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PCAOB Describes Approach to 2006 Inspections

The PCAOB has issued a statement outlining its approach to inspections of internal control audits in 2006. The inspection process will focus on the degree of integration between the audit of internal controls over financial reporting and the audit of the financial statements, whether the auditor applied a top-down approach, whether the auditor properly assessed and responded to identified risks, and the auditor's use of the work of others. The 2006 inspection cycle is scheduled to begin the week of May 1, 2006.

All of the inspection staff's audits of internal controls over financial reporting in 2005 occurred before it issued guidance on May 16 discussing how to conduct an efficient and risk-focused audit under Auditing Standard No. 2. In the fall of 2005, the PCAOB's Division of Registrations and Inspection met with leaders of eight of the U.S. firms that were subject to review to provide feedback to the firms on their implementation of AS2 and to learn about improvements the firms had made to their methodologies. The staff also issued a report in November of last year identifying the ways to make audits more effective and efficient in the future.

The 2006 inspections will include meetings with senior firm leadership, a review of the national office inspection procedures and the engagement inspection procedures for accelerated filer audits that are reviewed. The meetings with senior firm leaders will provide the inspection staff with the audit firms' views on how they achieved efficiencies in the four focus areas. The staff will apply what it learns in these meetings to determine the extent to which the firms' strategy supports audit efficiency in performing an integrated audit. The staff will note any innovative practices or opportunities for improvement on which to follow up with the national office.

The inspection staff will examine the national offices' guidance and audit tools for their approach to the four key focus areas. The staff will evaluate the firms' training programs and any systems for monitoring their engagement teams to ensure their focus on achieving efficiencies during the audit process. At the engagement team level, the staff will look for efficiencies in at least one of the four focus areas in the inspections of accelerated filer audits. The staff will review portions of the firms' AS2 work relating to the audit of financial statements. The inspectors will also select high risk areas of the financial statement audit for review and portions of the internal control audit that support those high risk areas.

In their review of internal control procedures for high risk areas, the inspection staff will consider whether the engagement team assessed the effect of any significant deficiencies or material weaknesses in internal controls on the financial statement audit, and the effect of any significant audit adjustments on the audit of internal controls. The inspection procedures are intended to be integrated inspections of integrated audits. Inspectors will evaluate whether firms failed to detect material weaknesses, or whether there was a material failure to comply with auditing standards, or a material misstatement of the financial statements, resulting from a failure to consider information that was obtained in connection with the audit of internal controls.

The inspection team will combine the review of internal control over financial reporting auditing with its review of financial statement audit procedures, rather than relying on a separate team of inspectors for internal control procedures. The PCAOB developed internal guidance and related training to ensure an efficient and consistent approach when evaluating the quality of audit work and the progress that firms have made in implementing AS2 and the May 2005 guidance.

The Board is aware that many firms have improved their methodologies and have provided additional training to improve their audits of internal controls. The 2006 inspections should help firms identify any additional areas in which their integrated audit efficiency can be improved.