PCAOB Adopts Engagement Quality Review Standard

The PCAOB on July 28 adopted Auditing Standard No. 7, Engagement Quality Review, which creates a framework to strengthen the engagement quality review process. Chair Mark Olson said the issue piqued his interest in 2006 when he met with the inspection staff and asked about their most problematic audit issues. Among the most frequent responses, he said, were concerns about the range in quality and rigor of the concurring partner or second partner reviews. The approval of the standard follows an initial proposal in February 2008 and a reproposal with revisions in March 2009. The Sarbanes-Oxley Act mandated that the PCAOB adopt a requirement that each registered public accounting firm provide a concurring or second partner review of each audit report.

Auditing Standard No. 7 applies to all audit engagements, including engagements to review interim financial information, which are conducted pursuant to the PCAOB's standards. Upon SEC approval, the standard will be effective for audits and interim reviews for fiscal years beginning on or after December 15, 2009.

The standard outlines a framework for the engagement quality reviewer to evaluate the significant judgments and related determinations reached by the engagement team in forming a conclusion about the engagement. Deputy Chief Auditor Greg Scates said the standard reflects commenters' concerns that the review should not become a second audit. The standard focuses the reviewer's attention on the areas that are most likely to contain a significant engagement deficiency. The requirements are customized for interim engagements.

If the engagement quality reviewer is from the same firm as the auditor, he or she must be a partner or serve in an equivalent position. If a firm uses an outside reviewer, he or she must be an associated person of a registered firm. The standard reflects the concerns of smaller accounting firms with limited resources. For example, a firm that is exempt from the SEC's auditor independence rules will also be exempt from the standard's two-year cooling off period --the time between a person's departure from a firm and that person's ability to serve as the engagement quality reviewer for that firm's audits. The firm must use a reviewer who meets the qualification requirements of the final standard.

Board member Daniel Goelzer commented on the three issues of greatest concern during the comment process. The first was that the standard may lead a reviewer to perform a re-audit. Goelzer said the standard makes clear that reviewers are responsible for evaluating how the engagement team identified and responded to risk, not for starting from scratch to independently determine the risk.

Another concern was the standard that a reviewer had to meet in determining whether to provide concurring approval. The standard provides that a reviewer may issue concurring approval only if he or she is not aware of a significant engagement deficiency. The reviewer's work must be conducted with due professional care, which is a concept well understood by the auditing profession.

A third area of concern was the extent and nature of the documentation that must be created in connection with the reviewer's work. The documentation must be sufficient to enable an experienced auditor, having no previous connection with the engagement, to understand the procedures that were performed by the reviewer. The documentation is not expected to duplicate the audit work papers. Goelzer noted that if a reviewer raises an issue with the engagement team, the reviewer's documentation must reflect that discussion only if it is necessary to an understanding of the review and if it is not fully reflected in the audit work papers.

Board member Charles Niemeier observed that staff inspections continue to find serious audit deficiencies at firms of all sizes. He believes that better engagement quality reviews will help catch those deficiencies and prevent harm to investors. Niemeier also emphasized that while the standard is rigorous, it is not a re-audit. The reviewer is expected to talk to the engagement partner and team members, review relevant documents and determine whether to sign off with concurring approval. The reviewer does not test, request confirmations, conduct walk-throughs or perform any other procedures that are necessary to obtain reasonable assurance that the financial statements are fairly stated, he explained.

Niemeier also addressed the issue of documentation. He said the proposals have undergone significant refinements in that area, largely as a result of the comment letters the Board received. Niemeier said the standard does not require duplication of the engagement documentation since the reviewer will perform different procedures.

The standard includes an appendix which outlines the differences between Auditing Standard No. 7 and the standards issued by the International Auditing and Assurance Standards Board and the Auditing Standards Board. Board Member Steven Harris noted that neither of those standards require the same level of assurance. He added that the documentation requirement is in direct response to deficiencies related to second partner reviews that were identified during PCAOB inspections. The standard enhances the reviews performed by a second partner, he said, which will give investors greater assurance that the audits performed by registered accounting firms reflect the highest level of audit quality.

The Board meeting was the last for Olson whose resignation becomes effective on July 31. The SEC has appointed Goelzer as the acting PCAOB chair. Goelzer was a founding member of the Board and has served for six years. He is currently serving a second term. The Board members all thanked Olson for his leadership over the past three years.