The PCAOB Reports on its 2021 Conversations with Audit Committee Chairs
During its 2021 inspections, Public Company Accounting Oversight Board inspection teams spoke with more than 240 audit committee chairs of U.S. public companies. On March 24, the Board released 2021 Conversations with Audit Committee Chairs (2021 Conversations Report), which summarizes these discussions. This is the third year the PCAOB has published the results of the inspection staff’s interactions with audit committee chairs. See The PCAOB Speaks – With Audit Committee Chairs, January-February 2021 Update and What the PCAOB Heard: Report on Conversations with Audit Committee Chairs, January 2020 Update.
The PCAOB’s audit committee chair conversations were “largely open-ended or unstructured” and accordingly the 2021 Conversations Report provides insight into the issues on which chairs are focused. For example, the use of technology in auditing seems to be on the minds of many chairs, although their views are nuanced. On the one hand, several saw the auditor’s use of technology as a strength and thought that automation, data analytics, and artificial intelligence had considerable potential to improve audit efficiency. In fact, some were concerned that their auditor was not deploying technology fast enough. At the same time, a recurring theme in the conversations was that technology is not a “silver bullet” and that reliance on technology “dulls auditors’ ability or inclination to incorporate their business insights into procedures.”
Another theme that emerges from the report is that environmental, social, and governance (ESG) matters are becoming a key topic of auditor/audit committee discussion. Some chairs characterized the issue as “huge” and the PCAOB observed that “matters related to ESG are either already at the top of many audit committee agendas or they are gaining such prominence. A third recurring topic was the importance of timely auditor communications with the committee and of avoiding surprises. While most chairs had a positive view of the timeliness of their auditor’s communications and of their “proactive mindset,” some complained about “pileups” at year-end and indicated that they “challenge their auditors continually to adjust workflows” in order to avoid these sorts of crises.
Below is a summary of the topics addressed in the 2021 Conversations Report.
Communications with the Auditor
PCAOB auditing standards require the auditor to communicate with the audit committee regarding certain matters related to the audit and to obtain certain information from the committee. The staff asked audit committee chairs which of the required communications topics occupied the most time during audit committee meetings. The responses cited the following topics:
Accounting matters. The most frequently mentioned topic was accounting policies and practices (including impairments and goodwill accounting issues, accounting implications of the COVID-19, revenue recognition, and implementation of the new accounting standard on credit losses).
CAMs. The auditor’s report must disclose critical audit matters (CAMs). Audit committee chairs said that CAMs were an important discussion topic, including how the auditor identified and disclosed CAMs.
Audit process. Chairs reported discussion with their auditor about the conduct of the audit, including planning, scope, procedures, auditor needs, levels of cooperation, and new standards.
Controls. Some audit committee chairs said they spent considerable time discussing matters related to controls, including cybersecurity incidents, implementation of information technology, and the control impact of spinoffs and other transactions.
COVID-19. Audit committee chairs mentioned discussions with auditors regarding the impact of COVID-19 on company liquidity, going concern assessments, relevant disclosures, and management of the audit in the remote environment and the audit risk assessment.
Independence. Audit committees cited discussion of independence, including any violations.
Risks. Audit committee chairs frequently mentioned discussion of risk, including communication regarding high-risk areas and risks related to fraud, changes in accounting practices, and management override of controls.
Apart from required discussion topics, audit committee chairs mentioned three other issues: gauging management “tone at the top” and competence; big picture-topics, such as industry trends and challenges; and regulatory developments.
Auditor Strengths and Areas for Improvement
The PCAOB asked audit committee chairs where they thought auditors performed well and where they thought there was room for improvement.
The areas in which the chairs thought that auditors were performing well were communicating in a comprehensive and timely manner (e.g., transparency, “plain English” and communications free from a promotional or “selling” tone); having deep knowledge of the company’s industry, especially industry-specific accounting issues; taking a proactive and responsive approach (e.g., promptly informing the committee of “yellow flag” issues); and using technology in the audit (e.g., using automation, data analytics, and artificial intelligence to improve audit efficiency).
The areas in which chairs thought there was room for improvement were situations in which there were last-minute crisis (presumably referring to issues which arose shortly before filing deadlines), managing costs and fees, and addressing engagement team turnover. Other auditor weakness areas were the flipsides of strengths: Some audit committee chairs wanted more deployment of technology to improve the audit effectiveness, and some were concerned that technology might weaken the audit by eliminating human interaction. Similarly, some chairs cited inadequate communications with the engagement team, including a need to improve communication between internal and external audit.
PCAOB Inspection Reports
About 70 percent of audit committee chairs said they reviewed the audit firm’s PCAOB inspection report or discussed it with their auditor. On the plus side, chairs thought that these reports provided insight into trends in PCAOB inspection findings and facilitated their ability to compare firms. However, the PCAOB also heard complaints about the reports, including that they were not timely and lacked sufficient detail.
Firm Quality Control Systems
The PCAOB asked audit committee chairs for their views on their audit firm’s quality control system. The themes mentioned in response included the importance of importance “robust, consistent firm processes across the U.S. firms and the global networks,” of continuous education to keep audit staff current on changes in standards and audit methodologies, and of audit firm tone at the top. Chairs also expressed satisfaction, from a quality control perspective, with the multiple layers of review at the firms, including engagement quality reviewers, consultations with the national office, and industry or topic specialists. (This is surprising, since audit committees have been known to complain that multiple review layers and national office consultations hamper the quick resolution of issues.)
Annual Assessments of the External Auditor
The PCAOB inspectors asked audit committee chairs whether they performed an annual assessment of their auditor, and if so, to describe the assessments. About 75 percent of those who responded said they did perform an annual assessment of the external auditor. As to assessment techniques, frequently mentioned tools included surveys and checklists to gauge auditor proficiency, independence, engagement with management, and other topics. One audit committee chair described an assessment process that included three committee executive sessions—one with the auditors, one with management, and one with audit committee members only.
Use of Technology
As discussed above, the chairs saw both opportunities and challenges stemming from technology. On the positive side, they thought that data analytics, workflow automation, and automated testing had “transformative potential” and could help auditors in spotting anomalies, detecting fraud, and identifying and assessing risks. They were also optimistic that automation had the potential to enhance audit efficiency, constrain costs, and permit personnel to spend more time focusing on risks.
However, chairs expressed a variety of concerns regarding the use of technology in auditing, including:
Cybersecurity. Chairs are concerned that technology systems at audit firms are vulnerable to hacking and that a ransomware attack affecting the company’s data would impact the audit.
Quality control. Chairs emphasized the need for quality control in the use of technology and noted that “low-grade information cannot be predictive.”
Room to improve and grow. Audit committee chairs noted that artificial intelligence and other technologies “are still in their early stages of adoption and utility” and underscored the need for auditors to educate the audit committee on its uses, benefits, and challenges.
Information Outside the Audited Financial Statements
Of those audit committee chairs that reported discussing information outside the financials with their auditors, 70 percent cited ESG matters. This included discussion about the accuracy of ESG data and the potential need for new processes or controls with respect to ESG information. Audit committee chairs also frequently mentioned discussion with their auditors on the use of non-GAAP information.
Comment: The 2021 Conversations Report provides insight into what is on the minds of public company audit committee chairs. Audit committees may want to consider how their agenda and dialogue with their auditor match those identified in the report as recurring themes. In addition, the report includes a “What’s Working Well: Communications Between Auditors and Audit Committees” section. While the suggestions in this section are general, audit committees might find them a useful source of ideas and may want to consider whether they are following these practices or, if not, whether any are worth emulating.
In 2022, the PCAOB will undoubtedly continue its practice of engaging in dialogue with audit committee chairs. An audit committee chair who is contacted by the PCAOB inspection staff as part of an inspection of the company’s auditor may want to review the 2021 Conversations Report as a way of understanding what to expect during the interview.