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  • Writer's pictureDaniel Goelzer

SEC Chief Accountant Calls on Auditors to Improve and on Audit Committees to Be Proactive

Earlier this year, the PCAOB announced that approximately 40 percent of the audits inspected in 2022 will have one or more deficiencies included in Part I.A of the audit firm’s inspection report, up from 34 percent in 2021 and 29 percent in 2020.  See 2022 PCAOB Inspections Preview Says 40 Percent of Audits Reviewed Had Deficiencies, July 2023 Update.  In connection with that announcement, PCAOB Chair Erica Williams described the 40 percent deficiency rate as “completely unacceptable.” 

 

SEC Chief Accountant Paul Munter has now also issued a statement commenting on the increase in inspection deficiencies and urging auditors “to exercise objective, impartial judgment and rigorous professional skepticism in gathering and evaluating evidence throughout the audit to support the audit opinions provided.”  An Investor Protection Call for a Commitment to Professional Skepticism and Audit Quality (February 5, 2024).  Mr. Munter’s statement also emphasizes the role of audit committees in promoting audit quality.  “Auditors and audit committees serve as gatekeepers for investor protection and the financial reporting process and have an important role in facilitating the high-quality audits that are critical to the proper functioning of our capital markets.”

 

Auditors’ Exercise of Professional Skepticism

 

With respect to auditors, the theme of Mr. Munter’s remarks is the importance of professional skepticism. He points out that during the past three annual inspection cycles, audits of internal control over financial reporting have been a frequent source of deficiencies.  “Accordingly, we remind auditors of their responsibility to exercise professional skepticism in the gathering and evaluating of evidence, including related to internal controls, and approaching management’s judgments in these areas with professional skepticism.”  He also notes that companies facing challenges, such as “pressure to meet earnings expectations in the face of declining revenue or increased costs” may present enhanced fraud risk.  In these circumstances, auditors must consider whether proper professional skepticism “requires more persuasive evidence to corroborate management’s assertions.”

 

Mr. Munter describes four “strong practices” that support auditor professional skepticism. 

 

  • The auditor “should frequently and proactively engage with the audit committee.” Auditor-audit committee discussions should include, among other things, any red flags arising from the management’s interactions with the auditor.  “[T]he auditor should not agree to truncated or summary presentations of their concerns with management or management responses to audit concerns with the audit committee.”

 

  • The auditor should integrate specialists and other experts into the engagement team to assist in auditing areas where specialized knowledge is needed. “Doing so will help ensure that the auditor has adequate expertise to challenge management’s assessments and assertions.”

 

  • Engagement team members should be trained on biases that could affect auditor judgment and might undermine professional skepticism.

 

  • The engagement partner should ensure that the team is empowered to exercise professional skepticism and challenge management judgments.  This may, for example, include “insulating audit staff from any undue pressure to accept less than persuasive audit evidence, and refusing management requests or demands to replace audit team members.”

 

Role the Audit Committee in Prioritizing and Promoting Audit Quality

 

Mr. Munter also reminds audit committees that they are “critical gatekeepers for investor protection” and of the “benefit of having an audit committee that is independent of management.”  Audit committees should prioritize, and aim to promote, audit quality.  For example, in selecting an auditor, committees should encourage firms to compete based on their ability to perform a high-quality audit.  Committees should also frequently evaluate their process for assessing the auditor’s performance.  Factors that audit committees should considering in monitoring performance include:

 

  • The results of the auditor’s PCAOB inspections, the firm’s internal monitoring programs, or other firm audit quality reporting.

 

  • Whether the engagement team has appropriate industry expertise and whether the engagement partner is sufficiently engaged and provides leadership to the engagement team.

 

  • The engagement team’s total hours and staffing mix (such as, the use of specialists, the experience of the members of the engagement team, and the portions of the engagement performed by other auditors).

 

  • Significant changes in hours or staffing mix from previous audits.

 

The audit committee should also support the auditor’s independence and encourage the exercise of professional skepticism.  To accomplish this, Mr. Munter encourages audit committees to:

 

  • Meet – formally or informally -- with the auditor, independent of management.

 

  • Engage in “open dialogue” with auditor that includes in-depth discussions of financial  reporting and internal control matters.

 

  • Ask the auditor “probing questions to assess audit quality.”

 

  • Speak directly with the engagement team about the importance of professional skepticism and the audit committee’s support of the engagement team.

 

  • Avoid “substituting management’s judgments or interactions with the independent auditor for the audit committee’s own judgments and engagement.”

 

Comments:  Mr. Munter has issued a series of statements over the past several years calling on audit committees to be more proactive in various facets of their oversight of the external auditor.  See, e.g., SEC Chief Accountant Discusses Audit Committee Oversight of Other Auditors, April 2023 Update and Acting Chief Accountant Stresses Auditor Independence and Audit Committee Oversight, November-December 2021 Update.  Audit committees should seriously consider the suggestions in his most recent statement regarding how they can enhance their monitoring of auditor performance and foster an environment that encourages professional skepticism.  As noted in prior Updates, in light of the history of SEC pronouncements concerning audit committee responsibilities, the SEC may ask about the rigor of audit committee oversight in cases where there has been an audit or financial reporting failure.

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