information that the PCAOB is proposing to require useful in their work.  They should also consider whether the benefits would outweigh the costs of collecting and reporting this new data.  These costs would inevitably be borne by audit clients and their investors.  The comment period on both proposals runs until June 7, 2024.

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