The PCAOB 101.
Although some market participants believe the PCAOB directly regulates publicly listed companies registered with the U.S. Securities and Exchange commission (SEC), this activity does not fall within the board's purview. Instead, its stated objective is to "protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports." The board has the authority to inspect the audit operations of public accounting firms that audit public companies, and it can impose disciplinary actions for violations of the Sarbanes-Oxley Act as well as PCAOB and SEC rules.
Although most internal auditors are likely familiar with the PCAOB, some may not be aware of its specific activities or the rules that govern its authority. The board's financial reporting hierarchy, for example, or its standard-setting process, may be unknown even to internal auditors at companies that are subject to Sarbanes-Oxley requirements. Because of the PCAOB's impact on organizations worldwide, internal auditors should be familiar not only with its requirements, but also with the way in which it operates and governs financial reporting processes. As the PCAOB continues to issue standards and rules, its influence will likely grow, making knowledge of its activities even more important to those in the audit profession.
HIERARCHY AND LEADERSHIP
The PCAOB's powers and rule-making authority are subject to SEC oversight. While the SEC serves as primary overseer of U.S. financial reporting processes, the PCAOB provides assistance by functioning as a liaison between registered accounting firms and the SEC. Similar to the SEC, the board seeks to protect investors by overseeing financial reporting processes. Although the PCAOB has been assigned specific tasks, such as writing and modifying audit standards, it must obtain approval from the SEC before taking any significant actions.
The SEC also oversees PCAOB leadership appointments. After consulting with the U.S. secretary of the Treasury and the chairman of the U.S. Federal Reserve Board, the SEC appoints PCAOB members, including its chairman. In May 2003, the SEC unanimously appointed William Webster as PCAOB chairman, who was succeeded in June 2006 by Mark Olson. The board comprises four other members: Kayla Gillan, Daniel Goelzer, Bill Gradison, and Charles Niemeier. Each PCAOB member is elected to a five year term and must serve on a full-time basis. Two members of the PCAOB must be, or have been at some time in the past, certified public accountants (CPAs). The other three members must not be, or have ever been, CPAs.
The PCAOB has several specific responsibilities, as established under Sarbanes-Oxley Section IOI. These include:
* Registering public accounting firms that prepare audit reports for corporate issuers.
* Establishing, adopting, or modifying standards related to auditing, quality control, ethics, independence, and anything else pertaining to the preparation of audit reports.
* Routinely inspecting registered public accounting firms.
* Enforcing compliance with Sarbanes-Oxley and securities laws by investigating and disciplining violators.
* Preparing and submitting a budget each year to the SEC for approval.
The PCAOB can also perform other duties or functions when necessary to promote high professional standards, improve the quality of independent financial statement audits, and protect the public's interests. These duties all have one thing in common: They focus on promoting the public's confidence in financial reporting processes and enhancing participation in U.S. and international markets.
REGISTRATION OF ACCOUNTING FIRMS Sarbanes-Oxley Section 102 requires registered public accounting firms to register with the PCAOB--the board approves or disapproves applicants within 45 days. The PCAOB can deny registration to any non-U.S. public company accounting firm that plays a substantial role in preparing audit reports but does not actually issue them. As of April 2008,I,848 accounting firms were registered with the board, five of which had pending withdrawals. Approximately 43 percent of the registered accounting firms are based outside the United States, located across 82 countries. For all U.S. organizations that are not subject to either Sarbanes-Oxley or SEC rules, audit reports must be conducted in accordance with the American Institute of Certified Public Accountants' (AICPA's) Auditing Standards Board.
Both the PCAOB and the SEC have the power to sanction and revoke registrations. In September 2007, the SEC charged 69 auditors for issuing audit reports without registering with the PCAOB. Hence, internal auditors can assist their audit committee by making sure the company's financial statement auditors are registered with the PCAOB at its Web site: www.pcaobus.org/Registration/Registered_Firms.pdf.
STANDARD-SETTING Section I03 of the Sarbanes-Oxley Act places responsibility for writing and modifying audit standards with the PCAOB, subject to SEC approval. To date, the PCAOB has established five SEC-approved audit standards (ASs):
* AS1: References in Auditors' Reports to the Standards of the Public Company Accounting Oversight Board. The most significant provision of ASI is its authorization for the board to establish audit standards for use by registered accounting firms. In addition, it requires registered firms to acknowledge their adherence to the PCAOB's standards.
* AS2: An Audit of Internal Control Over Financial Reporting Performed in Conjunction With an Audit of Financial Statements. AS2 was created to require registered accounting firms to evaluate and give an opinion about management's assessment of internal controls related to financial reporting, pursuant to Sarbanes-Oxley Section 404. Because of the excessive resources required of both registered accounting firms and public companies to comply with this standard, AS2 was superseded by AS5.
* AS3: Audit Documentation. AS3 requires registered accounting firms to prepare and retain documentation under the PCAOB rules. Workpapers and other audit-related documents must be maintained for seven years--anyone who destroys workpapers or audit-related documentation faces a maximum of 10 years in prison. If the destroyed documentation is related to a federal investigation or bankruptcy proceedings, perpetrators face a maximum prison sentence of 20 years.
* AS4: Reporting on Whether a Previously Reported Material Weakness Continues to Exist. AS4 provides requirements and guidance for registered accounting firms that are engaged to report on material weaknesses previously identified during a Section 404 evaluation. Because the AS4 engagement is entirely optional, it can be performed by either an organization's registered accounting firm or its internal auditors. The objective of AS4 engagements is to provide reasonable assurance that the material weakness no longer exists.
* AS5: An Audit of Internal Control Over Financial Reporting That Is Integrated With an Audit of Financial Statements. AS5 supersedes AS2 and takes a more conservative approach to ensuring the effectiveness of public companies' internal controls over financial reporting. It states that registered accounting firms should evaluate management's assessment of internal controls while simultaneously performing the financial statement audit. AS5 helps increase both external and internal audit efficiency by clarifying the use of relevant work by others, emphasizing the importance of having both internal auditors and their organization's registered accounting firm create clear, comprehensible workpapers and audit related documentation.
Recently the board submitted another audit standard to the SEC for approval, AS6: Evaluating Consistency of Financial Statements. AS6 would update registered public company accounting firms' responsibility for evaluating and reporting on the consistency of public companies' financial statements. The standard aims to clarify the steps registered public accounting firms should take to enhance the quality of disclosures pertaining to clients' accounting changes, such as changes in an accounting principle.
In April 2004, the PCAOB formed a Standing Advisory Group to advise the board on establishing audit and related professional standards. The group presently comprises 36 members who represent the audit profession, public companies, investors, and others. The board invites representatives from the Auditing Standards Board of the AICPA, the U.S. Department of Labor, the Financial Accounting Standards Board, the Government Accountability Office, and the International Federation of Accountants' International Auditing and Assurance Standards Board. SEC representatives also attend the meetings. The Standing Advisory Group holds both open and executive sessions--decisions to recommend actions to the PCAOB are made at open sessions.
Some of the topics the advisory group addressed during 2007 include:
* The PCAOB's standard-setting process.
* The SEC's proposed rule regarding the International Accounting Standards Board's International Financial Reporting Standards.
* Fair value accounting within the broader context of auditing accounting estimates.
* Audit engagement team performance in areas such as planning and supervising audit engagements and conducting reviews of high-risk areas involving professional judgment.
* Risks and audit procedures associated with related-party transactions.
* Deficiencies associated with AS2 and the subsequent replacement of AS2 with AS5.
Standing Advisory Group members meet in person three times a year. Agendas for the group's meetings can be found on the PCAOB's Web site.
INSPECTIONS Sarbanes-Oxley Section 104 requires the PCAOB to inspect all registered public accounting firms. If a registered firm provides more than 100 audit reports, the PCAOB must inspect it at least annually. All other registered public accounting firms are subject to investigations every three years. Both U.S. and non-U.S. registered public accounting firms must adhere to the board's and SEC's rules.
During the inspections, the PCAOB assesses compliance with Sarbanes-Oxley, PCAOB, and SEC rules, as well as with professional standards pertaining to audit engagement performance and report issuance. Inspections include a review of selected audits of financial statements and internal control over financial reporting.
The PCAOB can perform its inspections announced or unannounced. While all registered public accounting firms are subject to routine PCAOB inspections, the board may perform an inspection with special instructions if and when necessary. If the board selection team identifies deficiencies, it typically alerts the firm--any deficiencies that exceed a specific threshold are disclosed to the public in the board's inspection report.
After a series of inspections in 2007, the PCAOB issued a report stating that many small U.S. public accounting firms, and some large firms, had control deficiencies in the following areas:
* Revenue recognition practices.
* Related party transactions.
* Equity transactions.
* Business combinations and asset impairments.
* Going concern issues.
* Loans and accounts receivable (including allowance for doubtful accounts).
* Service organizations.
* Use of work performed by other auditors and specialists.
* Independence issues related to performing prohibited services for audit clients.
* Ineffective concurring audit partner reviews.
During inspections, the board routinely evaluates the accounting firm's quality of work and examines its practices, policies, and procedures. Although many firms conduct peer reviews that cover these areas, PCAOB inspections carry additional weight due to the board's authority to investigate and take disciplinary action. Hence, PCAOB inspections have created a stronger incentive for public accounting firms to perform thorough, frequent self-evaluations. Per the PCAOB's rules, accounting firms must provide any necessary documentation and testimonial evidence in response to the board's staff requests.
The PCAOB also has the authority to conduct inspections of a registered accounting firm's quality control system. If the board identifies a quality control defect during its inspection, the accounting firm must remedy the defect within 12 months of the inspection report date; otherwise, the PCAOB will disclose the deficiency to the public. Because such disclosures can cause significant reputational damage, they provide another strong incentive for firms to self-evaluate effectively. Internal auditors can help prevent PCAOB disclosures by teaming up with their financial statement auditors to reduce redundancy of effort and seek situations where the internal auditors can simultaneously perform their own responsibilities and assist the financial statement auditors.
INVESTIGATION AND ENFORCEMENT Pursuant to Sarbanes-Oxley Section 105, the PCAOB may investigate and discipline violators. If the board believes one or more violations have occurred, review of the registered public audit firm escalates from an inspection to a formal investigation. Normally during a PCAOB inspection, however, the registered public accounting firm, and any other party associated with the violation, cooperate in an attempt to avoid penalties and negative publicity.
The PCAOB has several options for disciplining any wrongdoing:
* Suspend or revoke the accounting firm's PCAOB registration.
* Suspend or bar wrongdoers from further association with any registered accounting firm.
* Limit the accounting firm's activities, either temporarily or permanently.
* Assess civil penalties up to US $15. million for violations.
* Censure the accounting firm and wrongdoers.
* Require additional professional education and training.
Similar to SEC investigations, the PCAOB maintains some discretion with regard to its investigation findings. If necessary, however, the board will share information with the U.S. Department of Justice, certain federal bank regulators, state attorneys general, and appropriate state regulatory authorities. According to the PCAOB's most current published annual report (2006), the board initiated several preliminary investigations of registered accounting firms, but only eight resulted in formal investigations. Although several auditors were barred from auditing registered companies, the PCAOB allowed some of them to petition the board to do business with registered public accounting firms.
BUDGET AND FUNDING The PCAOB obtains funds from two sources--registered companies and registered accounting firms, though the vast majority of funding comes from public companies. Registered accounting firms pay only a one-time fee, whereas registered companies must pay each year. The SEC dictates that the board's accounting support fee must be allocated in a way that reflects the proportionate sizes of issuers.
Fifty percent of the PCAOB's 2006 operating expenses were related to registration and inspections. The PCAOB spent US $5.3 million and US $6.9 million in 2005 and 2006, respectively, to research emerging accounting and audit issues. The board has not indicated whether the increased expenses are due to greater costs for achieving audit quality, inflation, or other factors. According to the PCAOB's annual budget, its estimated total outlay for 2008 is US $144.6 million. Estimated accounting support fees for 2008 are approximately $134.5 million, which will cause the board to incur a deficit unless it finds a way to increase funding. The PCAOB estimates its staff will total 507 by the end of 2008.
WHO'S WATCHING THE WATCH DOGS?
In 2004, the PCAOB created the Office of Internal Oversight and Performance Assurance (IOPA) to evaluate the board's programs and to assess the efficiency, effectiveness, and integrity of its operations. The IOPA conducts both annual and special reviews when necessary and reports material and relevant findings to the public, U.S. Congress, and the SEC. The office also ensures that all PCAOB employees comply with applicable laws, regulations, and policies. Although the PCAOB prepares its own annual budget, subject to SEC approval, the IOPA ensures that the board uses its resources efficiently. More importantly, the IOPA makes sure the PCAOB adheres to its mission statement and protects and promotes the public interest in the integrity of financial statement audits.
Since 2004, the PCAOB has offered several forums on auditing in the small-business environment--nearly 2,000 members of the small-business community have attended these forums. Attendees include senior managers, audit committee members, and auditors of small companies.
The PCAOB has also committed to taking a leadership role in improving worldwide auditor oversight and audit practices. For example, the board works to create cooperative arrangements with non-U.S. regulators, such as the Accounting and Corporate Regulatory Authority in Singapore (ACRA). The PCAOB and ACRA have confirmed their intent to cooperate in the oversight of audit firms that fall within the jurisdiction of both groups. This strategy will likely help the United States' goal of harmonizing accounting standards worldwide. Since the board's creation, many other countries have developed similar regulatory bodies to help oversee public audit practices. The board considers the firm's internal inspection process the most important component of its quality control program.
While market participants may debate the PCAOB's approach and requirements, most would likely agree that its influence on financial reporting and corporate governance has been significant. If the board had been created sooner, it may have even prevented some registered public accounting firms from assisting in material frauds or helped ensure they possessed the competence to perform high-quality audit engagements.
More information about the PCAOB can be found on its Web site, www.pcaobus. org, including the board's mission statement and strategic plans, detailed reports on its responsibilities under Sarbanes-Oxley Section 101, meeting activities and briefing reports, SEC-approved audit standards, and both current and prior periods' annual reports. Annual PCAOB budgets from fiscal years 2004 to 2008 are also available on the site.
While the U.S. audit watchdog is familiar to most industry participants, its specific practices may not be so well-inderstood. An overview of PCAOB activities may help illuminate board processes and clarify the scope of its authority.
TOM OLACH,. PHD, CIA CPA, CMA
MINNESOTA STATE UNIVERSITY
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|Title Annotation:||Public Company Accounting Oversight Board|
|Article Type:||Organization overview|
|Date:||Jun 1, 2008|
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