PCAOB Releases 2021 Inspections Outlook and Audit Committee/Auditor Dialogue Tool
On April 6, the PCAOB released Spotlight: Staff Outlook for 2021 Inspections (2021 Outlook). This annual publication outlines areas the Board plans to focus on during the current inspection cycle. In addition, the 2021 Outlook provides an overview of changes in the inspections process, such as enhancing the unpredictability of inspections and the selection of nontraditional financial statement areas for review. The PCAOB also explains how inspections will address COVID-19 financial reporting and audit risks. The Board simultaneously released a separate document to assist audit committees in discussing inspection issues with their auditor. Audit Committee Resource: 2021 Inspections Outlook suggests questions related to the 2021 inspection focus areas that “audit committees—at their discretion—could use to further engage with their auditors.”
Staff Outlook for 2021 Inspections
The Board’s 2021 inspection plan has two primary objectives: to respond to the financial reporting and audit risks posed by COVID-19 and to reduce the predictability of inspections. As to COVID-19:
The Board plans to select audits for review in industries experiencing significant disruptions or elevated risks during the pandemic, such as transportation, entertainment, hospitality, manufacturing, certain aspects of the retail segment, and commercial real estate (including real estate investment trusts).
Inspections will focus on financial statement items and other reporting matters that have been particularly affected by the pandemic, such as impairments, going concern assessments, allowance for loan losses, and increased risk of fraud.
As to predictability:
The Board intends to significantly increase the percentage of audits select randomly (rather than based on audit risk or difficulty), especially for the largest accounting firms.
Inspectors will select accounts that have not traditionally been addressed for review. Since the Board has historically focused on the financial statement aspects that are the most challenging to audit, this apparently means that in 2021 inspections will concentrate on lower-risk, more routine accounts. The Board adds that it “will, of course, also continue to target areas that we believe pose higher risks of material misstatement in particular audits, or that are the subject of recurring audit deficiencies.”
In addition to these process changes, in 2021 the Board plans to place emphasis on these topics:
Audit areas with continued deficiencies. The 2021 Outlook identifies revenue, accounting estimates, internal control over financial reporting, and independence as audit areas with recurring deficiencies and opportunities for improvement. In this context, the inspectors will also focus on audit firm procedures to identify and remediate audit deficiencies.
Firms’ quality control systems. The Board plans to review audit firm quality control systems “as part of our goal to move towards a more preventative regulatory approach.” In addition, continuing the approach taken in 2020, inspections will include quality control areas likely to be affected by COVID-19, including “leadership communications, consultation requirements, client acceptance and continuance procedures, real-time monitoring, and pre-issuance reviews.”
Firm compliance with auditor independence requirements. Inspections continue to identify deficiencies that “suggest some firms may not have appropriate quality control systems in place to prevent and/or detect violations of applicable independence rules.” The 2021 Outlook cites, among other things, compliance with audit committee pre-approval of non-audit services and auditor communications with the audit committee regarding independence as areas of attention.
Fraud procedures. 2021 inspections will assess how auditors identify and assess risks of material mis-statement due to fraud and how auditors design and implement audit responses to these risks. Inspectors also plan to focus on how auditors incorporate unpredictability in their selection of audit procedures.
Critical audit matters. PCAOB standards require the auditor to identify and communicate in the audit report critical audit matters (CAMs) identified in the audit. CAMs are those aspects of the audit that involved challenging, subjective, or complex auditor judgment. See More PCAOB Advice for Audit Committees on CAMs, July 2019 Update). Inspectors will review how individual engagement teams applied the CAM requirement.
Implementation of new auditing standards. New PCAOB requirements for the auditing of accounting estimates and for the auditor’s use of the work of specialists took effect for audits of fiscal years ending on or after December 15, 2020. The Board will review how firms implemented these new standards.
Supervision of audits involving other auditors. Inspections will assess how auditors supervised the work of other participating auditors, particularly given travel restrictions due to COVID-19.
Responding to cyber threats. If there was a cyber incident affecting a public company or broker-dealer selected for review, the inspectors will evaluate how the engagement team applied the audit firm’s cyber incident guidance, including whether and how the team reevaluated its risk assessment or modified the audit to address the effects of the breach on controls.
Auditing digital assets. The inspection staff will select audits for review where transactions in digital assets are material to the financial statements and will review how the audit firm identified and assessed the risks of material misstatement, including valuation issues.
In 2020, the PCAOB invited the audit committee chairs of most U.S. public companies with audits selected for inspection to speak with the inspection staff. See The PCAOB Speaks – With Audit Committee Chairs, January-February 2021 Update. The Board plans to continue this practice in 2021.
Audit Committee Resource
The new Audit Committee Resource suggests specific questions that audit committees might ask their auditor in in the areas highlighted in the 2021 Outlook. Examples of these questions are:
Auditor’s risk assessments. How has the auditor assessed risks of material misstatement related to the public company’s technology systems, including relevant cyber threats, and how has it addressed those potential risks?
· Firm compliance with auditor independence requirements. How can the audit committee and management assist the auditor in complying with independence requirements?
Critical audit matters. What items, if any, were considered “close calls” but ultimately not identified as a CAM by the auditor? Why were these items not determined to be CAMs?
Implementation of new auditing standards. Was the audit of the company’s estimates affected by the PCAOB’s new requirements?
Supervision of audits involving other auditors. Did restrictions on travel and in-person interactions create challenges for supervision and review of work performed by other auditors? If so, how were these challenges addressed?
Comment: The 2021 Outlook provides audit committees with insight into why a company’s engagement may – or may not – be selected for review this year and why the inspectors may emphasize some aspects of the audit and ignore others. In addition, areas of PCAOB inspection emphasis may become areas of additional auditor focus in subsequent audits. Accordingly, audit committees may find the Audit Committee Resource publication helpful in planning discussion of the company’s 2021 audit with the auditor.
The 2021 Outlook may also be helpful in evaluating the results of the 2021 inspections when they become available. One would assume that de-emphasizing high risk/high challenge engagements and financial statement areas will result in fewer inspection findings. Accordingly, the results of the 2021 inspections may not be comparable to those in prior years. Conversely, deficiencies identified in 2021 may be of particular concern if they relate to aspects of the audit that should have been relatively routine.