1 1666 K Street, NW Washington, D.C. 20006 Telephone: (202) 207- 9100 8430 Facsimile: (202) 862- ) PCAOB Release No. 2015- CONCEPT RELEASE ON AUDIT QUALITY 005 ) , 2015 July 1 INDICATORS ) ) PCAOB Rulemaking ) 041 Docket Matter No. ) ) NOTICE OF ROUNDTABLE ) ) The Public Company Accounting Oversight Board is issuing this concept Summary: release to seek public comment on the content a nd possible uses of a audit quality indicators. " The indicators are a group of potential " potential portfolio of quantitative measures tha t may provide new insights about how to evaluate the quality of audits and how high quality audits are achieved. Taken together with qualitative context, the indicators may inform discussions among those concerned with the financial reporting and auditing process, for example among audit committees and audit may strengthen audit planning, firms. Enhanced discussions, in turn, may also stimulate execution, and communication. Use of the indicators competition among audit firms focused on the quality of the firms ' work and, thereby , increase audit quality overall . Issues raised by the release (i) include: indicators, (ii) the usefulness of the nature of the potential particular i ndicators described in the release, (iii) suggestions for other indicators, (iv) potential users of the indicators, and (v) an approach to implementation over time of an audit quality indicator project . The Board seeks advice on these subjects through the comment process and will also convene a public roundtable about the concept release, on a date to during the four th quarter of 2015. be determined Additional details about the roundtable will be forthco ming. Public Comment: Interested persons may submit written comments to the Board at the following address: Office of the Secretary, Public Company Accounting 2803. Oversight Board, 1666 K Street, N.W., Washington, D.C. 20006- Comments may also be submitted by e- mail to [email protected] or through the Board' s website at www.pcaobus.org. All comments should refer to PCAOB Rulemaking Docket Matter No. 041 in the subject or reference line. Comments should be received no later than 5:00 p.m., Eastern Standard Time, on September 29, 2015.
2 PCAOB Release No. 2015 -005 July 1, 2015 Page 2 Board Contacts: Gregory J. Jonas, Director, Office of Research and Analysis (202/591- 4320, [email protected] ), Stephen Kroll, Senior Advisor, Office of [email protected] ), and George Research and Analysis (202/591- 4369, -7734, Wilfert, Deputy Director, Office of Research and Analysis (949/435 [email protected] ). I. Introduction The responsibilities of the Public Company Accounting Oversight Board (the " or "PCAOB "), under the Sarbanes "Board , as amended ("Sarbanes - -Oxley Act of 2002 1 Oxley" are all ultimately directed at improving audit quality and thereby benefiting ) 's audit quality indicator ( ) project , identified as a priority investors. The Board "AQI" 2 can be an important part of that effort. Its objectives are simply beginning in 2013, stated: to identify a portfolio of quantitative measures of public company auditing "indicators "), whose consistent use (called may enhance dialogue about and understanding of audits ; and to explore how and by and ways to evaluate their quality 3 whom the portfolio of indicators can best be used. Ultimately, this effort may produce higher quality audits. This concept release describes and seeks comment on 28 potential indicators; suggestions for other indicators are specifically sought. The Board hopes ultimately to refine the list to a smaller number that is manageable and effective. The 28 potential audit indicators fall into three groups. The first is " professionals, " and includes measures dealing with the " availability, " "competence, " and " of those performing the audit. The second is "audit process, " and includes "focus 's measures about an audit firm " "incentives, " "tone at the top and leadership, " attention to " "independence, " and record of " monitoring and infrastructure, 1 Pub. L. No. 107- 204, 116 Stat. 745 (2002) . In addition to the direct responsibilities given to the Board in Sarbanes -Oxley, the statute specifically authorizes to promote high professional standards among, and improve the the Board to act " " accounting firms registered with the Board "in order quality of audit services offered by, " Sarbanes to protect investors, or to further the public interest. -Oxley Section 101(c)(5) of the Sarbanes -Oxley Act, 15 U.S.C. 7211(c)(5). 2 See Public Company Accounting Oversight Board, Strategic Plan: Improving the Relevance and Quality of the Audit for the Protection and Benefit of – 2016 5 (Nov. 2012). Investors, 2012 3 The possible application of the indicators to brokers and dealers in securities that are not public companies but whose audits are within the jurisdiction of the Board is discussed below, at pages 29 and 31 (Question 39 ).
3 PCAOB Release No. 2015 -005 July 1, 2015 Page 3 "audit results, " and includes "financial statements, " "internal remediation. " The third is " "communications between auditors and audit committees, " control, " "going concern, and "enforcement and litigation. " The individual indicators are intended to address different variables, but they a core insight : without grow out of such as a portfolio of AQIs the nature of the a tool audit makes , in which certain drivers of audit quality are less than transparent, assessing quality difficult. The indicators discussed in this release are quantitative and operate in an integrated manner along ual information for each audit or with context . They are not formulas and may have their greatest us e as related comparison Context – provided by each audit to which the generators of questions for the auditor. indicators are applied and by the application of the indicators to the audit firm that conducts the audit (and perhaps other firms) – is essential to understanding their meaning and implications. Identifying relevant indicators is only the first step in using them. The release discusses their potential availability and value to audit committees, audit firms, investors, and audit and other regulators. are involved, including A number of issues how to shape the indicators to maximize their value to users, how use of the indicators should be phased in, who should provide the information involved and who should receive it, whether and to what extent the information should be public, and whether any continuing AQI project should focus initially on only certain audits or audit firms. The five parts of the concept release following this Introduction each focus on he purpose of AQIs and the one or more of these issues. The release first explains t project . Next, the discussion lists, and describes the design of, the 28 potential AQI indicators. The release then turns to the best ways to move the AQI project forward and asks which potential users of AQIs could find the indicators most immediately useful. That discussion also explores how variations in the size of audit firms, or the size or nature of audited companies, might be handled. The following section briefly describes AQI outreach efforts in which Board staff has engaged, as well as contemporary efforts, here and abroad, to promote an understanding of the nature and use of AQIs and related data . The release' s final p art is the detailed and the elements of audit quality description, in Appendix A, of the potential indicators. The promise of AQIs, in generating insights into the foundations of audit quality, both within and among audit firms, and in creating incentives for competition in quality, at this stage the AQI project poses considerable. Still, the Board recognizes that is many questions , from the appropriateness or operation of particular proposed indicators to the way the information they generate might be obtained and used. This concept release is intended to stimulate informed discussion and elicit detailed comments and suggestions from all interested parties about the answers to these questions . Particular questions of interest to the Board are noted in the release and in Appendix A.
4 PCAOB Release No. 2015 -005 July 1, 2015 Page 4 The Purpose of Audit Quality Indicators and the AQI Project II. Under -Oxley, the Board oversees the audit s of both public companies Sarbanes 4 . and non- public broker s and dealers in securities The AQI project focuses on the s of public companies. An independent audit committee of the board of directors of audit 5 each public company listed on a U.S. national securities exchange or association is responsible for the appointment, compensation, and oversight of the work of the auditor 6 of that company atements. 's financial st The shareholders of most listed and non- listed the selection of their companies public companies are asked to ratify ' respective auditors. , in considering their companies ' financial condition, look to the And investors 7 " "preparation of informative, accurate, and independent audit reports. The goal of the AQI project is to improve the ability of persons to evaluate the quality of audits in which they are involved or on which they to enhance discussions among interested rely and parties ; use of the indicators may also stimulate competition by audit firms based on The indicators proposed in this release are not put forward to modify, or to . quality of, , or to impose suggest modification the objective of the audit of financial statements new audit performance requirements. The 2008 Final Report of the Advisory Committee on the Auditing Profession to the U.S. Department of the Treasury (the " Treasury Advisory Committee, " sometimes also called "ACAP ") recommended that the Board, in consultat ion with other parties, "determine the feasibility of developing key indicators of audit quality and effectiveness 8 The discussion of and requiring auditing firms to publicly disclose these indicators. " 4 See Section 101 (a) of Sarbanes -Oxley, 15 U.S.C. 7211(a). See supra note 3. 5 In this release, the term " public company " is used in place of the more issuer, " in section 2(a)(7) of Sarbanes technical term " -Oxley, 15 U.S.C. 7201(a)(7). 6 Audit committees of some registered investment companies have similar duties, and audit committees of both listed and non- listed companies have other responsibilities under Sarbanes -Oxley. See the discussion infra notes 11, 23, and 24. 7 -Oxley, supra note 4. Section 101(a) of Sarbanes 8 Report of the Advisory United States Department of the Treasury, Final Committee on the Auditing Profession, Chapter VIII, Recommendation 3 of Advisory Committee on the Auditing Profess ion, Final Report to the Department of the Treasury, (October 6, 2008), at VIII:14, available at http://www.treasury.gov/about/organizational - structure/offices/documents/final . The "other " parties with whom the -report.pdf Committee suggested the Board work included " auditors, investors, public companies, audit committees, boards of directors, and academics. " Id. See the discussion at Part V of the concept release (Outreach; Other AQI Projects), infra at pages 31- 34. The
5 PCAOB Release No. 2015 -005 July 1, 2015 5 Page that recommendation emphasized the gap such indicators could fill and the effect they could have: A key issue in the public company audit market is what drives competition for audit clients and whether audit quality is the most significant driver. Currently, there is minimal publicly available information regarding indicators of audit quality at individual accounting firms . Consequently, it is difficult to determine whether audit committees, who ultimately select the auditor, and management are focused and have the tools that are useful in assessing audit quality that would contribute to making the initial auditor selection and subsequent auditor retention evaluation processes . (Emphasis supplied.) more informed and meaningful equiring firms to disclose indicators of audit The Committee believes that r provided by such firms, may enhance not only the quality of audits quality but also the ability of smaller auditing firms to compete with larger auditing ted to ratification of firms, auditor choice, shareholder decision- making rela 9 of registered auditing firms. auditor selection, and PCAOB oversight (Emphasis supplied.) -Chairs ' Statement at the beginning of the 2008 Final Report noted that The Co the Treasury Advisory Committee 's "Subcommittee on Concentration and Competition [which studied the AQI question] discussed enhancing audit quality as a key element in 10 " improving the viability and resilience of the auditing profession. The lack of information identified by the Treasury Advisory Committee arises the circumstances of auditing. Although a public company 's audited from inherent financial statements and related auditor 's report are themselves made public, and 's audit certain disclosures are now required by law to be made to the company Committee also recommended that the Board should m onitor the indicators that it found to be feasible. Id. at 16 -17. 9 Id., at VIII: 14 -15. The Board held its first discussion of the feasibility of developing AQIs with its Standing Advisory Group in late October 2008, several weeks after release of the Treasury Advisory Committee Report. The project was deferred , and it was reopened by the Board in late 2012. See supra note 2. thereafter 10 Id. at II: 5. The Co -Chairs of the Treasury Advisory Committee were Arthur Levitt, Jr., Chairman of the United States Securities and Exchange Commission (the "Commission " or "SEC" ) fro m 1993 -2001, and Donald T. Nicolaisen, the Commission's Chief Accountant from 2003- 05 and a former senior partner of PricewaterhouseCoopers.
6 PCAOB Release No. 2015 -005 July 1, 2015 Page 6 11 committee, t hose items provide limited information on which to evaluate the quality of an audit and explain how auditing actually takes place. The manner in which the audit is conducted lies primarily under the surface, and the strengths and weaknesses of the process are opaque. The sole observable output of the audit is a standardized report that cannot be used to distinguish auditors from one another. Since this is so, it is difficult to evaluate the elements of audit quality (although Board members have learned tha t some audit committees are experimenting with various kinds of AQIs to inform discussions with their companies ' auditors ), or to understand how it might be strengthened; it is also hard to recognize and reward audit quality when it is present. e reasons, audits currently may fall within the class of what economists For thes 12 "credence goods. call " and impact of the auditor That is, the quality 's services may be difficult or in some cases impossible to ascertain accurately . The auditor is usually in the best position to determine the scope of the service required; the client has limited the quality of the ability to make a similar judgment, and the outcome of the service – – is either unobservable or can only be observed at significant cost to the audited audit company or others . As indicated above, the Board hopes through the AQI project to contribute to a clearer view of auditing by identifying key variables, in the form of indicators, that may reflect, and by doing so inform discussions about, audit quality, and then exploring how the data generated by the indicators can be used prudently and effectively. The indicators three principles . The first is that , they should have been developed around 11 See , e.g. Section 10A(k) of the Securities Exchange Act of 1934 (the "), 15 U.S.C. 78j -1k, and "Exchange Act 07 of Regulation S -X, 17 CF R. Rule 210.2- 210.2- 07 which require the auditor to report to the audit committee (i) all critical accounting policies and practices to be used in the audit, (ii) all alternative treatments of financial information within General Accepted Accounting Principles ( "GAAP ") discussed with management, their ramifications, and the treatment preferred by the auditor, and (iii) other material written communications between the auditor and er or schedule of unadjusted differences. management, such as any management lett also Auditing Standard No. 16, Communications with Audit Committees See , which requires the auditor to communicate to the audit committee, among other things, the following matters: (i) the over all audit strategy and timing of the audit, (ii) significant risks identified by the auditor, (iii) timely observations arising from the audit that are significant to the financial reporting process, (iv) critical accounting practices and policies, (v) critical accounting est imates, and (vi) qualitative aspects of the company's significant accounting policies and practices. 12 Monika Causholli and W. Robert Knechel, An Examination of the Credence Attributes of an Audit , 26 Accounting Horizons 631(2012), available at http://aaajournals.org/doi/abs/10.2308/acch- 50265 .
7 PCAOB Release No. 2015 -005 July 1, 2015 Page 7 ency of approach and objectivity to be quantitative wherever possible, to add consist what would otherwise in most situations be only subjective judgments econd is . The s that The third is they should generate data that enables users to pose critical questions. that they should be used and function toget her as a " balanced portfolio" of audit quality. be determinative; in application to actual audits (or to No single indicator is likely to , e.g., audit comparative analyses of industry audit practices, or even firms firm offices, ), the indicators should work collectively, so that certain indicators can themselves balance others to inform discussion. The indicators are meant to be a tool. As such, they have inherent limitations that have to be recognized if they are to be effective. They are not algorithms, benchmarks, or safe harbors against enforcement or other claims , and they do not lead the quality of a particular audit or whether an auditor directly to formulas for determining has met its obligations. The reason AQIs cannot be used in any of these ways is that analysis of AQI data almost always requires a context. Their meaning in evaluating ch they arise. Reasonable explanations can audit quality depends on the situation in whi exist for divergent numbers, and a variety of other factors may affect a particular audit; for example, the environment in which an audited company operates , or the regulatory way accounting standards affect a particular company , may become an important prism through which to view AQI data relating to a firm 's audit. The quantitative character of in fact it can and often will require – qualitative the indicators does not exclude – analysis, and hence the judgment of the persons using the indicators, about context and not all of the factors that drive the interaction of the indicators as a group. Moreover, . For example, professional skepticism and audit quality can easily be measured directly haracteristics for auditors due care are critical c . Placing AQI data in context can involve what might be called " An "comparability. -manager -staff ratio for its upcoming audit might audit committee informed of the partner , to obtain context, how the ratio compares with that for other audits by its want to know auditor, and other auditors, and why there are similarities or differences. All audits, even of companies of ostensibly the same size, do not raise the same issues. The same need for context could arise in the case of engagement or retention decisions; an audit committee considering whether to retain an audit firm might want to know how its -wide indicators compare with those of firms of similar size and capacity. Without firm the answers to q uestions of this sort, with data from both engagement and firm levels based on consistent definitions of the indicators , the audit committee 's ability to evaluate what it has been told may be limited. Again, however, the question is not simply whether num bers are comparable, but why (or why not), and at that point qualitative analysis can be helpful. And since AQIs are not benchmarks, even comparability of AQIs in two audits may not imply comparable audit quality. Comparing AQIs from different audits or audit firms , for example in the context of discussions between an audit committee and an engagement team, depends on
8 PCAOB Release No. 2015 -005 July 1, 2015 Page 8 understanding what makes two engagements comparable and which differences among firms or engagements matter. Can audits of companies in dif ferent industries be comparable? What about different methods of measurement? Firms may measure various audit activities in their own ways . They may even measure items differently in these and when different segments of their practices. Understanding whether differences are significant is one of the challenges of the AQI project . The heart of the project, then, is learning what indicators can signal quality in the may have conduct of audits. If one can measure a number of elements of an audit, one a mo re informed basis for asking about, and understanding, how the audit firm approaches the audit, and similar public company audits, and the results of that 13 approach. Even if one cannot tie indicators directly to specific results, it may still be possible to generate questions and trigger discussions that strengthen audit planning and execution, and, equally important, create an environment conducive to sustained audit quality and its recognition. firm Finding the best ways to use data illustrates the sorts of inquiries the -level Board hopes the AQI project may stimulate . When looking to that data for context, is office, regional, industry , or firm -wide data the most likely to be useful ? It is hard to answer that question in the abstract. Firm -wide da ta may be crucial for tone at the top or quality incentive questions, but analyses based on industry audits, or office or regional experience, may be critical to other discussions, especially if there have been in the industr y or geographic area in which a public quality questions about audits operates . company The indicators can also have two broader effects. First, comparative information market in quality about audit firms may over time help to drive a more vibrant " " for audit and may counter services and stimulate competition among audit firms on that basis ; both pressures on audit firms to reduce audit effort or resources inappropriately consequences may enhance audit quality across the profession. Second, as the project evolves, the potential availability of AQI information may help investors become better able to evaluate the audit quality associated with particular financial statements , with a consequent effect on investment decisions . The AQI project is closely related to two other Board projects studying the details 14 These are the Division of Registration and Inspection' s analysis of the of audit quality. 13 The Board's inspection program indicates that the quality of public company audits inspected remains uneven. Some engagement teams do an excellent job, while others are deficient in important respects. 14 As noted above, the efforts of the Board are all aimed, directly or indirectly, at audit quality. Audit regulators in other parts of the world are also part of a
9 PCAOB Release No. 2015 -005 July 1, 2015 Page 9 "root causes " of audit successes and deficiencies, and the Office of the Chief Auditor 's 15 s quality The root standard setting project updating the Board' -control standards. cause project is working closely with audit firms to identify factors that differentiate high quality from deficient audits and audit practices. It has informed the AQI project to date (so that there is a significant overlap in the areas on which the two projects focus), and it is likely that the root cause project will continue to surface prime candidates for AQIs ect focuses, among other things, in the future. The quality control proj the types of on information, including AQIs, that an audit firm should incorporate in its audit practice, and then monitor, to allow it to flag and remediate problems before they result in audit 16 deficiencies. Questions – Overview Readers of the release are encouraged to answer any and all questions posed here and in later parts of the release in which they have an interest and to comment on any aspect of the release not covered by specific questions. They are especially enc alternative approaches in any relevant area . ouraged to provide suggestions for Question 1 . Is increasing knowledge about, and use of, the audit quality indicators discussed in this release likely to provide insights about how to evaluate, and ultimately improve, audit quality? If so, why? If not, why not? Question 2 . Are the 28 specific the AQI project, and some number of likely to build a strong knowledge base to indicators described below, discussions of audits among those involved in the f inancial enhance reporting process or other users of AQIs ? . Can the development of audit quality indicators, as Question 3 described in this release, have unintended consequences, either positive similar effort to enhance the strength and usefulness of the auditing of public companies. 15 All three of the initiatives are discussed in the Board's Strategic Plan for 2014- 2018. See Public Company Accounting Oversight Board, Strategic Plan: Improving the Quality of the Audit for the Protection and Benefit of Investors, 2014 – at 10 -12, 15, 18 (Nov. 2014), 2018 http://pcaobus.org/About/Ops/Documents /Strategic%20Plans/2014- 2018.pdf . See also, paper prepared for the Meeting of the Standing Advisory Group of the Public Company Accounting Oversight Board (June 24- 25, 2014), http://pcaobus.org/News/Ev ents/Documents/0624252014_SAG_Meeting/ 06242014_AQI.pdf . 16 See also the discussion infra at page 14.
10 PCAOB Release No. 2015 -005 July 1, 2015 Page 10 or negative, for audit committees, audit firms, investors, or audit or other regulators ? What are they? Can any negative consequences be alleviated? How ? . What is the nature of the context that those using AQIs as a Question 4 basis for analysis and discussion will generally require to be able to benefit from that use? Is the information required to build that context the necessary contextual information feasible? available? Is access to Potential Audit Quality Indicators III. 17 . Audit quality can be viewed from several perspectives One is an auditor 's operating in full compliance with professional auditing standards and applicable law. A 's meeting the needs of a public company 's investors, and the second is an auditor 17 A classic academic definition speaks of "audit quality " as "the market - assessed joint probability that a given auditor will both (a) discover a breach in the client's accounting system, and (b) report the breach. " Linda E. DeAngelo, Auditor Size , 3 J. Acct. & Econ 183 (1981). and Auditor Quality The U.S. Government Accountability Office ( "GAO ") (then named the General Accounting Office) provided a more detailed definition in a study of auditor rotation required by Sarbanes -Oxley, one that incorporated more directly the standards for the conduct of an audit in footnote 14: [A quality audit is an audit conducted] in accordance with generally accepted audi ting standards (GAAS) to provide reasonable assurance that the audited financial statements and related disclosures are (1) presented in conformity with GAAP and (2) are not materially misstated whether due to errors or fraud. This definition assumes that reasonable third parties with knowledge of the relevant facts and circumstances would have concluded that the audit was conducted in accordance with GAAS and that, within the requirements of GAAS, the auditor appropriately detected and then dealt with know n material misstatements by (1) ensuring that appropriate adjustments, related disclosures, and other changes were made to the financial statements to prevent them from being materially misstated, (2) modifying the auditor's opinion on the financial statem ents if appropriate adjustments and other changes were not made, or (3) if warranted, resigning as the public company's auditor of record and reporting the reasons for the resignation to the SEC. GAO, Required Study on the Potential Effects of Mandatory Audit Firm Rotation , GAO- 04- 216, note 14, at page 13 (November 2003), http://www.gpo.gov/fdsys/pkg /GAOREPORTS -GAO- 04- 216/content -detail.html .
11 PCAOB Release No. 2015 -005 July 1, 2015 Page 11 marketplace, for independent, effective, and reliable audits of the company 's financial due professional care , including statements, conducted by auditors who exercise among other things, reduce the risk of material professional skepticism; such audits, errors or accounting fraud and provide timely reporting of material weaknesses in the company 's internal control over financial reporting ( "internal control "), and of going concern issues. A third is facili tating, as part of the process, the timely and effective supply of information, most importantly to the company and public 's audit committee investors reasonable assurance . The end result should be robust audits that provide " " and "present fairly, in [that] the financial statements are free of material misstatement, all material respects, the financial position of the Company . . . in conformity with 18 ]." generally accepted accounting principles [ or another applicable reporting framework (In one sense, the higher the level of audit quality, the more certain users are that financial statements are free of material misstatements.) These perspectives reflect the dual nature of the audit, as a process and a result, while confirming that the ultimate test is the strength of the result described in the preceding paragraph. Mo re important, they suggest the need for a broad approach to identifying audit quality indicators, to reflect the different factors that can affect such quality. y, developed by the AQI p and audit qualit roject The framework for analyzing ) audit professionals, (ii) audit discussed in this concept release, has three parts: (i process, and (iii) audit results. As indicated above, the audit professionals portion of the relating to auditors ' availability, competence, and focus, framework includes indicators with emphasis on the details of staffing and experience; audit process includes relating to tone at the top and leadership, incentives, independence, indicators infrastructure, and monitoring and remediation; and audit results includes indicators rol, timely reporting of going concern concerning financial statements, internal cont issues, communications between auditors and audit committees, and enforcement and litigation. The framework focuses as much, if not more, on factors that have not generally – those relating to audit professionals and heretofore been observable process – as on those that have, relating to audit results. 18 See paragraphs .08 . and h . of AU Section 508 . The basic element of e the report in paragraph .08 h is: "[a]n opinion as to whether the financial statements present fairly, in all material respects, the financial position of the Company as of the balance sheet date and the results of its operations and its cash flows for the period then ended in conformity with generally accepted accounting principles. " Of course, audits of public companies must be performed in accordance with the all applicable reporting and related professi onal practice standards, including the rules relating to evaluation of internal control on financial reporting.
12 PCAOB Release No. 2015 -005 July 1, 2015 Page 12 Using this three part framework, the Board has identified 28 indicators as candidates to provide insight into audit quality, out of a total of about 70 possible 19 indicat ors the project team reviewed. The framework and proposed indicators reflect s Divisions (as noted above, the work of the Division of the experience of the Board' ' root cause initiative has been especially important), Registration and Inspections but are audit they to some extent intuitive at this stage of the project. Thus, the " " factors are generally consistent with those discussed by the Treasury professionals Advisory Committee and others noted in section V, and the " " factors audit process reflect elements in both the Board' s existing quality control standards and widely -used internal control frameworks. Criteria used to evaluate potential indicators (by a team of experienced auditors from the Board' s Office of Research and Analysis, Division of Registration and Inspections, and Office of the Chief Auditor) included anticipated correlation to audit quality, potential usefulness, potential for unintended consequences, manage to measure" benchmark, scalability, quantifiabili ty, potential for becoming a " availability of data, redundancy, potential to become a lagging indicator, anticipated precision of the signal the indicator would generate, and ability of the indicator to generate insight into possible root causes of audit strengths or weaknesses. The AQI project is focusing on ways to evaluate the potential indicators in the future and compilation and evaluation of available data is ongoing. One goal of the concept release is to generate discussion and use of the indicators that can aid in that effort. 19 Of those, about 40 were presented to the Board's Standing Advisory Group in its May 2013 meeting, which included break -out sessions to discuss possible indicators; the Discussion Paper which included the 40 potential indicators can be found at http://pcaobus.org/News/Events/Pages/05152013_SAG.aspx . Many additional potential indicators came from the ensuing discussion.
13 PCAOB Release No. 2015 -005 July 1, 2015 Page 13 20 The 28 potential indicators are: 1. Staffing L everage Availability Workload 2. Partner 3. Manager and Workload Staff Resources Accounting and A 4. Technical uditing Persons with S pecialized S kill and K nowledge 5. 6. Competence Experience of A udit P ersonnel Audit Expertise of 7. Industry Personnel Audit Personnel 8. Turnover of at Service Centers 9. Amount of Audit Work Centralized Training H ours per 10. udit P rofessional A Focus 11. Audit ours and R isk A reas H AUDIT PROFESSIONALS Allocation of udit H ours to P hases of the A udit 12. A S T Tone at the 13. Results of I ndependent op and urvey of F irm P ersonnel Leadership 14. Quality R Incentives C ompensation atings and 15. Fees, Effort, and Client Risk Audit Compliance with I ndependence R equirements Independence 16. upporting Infrastructure Investment in I nfrastructure S 17. Q uality A uditing Monitoring and esults R 18. Audit F irms ' I nternal Q uality R eview AUDIT PROCESS 19. PCAOB Inspection Results Remediation Technical ompetency T esting 20. C F S 21. Financial Frequency and I mpact of tatements inancial S tatement Restatements for E rrors Fraud and other F inancial Reporting Misconduct 22. 23. Audit Quality from Measures of F inancial Inferring eporting uality R Q C ontrol 24. Timely Internal eporting of I nternal C ontrol W eaknesses R C Going C oncern 25. Timely Reporting of G oing oncern I ssues ndependent Communications ommittee C udit A of 26. Results of I s S urvey between Auditors and Members AUDIT RESULTS ommittee C udit A Enforcement and roceedings P 27. Trends in PCAOB and SEC E nforcement itigation 28. Trends in P rivate L L itigation Appendix A (which should be read together with this section of the release), describes the objective of each indicator, discusses briefly the reason for its inclusion , 21 calculations for the indicator at both the engagement and firm possible and contains levels. In the case of one (indicator 7) calculation is suggested only at the engagement level because the scale of an audit firm practice could make generation of meaningful 20 More detailed discussion of Audi t Professionals, Process, and Results indicators, appears at pages A-2, A -12, and A -19, respectively, of Appendix A. 21 As discussed at several points in this release, the definition of " firm " level raises a number of its own issues.
14 PCAOB Release No. 2015 -005 July 1, 2015 Page 14 indicators (13, 14, and 26 ) calculation data at the fir m level difficult. In the case of three is suggested only at the firm level, to assure sufficient sample size and anonymity. is sought below about ways to test the strength of the indicators as ways to Comment eval uate, and their usefulness for informing discussions about, audit quality . s goal is to identify a In presenting the indicators for comment, the Board' manageable number of indicators help provide an effective practical picture of that can to inform discussions that may produce improvements in quality audit quality . Certain indicators on the current list may ultimately prove to be duplicative, and others may not generate sufficiently useful information; comments may suggest new indicators that should be added to the list. Again, the ability of the indicators identified to function as a group is thought to be critical to their successful use. balanced The choice of indicators is not fixed. The effort is new, and by their very nature audit quality indicators must be capable of change over time to reflect advances in learning and changes in the way audits are conducted. In addition, subsequent events, for example restatements for errors affecting the public company using the indicators , can cause particular indicators to be re- evaluated. One of the purposes of the project is to assemble a sufficiently large collection of information about the indicators and subsequent events to refine the ideas the release puts forward. Additional experience, including that made possible by use of the first generation of AQIs, may suggest valuable new or substitute indicators, or broader approaches to measuring audit quality. In particular, analysis by the Board' s Division of Registration and Inspecti ons of data about individual audits, audit firms, and audit quality, especially the work of the Division 's root cause analysis project, should become increasingly closely coordinated with the AQI project and may prove critical in evaluating particular AQIs . Questions - Selection of Indicators (as listed above and described in Appendix A) Question 5 . Should any indicators be omitted from the list proposed in this release? Which indicators? Why? Question 6 . Should any indicators be added to the list? Wha t are they? Why? How would they be quantified? Question 7 . Which indicators are likely to be the most useful in evaluating audit quality and informing discussions of audit quality ? Why? The least useful? Why? Question 8 . Which indicators, including any mentioned in response to Question s 6 and 7, are in use today? How are they being used? Which ones are relatively more effective? Less effective?
15 PCAOB Release No. 2015 -005 July 1, 2015 Page 15 . Definition of the Indicators. Question 9 Are the indicators clearly defined? a) b) Which indicators would benefit from a clearer definition? Are the suggested methods for measuring each indicator c) clear? Are there other ways to measure particular indicators that d) would be more effective? e) While most indicators depend onl y on data from a firm 's public company practice, some include information concerning workload from both public company and non- public company practice. Are there other indicators that would be more useful if they were extended to the breadth of an audit firm 's practice? Question 10 . Do particular indicators risk becoming too complex in operation to reflect the reality of particular audit situations? 1 Question 1 . Does the time lag between an audit year and the availability of information for many of th e results indicators ( e.g., whether a restatement has occurred) affect their value? How? Question 1 . Are there one or more indicator s among the 28 that are 2 superior to other indicator s on the list and cover the same subject or subjects or more indicators are un necessary for that reason ? , so that one Please identify the redundant indicators and explain. Question 13 . Are data available for each of the indicators? To what extent, specifically, is the data already broken out in audit firms ' operating systems? Question 14 . The indicators operate at the engagement level, the firm level, or in most cases both.
16 PCAOB Release No. 2015 -005 July 1, 2015 Page 16 a) How should " engagement level " be defined in the case of a global audit in which work is referred to one or more "other " (whether or not the firm or firms involved are part of auditors the engagement firm 's global network)? Who should make that determination? b) Would one or more of the indicators be more useful if it also 's "office "regional " levels, not operated at an audit firm " or engagement " and "firm -wide merely at " .g., " levels (so that, e the percentage of an office' s work devoted to a single large client would be known)? Which indicator or indicators? c) Would one or more of the indicators be more useful if it also operated at the level of the audited company 's industry or economic sector (so that, e .g., indicators for the audit of a particular bank could be compared with the average of indicators for all of an audit firm 's banking clients)? 5 . What are the elements of " context " required for successful Question 1 analysis of the 28 potential AQIs? Are those elements ordinarily available to AQI users? If not, is it feasible to make the elements of context available? Question 16 . Comparability. a) How important is comparability to the value of AQIs? b) What are the most important elements of comparability in the analysis of AQIs? c) Is comparability more likely to be fostered by firm -wide data (either within or among firms) or data focused on in dustry, regional, or office practices? d) Does the existence of differences among firms in the way certain matters (e.g., classification of personnel) are measured affect the value of AQIs if those differences are disclosed? If they are not disclosed?
17 PCAOB Release No. 2015 -005 July 1, 2015 Page 17 17 . How should audits of different size and complexity be Question -level data? weighted in the calculation, analysis, and discussion of firm Question 1 8 . What are the costs and obstacles to audit firms of compiling Can data be created at reasonable cost for any the relevant data? indicator for which they are not now available? If not, is there another indicator of comparable scope, either among the 28 or otherwise, for which it would be less costly to obtain the necessary data? 9 . In what situations could generation of AQI data impose Question 1 collection or evaluation costs (whether involving specific indicators or the benefits? Could those use of AQIs generally) without commensurate costs be reduced? How? Question 20 . Could the collection and evaluation costs of AQIs be a greater economic burden for smaller audit firms than larger audit firms? Could this burden disadvantage smaller firms in competing for audit if p by the indicators? business erceptions of quality are driven 21 . In what ways should Question the various indicators be evaluated or field -tested? IV. Use and Availability of Audit Quality Indicators Identifying promising indicators is only the first step. For AQIs to help turn a clearer view of audits into increases in audit quality, people who influence audit quality must use them in their decision- making. AQI An can take different shapes for the future, depending on choices project among a number of variables. These include (i) the potential users involved, (ii) the options for obtaining and distributing the relevant data, (iii) potential approaches to phasing in AQIs (so that, for example, not al l data would be available immediately ), and (iv) exclusion of certain audit firms or types of audits from the effort , at least initially, if relevant indicators are not adequately scalable. Again, choices in any of these areas could naturally change with experience.
18 PCAOB Release No. 2015 -005 July 1, 2015 Page 18 The Board believes that the potential primary users and Users of AQIs: A. range of uses of AQIs can be summarized as follows: Potential Use (Decisions AQIs Can Influence) Potential AQI User Assess reporting risk and audit quality • Audit Committees Retain and compensate auditors • • Oversee auditors • Assess and manage risk • Improve quality control efforts and, ultimately, Audit Firms audit quality Identify root causes of audit deficiencies and • remediate weaknesses • risk Assess reporting 22 Investors • Vote shares making • Inform policy - Assist root cause and quality control projects • PCAOB (and other Regulators) Stimulate public discussion of, and market • demand for, quality Other users of AQIs could include company management, the business press, academics, and the general public. As noted above, the indicators are intended to function as a balanced portfolio, and the initial assumption is that the portfolio would be the sam e for all users. (Experience and research, however, may indicate the benefits of modifying the group for situations where scalability or the nature of particular audits is a Different classes of users could receive different levels of disc losure of consideration.) AQI data. . Independent audit committees of the boards of directors of Audit Committees listed companies are directly responsible by statute or regulation for the appointment, ' auditors (inc level of compensation, and oversight of their companies luding resolution of disputes between the auditors and management concerning financial reporting), and 23 Audit committees for all (listed or those auditors report directly to the audit committee. 22 Investors could only use AQI information if, when, and to the extent that is made publicly available. at page 27. But of the discussion infra information See course use of AQI data by audit committees to produce higher quality audits can benefit inves tors in the companies involved. the 23 See Section 10A(m) of the Exchange Act and Exchange Act Rule 10A - 3(b). Foreign private issuers are exempt from these requirements if their home country law requires their having an independent "board of auditors, " with ro ughly similar authority, and some other listed companies – prima rily passive investment vehicles, are also exempt. See 17 CFR 240.10A -3(c)(6). Rule 32a- 4 under the Investment Company
19 PCAOB Release No. 2015 -005 July 1, 2015 Page 19 ers related to the audit and not) public companies must be given reports of critical matt are responsible for preapproving provision of permissible non- audit auditing and 24 services by the auditor to the company. may AQIs give the audit committees of both explore these matters and listed and other public companies additional relevant data to enhance dialogue with their auditors. Based on discussion with a number of their members, it appears that at least some to audit committees are beginning to consider the idea of AQIs and have started question and track their company like those outlined in this 's auditors using ideas release. A more systematic approach to the definition and aggregation of AQI data take these steps, especially producing enhance d dialogue could help audit committees ' auditors. But even if audit committees obtain information from with their companies their audit firms about their own company 's audits, they may lack comparative data (derived from other audit operations of the firm, let alone from those of other firms) to place that information in the context necessary to give it the greatest clarity. For example, an audit committee might inquire about the staffing ratio (the ratio of experienced senior personnel to all members of the engagement team) for its audit. The average staffing ratio for all audits the firm performs and all audits the firm performs in the company 's industry, as well as comparable figures for audits by other firms (when and if such data is available) , might all provide necessary context to indicate what the data means when an audit committee evaluates its audit engagement team or audit firm. Finally, without a more systematic approach, audit committees may have no s significance or the extent to which data from diff erent audits assurance about the data' are derived from standard definitions and calculations. audit committee would likely focus first on AQI data An at the engagement level for the audit the committee oversees. The indicators are intended to provide information 25 Even without oversight and evaluation of a current or pending audit. to help frame the a broader set of data, information about an engagement team or its deployment may increase audit quality. highlight issues that, if addressed, could Act of 1940, 17 CFR 270.32a- 4, requires oversight of the audit (but not selection of the auditor) of registered management investment companies by an independent audit committee of the board, but only if the company wishes to eliminate the need for a the province shareholder vote on ratification of auditor selection. Governance is largely -United States law for the remaining groups of public companies. of state or non 24 Section 10A(h) -(k) of the Exchange Act, Regulation S -X Rule 2 - See 01(c)(7) and Auditing Standard No. 16, supra note 11. 25 An exception would be a committee's review of tenders for new audit engagements, when the audit committee would likely focus on firm -level data from tendering audit firms (and potential competitors), to compare with firm - and engagement -level data relating to prior audits.
20 PCAOB Release No. 2015 -005 July 1, 2015 Page 20 Questions arise, however, about how to assemble data for an audit involving 26 Audits of global companies, for example, require participation more than one auditor. of auditors from multiple firms that may or may not be part of an affiliated network. ovide the most insight if audit quality differed Providing AQI data for each firm could pr widely from firm to firm. But AQIs for the portion of an audit performed by separate firms might be difficult to compile and might distort the picture of the audit as a whole. s are challenges Understanding and resolving these issue of the project going forward. An audit committee would more than likely then turn to information about the audit firm that performs (or is proposing to perform) the audit in question. The audit committee retains a fir seeks to associate its company with a reputable m, and it organization that can provide the market with a basis for confidence in the quality of a 's financial reporting. Moreover, the audit firm 's overall commitment to quality company can shape the engagement team, which does not operate in isolation; tone at the top, the incentive system, recruiting, retention, training, technology, tools, and knowledge bases all affect the strength of the engagement team 's work. The culture of the audit firm, and not just the engagement team, is likely to influence audit performance. Given these realities, the audit committee may have questions about how its engagement compares with engagements conducted by its audit firm for similar companies. AQIs related to the firm are likely to provide context for audit committees to evaluate engagement level AQIs, and ask questions about them, far more effectively than would otherwise be possible. For the same reason, audit committees may find it helpful to compare AQI data across (if the latter data are available) . Quality is a relative concept, and firms be instructive, when context and the details of AQI data differences among firms may are taken into account -level data, in context, may also help . The availability of firm answer the question posed by the Treasury Advisory Committee about the drivers of competition among, and levels of quality at, different audit firms , so that AQI data, properly used and understood, may help spark, and sustain, competition based on audit quality and its improvement generally. Finally, it may be useful to compare engagement AQIs to AQIs for other audits in the same industry, especially if the audit requires specialized skills. For example, audits of companies in the financial services or telecommunications sectors may require auditors with advanced training and an engagement team with a disproportionate number of experienced personnel. An audit committee may also be especially interested in other audits by engagement teams from the same office or region as the engagement team the audit committee is supervising. 26 See supra Question 14 a).
21 PCAOB Release No. 2015 -005 July 1, 2015 Page 21 An audit firm 's candid discussion of its AQIs with an audit committee, like its 27 , if that already occurs discussion of its external and internal inspection results may add value not only in relation to the committee' s oversight and evaluation of a particular s oversight of the financial reporting process audit, but also in relation to the committee' more generally. For that work with auditors who have a strong record audit committees of performance, AQIs may offer comforting and confirming evidence of quality. In other cases, the information may present insights (perhaps even troubling ones) that allow to encourage improvement or seek stronger auditing from others. audit committees Audit firms that provide information about the results of a PCAOB inspection coupled with results of the firm help an audit committee 's own internal quality reviews may understand how the fi rm performed on specific audits and in high- risk areas across audits; that information may in turn help the committee to ask more detailed questions than would otherwise be possible about specific substantive audit issues, quality While AQIs are no substitute for the communications about control, and remediation. audit strategy, risks, and other matters required by Auditing Standard No. 16, 28 "Communications with Audit Committees, " the information the former contain may complement those communications. The Board recognizes that ultimately each audit committee will have to judge for itself whether and how it wishes to use AQIs in its decision- making. The majority of audit committee members to whom members of the AQI project team have spoken in developing the project have expressed support. The Center for Audit Quality (the 29 sees audit committees as "CAQ "), whose own AQI proposals are discussed below, the logical recipients of the audit quality data they propose, and the Council of Institutional Investors ' list of factors audit committees should consider in determining whether to continue the retention of an outside auditor contains several factors that 30 Other audit committee members , however, question whether AQIs resemble AQIs. 27 See Information for Audit Committees about the PCAOB Inspection , PCAOB Release 2012- 003 (August 1, 2012). Process 28 Auditing Standard No. 16, supra note 11. The Standard is effective for audits of fiscal years beginning on or after Dec. 15, 2012. The release that accompanied approval of AS 16 by the Board states that " Auditing Standard No. 16 information to the audit does not preclude the auditor from providing additional committee. Nor does the standard preclude the auditor from responding to audit committee requests for additional information from the auditor. PCAOB Release " See No. 2012- 004. 29 See infra at page 34. the discussion 30 See Council of Institutional Investors, Policies on Corporate Governance section 2.13, available at http://www.cii.org/corp_gov_policies#2.13a .
22 PCAOB Release No. 2015 -005 July 1, 2015 Page 22 can provide useful insights in light of the information already available from existing or prospective auditors, the difficulty of tailoring AQIs to a company 's unique nces, and the possibility that AQIs could disrupt the standards and circumsta expectations that audit committees must meet. Some have also noted that audit ' time is already taken up with a wide range of duties and that devoting the committees time to use AQIs well could have the unintended consequence of spreading audit committees The Board specifically seeks comment on whether and ' attention too thin. how audit committees can most directly benefit from audit quality indicators. . Firms have long used some AQI -like measures to manage their Audit Firms audit practices. They may use them to measure efficiency and profitability, to flag 31 or to make compensation decisions. audits or offices with a higher risk of audit failure, thinking how such measures may help them to In addition, some firms are re- understand and respond to internal and PCAOB inspection findings, identify the root causes of the deficiencies involved, and remediate those deficiencies, upgrading management processes as a consequence. AQIs may provide useful perspectives in all of these areas. Audit firms may be in a unique position to make use of AQI data because of their ability to correlate the information across many audit engagements to strengthen quality ith audit committees could broaden the control and risk management. Discussion w base of comparison for firms and encourage them to invest in AQI measurement. Possible dissemination of AQIs from other firms might surface insights that a single firm was not in a position to identify itself. AQIs, applied carefully and thoughtfully, may Thus, become an important tool for audit firms, not only in improving the strength of their audits but in allowing them to distinguish themselves for audit quality and compete on that basis in the marketplace. The Bo ard hopes that firm s' comments on the release will discuss their experiences in analyzing audit quality, and that will continue to share those experiences with the AQI project team as the AQI effort continues to take shape. Investors . Investors are the primary beneficiaries of the financial reporting process and the group at which audit quality is ultimately aimed. They elect the In addition, a large majority of public directors of the company in which they invest. 32 companies request a shareholder vote to ratify the choice of auditor. 31 Firms may subject those audits to special procedures or to internal inspection. 32 Data obtained from Audit Analytics indicates that 90 percent of the public companies on the Russell 3,000 list as of April 2014 submitted at least one auditor ratification proposal to shareholders between 2011- 13. In its 2008 Report, the Treasury
23 PCAOB Release No. 2015 -005 July 1, 2015 Page 23 At present, t he visibility of the sources of audit quality to investors is even more limited than it is to audit committees. Investors have no direct channel to the auditor; communication is typically restricted to the standard auditor 's report about a company 's 33 financial statements and internal control over financial reporting. The result is that investor impressions of audit quality come largely from the frequency and magnitude of negative events, such as restatements for errors or fraud, related to public company financial reporting , material failures of internal control over of these events financial reporting, or, on the positive side, the absence . Such events can certainly be significant and indicate lapses in audit quality – But they or worse. occur in a vacuum, without context. they do not often help investors focus generally So on the components of the audit process and, more important, provide little information audits are planned and executed. about how quality Over the past decade, the PCAOB ' impressions of public inspection reports have been available to help inform investors discuss particular audit deficiencies, rather audit quality, but by design these reports than the broader elements that can make for quality, and then on an anonymous basis. Moreover, the reports are not necessarily representative of a firm 's overall practice, because inspections are risk -based and, in the case of the largest audit firms, involve only a small portion of the firm 's public company practice. Advisory Committee noted that " [a]lthough not statutorily required, the majority of public -80% of smaller —nearly 95% of S&P 500 and 70% companies in the United States —put auditor ratification to an annu al shareholder vote. " Report of the companies Treasury Advisory Committee, supra note 8, at VIII: 20. 33 To address this circumstance, the Board has proposed changes to its auditing standar ds and rules that can provide new information to shareholders about the most critical issues addressed by the auditor, the auditor's evaluation of " other information " in the document containing the financial statements, and the identity of the engagement partner and certain other participants in the audit. That information would be largely explanatory but can also help investors and others better evaluate audit (i) Proposed Auditing Standards – the Auditor's quality across engagements. See Report of an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion; the Auditor's Responsibilities Regarding other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor's Report; and Related Amendments to PCAOB Standards , PCAOB Release 2013- 005 (August 13, 2013), and (ii) Improving the Transparency of Audits: Proposed Amendments to PCAOB Auditing Standards to Provide Disclosure in the Auditor's Report of Certain , PCAOB Release No. 2013 -009 (December 4, 2013); Participants in the Audit Supplemental Request for Comment: Rules to Require Disclosure of Certain Audit on a New PCAOB Form , PCAOB Release No. 2015- 004 (June 30, 2015). Participants
24 PCAOB Release No. 2015 -005 July 1, 2015 Page 24 ' attention portfolio of properly chosen AQIs might refocus investors Data from a on the broader elements of audit strength or weakness and the characteristics of quality . It could alert investors to audit quality at a particular engagement, or even a audits particular firm s high -quality , provide them with context to understand what constitute , and enable researchers or analysts to provide investors with further insight s into audits audit quality at the engagement or firm levels. It could also inform investors voting to s choice of auditor . By having these effects, AQIs could, ag ratify an audit committee' ain, ultimately increase pressure for differentiation in the audit market in terms of quality and . hence drive overall enhancements in quality available (an issue discussed If and when AQI data were to be made publicly 34 , below) investors would likely focus first on engagement level AQI information about particular companies in which they invest or might invest. They might also benefit from -level data (whether reflecting industry, office, regional, or firm firm for the -wide data) reasons discuss ed above in connection with usage of AQIs by audit committees, namely comparison and context. Investors might receive AQI data from several sources over time, including audit committee reports or documents published by audit firms or the Board. to better distinguish variations in measures that relate to quality may The ability produce greater market differentiation among audits and stimulate competition in quality that may also have an effect on securities prices. This in turn could generally help investors given the public goods nature of securities prices . 35 on Audit s Investor Advisory Group A presentation by the Board' Working Group s October 16, 2013 meeting emphasized that Quality Indicators at the Advisory Group' "measure the quality of the actual audit, " "help establish accountability for AQIs should " operate in a "forward -looking audit quality, "information or predictive " way, and contain content. Working Group sought measures " that provide investors with timely " The information with r " Seventeen of the Working Group' s espect to the credibility of audits. 27 proposed indicators are reflected in the 28 potential indicators in this release, and several others are the subject of questions on the indicators. The Board encourages comments that discuss these issues in detail. The Board . 's inspections staff already receives certain data that The Board -like measurements in its work, primarily to flag resemble AQI data, and it has used AQI firms, offices, and audit engagements that are at a relatively higher risk of audit within the context discussed in this concept release , , deficiencies. Expanded AQI data 34 See the discussion infra at page 27. 35 See infra note 41. The Investor Advisory Group is a forum for the investor community to provide its views and advice on matters affecting investors and the work of the Board.
25 PCAOB Release No. 2015 -005 July 1, 2015 Page 25 can assist the Board in several ways. First, the data can inform the development of inspection strategies. Second, the data can provide the Board with insights into trends in overall audit quality at the firm, network, or profession levels. Third, it can broaden the foundation for the Board' s consideration of policy issues. Finally, as noted above, d inform analysis of the root causes of expanded use and analysis of AQIs coul inspection findings, evaluation of firms ' remediation efforts, and the effort to update auditing standards, including those related to audit firm quality control. B. Obtaining and Distributing AQI Data tion envisioned by this release comes most importantly from The AQI informa audit firms. The data for 19 of the 28 potential indicators can be obtained only from the firms (or, in one case, from an independent survey of firm personnel); the data for eight aining indicators (the "audit results " indicators, indicators 21- 28) of the nine rem can be derived from public sources, while the remaining potential indicator is a possible survey of audit committee members. Information about background and context must also generally come from the firms, who are in the best position to provide it for firm and client industry indicators and for indicators relating to particular engagements. (As experience with AQIs grows, third parties, including academic researchers, may assume a role of assembling, analyzing and providing perspective for AQI information that is public, as is already done for, e.g., financial statement restatements for errors. The Board and other regulators could also analyze the indicators and provide context, subject to applicable disclosure limitations.) ource of Others could be involved in distributing AQI data, even if firms are the s that data and much of the accompanying context. Data aggregators might collect and publish AQIs derived from public information. Companies or audit committees could -level AQIs (and perhaps firm -level AQIs , for context) in thei include engagement r financial filings or audit committee reports to shareholders, as some do now to a limited extent. The Board could take one or more of several approaches to assisting in the distribution of the data. For example, as and when appropriate as the AQI projec t matures, it could (i) encourage firms and engagement teams voluntarily to discuss AQI engagement -level data with audit committees, or to do so publicly, (ii) require - or firm audit teams to provide that data to audit committees, (iii) collect and make "combined " AQI data public over time, as a single set of weighted figures for comparable firms, (iv) collate and make public on a firm -by-firm basis AQIs derived from public sources, and (v) consider requir ing reporting of the necessary data to the Board so that the Board could make it public, or even require firms to do so directly. (Of course, the strength of any approach, at the stage of the project involved, as well as any legal or other issues, would have to be examined at the time.)
26 PCAOB Release No. 2015 -005 July 1, 2015 Page 26 , among other things, the bution of AQI data likely depends on The timing of distri 's complexity, and the timing of the audit cycle. It is possible user involved, the company that the data could come to be included as a supplement to required communications at 36 the audit cycle. the beginning of Audit committees may, however, also benefit from an update following completion of planning and preliminary audit work and before the start of final audit procedures. If engagement -level information were made available to shareholders, directly or indirectly, disclosures might be made most effectively before 's requested shareholder vote to ratify the appointment of the auditor. Audit each year -level AQIs might be made available to shareholders annually, for example, firm through an annual report on audit quality released by firms for this purpose. Firms themselves would also receive data about other firms when the latter made the data publicly available, again, assuming that such a level of disclosure becomes part of the project. C. Impleme ntation over Time Of course, there is no need to adopt all of these approaches, and certainly no s are implemented in a series of need to adopt them simultaneously. Many project in include planned steps or phases rather than all at once. The advantages of a phase- as initial experience is evaluated and ability to build support flexibility to alter the project among the parties affected, if they perceive tangible benefits from each step along the way. (O n the other hand, a phased approach may delay the ultimate benefits of the project and may make it more difficult to implement the project 's later stages.) The manner of phasing in an AQI project would depend on the project 's details. For example, the pro ject s support of voluntary use of could initially involve the Board' , audit committees , and audit firms voluntary approach AQIs, by engagement teams . A could give audit committees and auditors time to become comfortable with the indicators and gain experi -making. It would also ence in using them to aid in decision provide time for study of the indicators and their effectiveness . After a period of learning project could expand to include required disclosure of and demonstrated benefits, the to audit c AQIs , public disclosure of AQI data, or both. ommittees might A phased approach ultimately produce a solidly grounded result. Again, variations are possible. To maximize voluntary use, t he Board could specify the most promising AQIs and provide standardized definitions and guidelines that would promote comparable data. The project could even begin with a relatively small number of indicators and expand the list for discussion over time, or consider pilot projects to permit testing and evaluation of the indic ators involved. 36 The CAQ suggests this approach in its paper on audit quality indicators. See Center for Audit Quality, CAQ Approach to Audit Quality Indicators (2014) at 6, available at http://www.thecaq.org/docs/reports -and- publicat ions/caq- approach- to-audit - quality -indicators -april -2014.pdf?sfvrsn=2 .
27 PCAOB Release No. 2015 -005 July 1, 2015 Page 27 One benefit of a phase- in would be to provide a basis for understanding more free fully the implications of making AQI information public. Firms are do so of course to are beginning to make some similar information public, as discussed now, and some below. Other firms may do the same, providing context for audit committees and beginning to do so for investors. But a general requirement that results in AQI data have to follow testing, and becoming public, because of its very nature, would evaluating, the use of AQIs and weighing the benefits and costs of public dissemination. No decision has been made about this subject in the use of AQIs may , but phasing produce the experience and information that can produce a basis for such a decision in the future. However the issues are ultimately involved in moving an AQI project forward resolved, the Board will have the responsibility, as the Treasury Advisory Committee intended, to monitor the terms and performance of any AQI project . D. Possible Exclusion of Certain Audit Firms or Certain Audits The optimal scope for an AQI project is also an important issue; its consideration raises three broad questions. The first is whether the project should extend to all, or only some, registered accounting firms. The Treasury Advisory Committee suggested enhance . . . the ability of smaller auditing that one of the uses of AQIs could be to " 37 " firms to compete with larger auditing firms . . . . But evaluations of AQI data likely need to consider differences in results in relatively larger and smaller firms, respectively, and the ramifications of t hose differences. Issues of scalability such as these are complex. The Board may need to consider whether the management of a smaller firm is sufficiently different than the management of a large firm that some AQI 's are not as relevant for one type of firm as the other, and how to creat e meaningful measures of quality for firms of significantly different sizes. The Board could decide, for example, to focus the AQI project initially on the largest audit firms, who audit the financial statements and internal control over s public companies (in terms of market financial reporting of most of the nation' capitalization). This approach will provide more time to study scaling of the indicators, but it may also limit the benefits for the excluded firms and their public company clients and encourage the market to differentiate between firms solely by size (because AQIs begin to apply to larger firms first) rather than audit quality. The second question of scope facing the Board is which public company audits should be reflected in indicator data. As discussed above, only listed companies are required to vest auditor selection , compensation, and oversight in independent audit 37 United States Department of the Treasury, Advisory Committee on the Auditing Profess ion Final Report, supra note 8.
28 PCAOB Release No. 2015 -005 July 1, 2015 Page 28 management a similar ; many registered committees investment companies operate in 38 Equally important, at all public ion under the Investment Company Act of 1940. fash must companies the audit committee (or if there is none the board of directors) preapprove any auditing or non- 's auditor . Th e audit service performed by the company AQIs may fact that be of use to any public company directors with potentially governance responsibilities, their shareholders, and their auditors , is a consideration in answering this question. project audits in A third, related, question is whether to exclude from the AQI certain industries where the nature, timing, and extent of audit work can differ from the norm and differ equally widely within the particular group of audits involved. For registered investment com panies are example, audits of employee benefit plans and likely to prove very different from the audits of global manufacturing companies. Are the differences enough to render application of AQIs to the former audits irrelevant, or make the comparison of AQIs in these situations misleading, or can pr oblems be addressed by comparing AQIs for one engagement against AQIs for other engagements in similar industries or entities ? Conversely, would excluding certain types of audits distort the results of firm -wide public company audit comparisons, or suggest that only industry - based comparisons are valid? (Brokers and dealers in securities pose their own issues, , if any , are -standing public companies ; many are small, and audit free because few to the Commission requirements for those companies focus both on financial reporting and compliance with critical customer protection rules. ) Again, the Board could decide to exclude audits in certain industries from the AQI . But an exclusion may limit the benefits of AQIs project and perhaps signal, incorrectly, that audits in certain industries are less important than audits in other industries. As an alternative, the project could initially apply to certain firms or to certain types of audits, with the Board making clear its intention to expand the number of firms or audits to which AQIs apply, over time. Finally, the Board could undertake special AQI efforts aimed at entiti es with special characteristics, including brokers and dealers in 39 securities. 38 See discussion at note 23. Registered management investment supra companies are required to select their auditor by a vote, cast in person, of a majority of the disinterested members of the board of directors. See section 32(a)(1) of the Investment Company Act of 1940. 39 As of May 24, 2014 (according to Commission data), 377 of the 4,007 brokers and dealers that filed audited financial statements with the Commissi on were subsidiaries of public companies of various sizes, but the remaining 3,630 were privately -owned compani es, many of which were small. The Board is not aware of information indicating that any of the brokers or dealers were free- standing public companies.
29 PCAOB Release No. 2015 -005 July 1, 2015 Page 29 Questions – Use of Audit Quality Indicators . For what class or classes of users would AQIs be most Question 2 2 valuable? Would some AQIs be more valuable than others to various classes of users? Question 2 3 . Are there one or more groups, in addition to audit committees, investors, audit firms, and the Board and other regulators, that the Board should consider to be primary users of audit quality indicators? If so, what are they? Does their need for the indicators, in each case, differ from those of other primary users? 4 Question 2 . Does the discussion of the uses of the indicators identify all uses should be ? likely uses? If not, what other considered Question 2 5 . How im portant to the usefulness of the indicators by audit and other users is AQI engagement committees -level -level data? AQI firm data for the audit engagement firm? Question 2 6 . To what extent do audit committees already receive AQI - like information from t heir audit firms? What are the most significant gaps in the information they receive compared to the information that could be contained in the potential AQIs ? 7 -level AQIs be useful to Question 2 . To what extent would engagement investors? AQI firm -level data for the engagement firm? What AQIs would be most useful? Why? 8 . Should engagement level AQI data be made public in Question 2 whole or part? Should firm level AQI data be made public in whole or part? Question 2 9 . How important to the usefulness of the indicators by, audit committees, audit firms, investors the Board and other regulators, and others is the public availability of firm -wide AQI data for the audit firm that performs a particular engagement? How important is the public availability of AQI data for other audit firms of comparable size? Question 30 . To what ex tent would firm -level data be more useful, for all or some indicators, if it were broken out in industry categories? Question 31 . Would it be useful to phase in any ongoing AQI project ? For example, should the project be voluntary for at least some per iod? If phasing is a good idea, what steps should the phasing involve? How should any phasing of the project be monitored?
30 PCAOB Release No. 2015 -005 July 1, 2015 Page 30 Question 3 2 . How should AQI data be made available, either during a Which of these approaches is preferable? phase- in or ultimately? By audit firms voluntarily to audit committees, at the a) engagement level, the firm level, or both? b) By audit firms voluntarily to the public, at the engagement level, the firm level, or both? By audit firms on a required basis to audit committees, at t c) he engagement level, the firm level, or both? By audit firms on a required basis to the public (whether d) directly or through the Board), at the engagement level, the firm level, or both? Would disclosure by audit firms directly or by the Board be preferable? 3 . S hould the Board consider steps to require audit firms to Question 3 - and firm -level AQI data available to audit committees? make engagement To investors? Question 3 4 . Should di stinctions be made, in the timing or nature of AQIs, among the audit firms that audit more than 100 public 40 companies ? What potential distinctions would be most useful? 35 . Should smaller audit firms be treated differently than large Question ones in designing an AQI project ? What would small mean for this purpose? Having less than a certain number of auditors? Auditing 100 or fewer public companies per year and not being part of a global network of firms? 36 . Should the size of the audited company set a limit on initial Question application of an AQI project ? What would an appropriate size be? Should the fact that a public company is not a listed company affect the way AQIs appl y to it? 40 For 2014, nine U.S. -based firms audited more than 100 public companies: BDO USA, LLP, Crowe Horwath LLP, Deloitte & Touche LLP, Ernst & Young LLP, Grant Thornton LLP, KPMG LLP, MaloneBailey, LLP, McGladrey LLP, and . http://pcaobus.org/Inspections/Pages/default PricewaterhouseCoopers LLP See .aspx Sarbanes -Oxley requires the Board to inspect annually " each registered public accounting firm that regularly provides audit reports for more than 100 issuers [ i.e. , public companies]. See Section 104(b)(1)(A) of Sarbanes -Oxley.
31 PCAOB Release No. 2015 -005 July 1, 2015 Page 31 . How should the nature of the industry affect the design of 37 Question ? For example, is the nature of audits of investment an AQI project companies or employee benefit plans sufficiently different than that of other public companies that the former require their own set of AQIs? . Would excluding certain types of audits from an AQI project 8 Question 3 distort the results of firm -wide public company audit comparisons, or suggest that only industry -based comparisons are valid? 39 . S hould an AQI project Question apply to brokers and dealers in securities? Sh project apply to carrying brokers, introducing a) ould the Should it apply differently to broker - brokers, or both? dealers that are subsidiaries of public companies than to -dealers that are privately broker -owned? b) What indicators would be most appropriate? Would indicators aimed at the special regulatory requirements for broker -dealer reporting be advisable? c) Who would the users of the information be? d) the variations within the audited population make Do ? comparability of information difficult Outreach ; Other AQI Projects V. In formulating the ideas reflected in this release, the Board and staff have of outreach, speaking with representatives of a number of engaged in a broad project have interested parties, as the Treasury Advisory Committee suggested. They met 41 s Standing Advisory and Investor Advisory Groups; several times with the Board' the first of those meetings involved an extensive review of potential AQIs that helped guide 41 The staff made formal presentations to meetings of the Standing Advisory 16 2013, that included break -out sessions to discuss possible Group on May 15- ), indicators (available at aobus.org/News/Events/Pages/05152013_SAG.aspx http://pc November 14, 2013 (available at http://pcaobus.org/News/Events/Pages /11132013_SAG.aspx ), and June 24- 25, 2014 that included a presentati on on "Initiatives to Improve Audit Quality – Root Cause Analysis, AQIs, and Quality Control Standards " (available at http://pcaobus.org/News/Events/Pages/05282014_SAG.aspx ). The staff attended and participated in a discussion that included a presentation by the Investor Advisory Group's Working Group on Audit Quality Indicators on October 16, 2013 (available at http://pcaobus.org/News/Events/Pages/10162013_IAGMeeting.aspx ).
32 PCAOB Release No. 2015 -005 July 1, 2015 Page 32 has been discussed with a he project development of this release. Equally important, t wide range of parties who reflect the classes of users outlined above. These include the Commission staff and federal banking regulators, the National Association of Corporate Directors (and smaller groups of audit committee members), the CAQ and been individual audit firms, and Financial Executives International. Presentations have made at various professional conferences, including ones sponsored by the American Institute of Certified Public Accountants and by the American Accounting Association, as well as at the PCAOB 's own Academic Conference. Board staff have met as well with representatives of the U.K. 's Financial Reporting Council (the " FRC" ), and the coordinated and led Canadian Public Accountability Board. Finally, the Board and staff discussions on audit quality indicators at the April 2014 plenary meeting of the International Forum of Independent Audit "IFIAR "). Discussion of AQIs Regulators ( during that meeting indicated that a number of audit regulators around the world were using AQI -like ideas to plan and evaluate their inspections. Attention was again devoted to the subject at the 2015 plenar y meeting of IFIAR, which indicated that interest in AQIs had continued to grow; a month earlier there had been extensive th 9 discussion of AQIs at the I FIAR Inspection Workshop in London. quality by The Board has also reviewed contemporaneous efforts to raise audit increasing audit transparency. In 2008 and 2009, the U.K. 's FRC, and the International Auditing and Assurance Standards Board (the "IAASB" ), began their own efforts to understand and describe audit quality indicators. The FRC issued a Februar y 2008 "audit quality framework (emphasizing firm culture, auditor skills and personal qualities, and the strength of the audit process), " in the hope of " support[ing] effective communication between auditors, audit committees, preparers, investors, and ot her 42 "A Framework for Audit Quality – The IAASB issued stakeholders on audit quality. " Key Elements that Create an Environment for Audit Quality, " on February 18, 2014. That document lists factors that can contribute to audit quality at the engagement, f irm, for financial statement audits ; a number of the factors and national levels are reflected in the AQIs discussed in this release, and the IAASB framework is "input, based on an " model similar to the potential process, and output discussed in this AQI framework release. But the IAASB framework does not attempt to create a system for quantifying 43 particular elements of audit quality. 42 Financial Reporting Council, The Audit Quality Framework (2008) 1, - https://www.frc.org.uk/Our Board/The- Audit available at -Work/Publications/FRC- -Quality Framework -(1).aspx . 43 International Auditing and Assurance Standards Board, A Framework for Audit Quality, Key Elements That Create An Environment For Audit Quality (2014), -key- http://www.ifac.o rg/publications -resources/framework -audit -quality available at elements -create -environment -audit -quality .
33 PCAOB Release No. 2015 -005 July 1, 2015 Page 33 The European Union (2006), the Technical Committee of the International Organization of Securities Commissions (2009), and the Basel Committee on Banking Supervision (2008 and 2014), have also addressed aspects of the need for audit firm 44 transparency and the link between transparency and audit quality. In addition, as indicated above, independent audit regulators around the world are interested in the possible use of AQIs and in making information about audit quality available to interested parties. For example, the Swiss Federal Audit Oversight Authority publishes 45 certain aggregated AQIs for the country 's five la rgest firms. nited Kingdom In the U , the FRC discusses its inspection reports, which include a numerical score, with the relevant audit committees; the FRC is now considering the extent to which the content of inspection findings should be made public by audit committees and is allowing audit committees of FTSE 350 companies that wish to do so to make certain inspection information public in the period before a final decision about the terms for publicity is 46 made. The Australian Securities & Investments Commission has issued rules to 47 n voluntary disclosure of AQIs, in part to assure comparability. gover 44 See Council Directive 2006/43/EC, Article 40, now implemented in national regulations, Technical Committee of the International Organization of Securities Commissions, Transparency of Firms that Audit Public Companies, Consultation Report (2009), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD302.pdf , Basel Committee on Banking Supervision, External audit quality and banking supervision , note 24, and (Bank for International Settlements, 2014), supra External audits of banks available at http://www.bis.org/publ/bcbs280.htm . 45 Activity Report 2013 Federal Audit Oversight Authority FAOA, (2014), 24- 25, available at http://www.revisionsaufsichtsbehoerde.ch/bausteine.net/file/showfile. aspx?downdaid=7814 . 46 U.K. Financial Reporting Council, FRC Statement PN 69/14: Transparency of AQR Findings (2014), available at https://www.frc.org.uk/News -and- Events/FRC -Press/Press/2014/November/Transparency -of-AQR -Findings.aspx . The Council's statement raises many of the issues discussed above, for example in disc ussing the limits on grading of inspections. 47 – Australian Securities & Investments Commission, Information Sheet 184 Audit transparency reports, Table 2, "Internal Indicators of Audit Quality, " (2013) 3, available at http://www.asic.gov.au/regulatory -resources/financial -reporting -and- audit/ auditors/audit -transparency -reports/ .
34 PCAOB Release No. 2015 -005 July 1, 2015 Page 34 Finally, over the last few years there has been increased focus on AQIs among audit firms themselves, for internal management and public outreach purposes. One firm published a that contains data on nine " transparency 2013 Audit Quality Report " that resemble or in some cases are the same as the AQIs discussed in data points firm Appendix A; the number grew to 12 in the 's 2014 Report. A second firm is beginning on the same path. The CAQ published its own discussion of audit quality CAQ Approach to Audit Quality indicators in April 2014; the discussion, entitled " 48 " Indicators, focused on possible disclosures, for internal discussions, in ten subject areas involving: audit firm leadership, characteristics of engagement teams, monitoring by firms of audit engagement performance and quality control, and reliability of audit reports; again the CAQ 's proposals overlap with some of the AQIs suggested by the Board. Finally, and ultimately more important, as noted above, some firms have turned to data and concepts similar to those described in this release in working with the Board on quality control and remediation. VI. Opportunity for Public Comment The Board will seek comment for a 90- period. Interested persons are day encouraged to submit their views to the Board. Written comments should be sent to the Office of the Secretary, Public Company Accounting Oversight Board, 1666 K Street, 2803. Comments may also be submitted by e- mail to N.W., Washington, D.C. 20006- [email protected] or through the Board' s website at www.pcaobus.org. All 041 comments should refer to PCAOB Rulemaking Docket Matter No. in the subject or reference line. Comments should be received no later than 5:00 p.m., Eastern Standard Time, on September 29 , 2015. The Board will consider all comments received. The Board will also convene a roundtable meeting in Washington, D.C., dur ing the fourth quarter of 2015, about this Concept Release. Additional details about the roundtable will be announced at a later date. 48 Center for Audit Quality, CAQ Approach to Audit Quality Indicators (2014), supra note 36.
35 PCAOB Release No. 2015 -005 July 1, 2015 Page 35 st day of July , in the year 2015, the foregoing was, in accordance with On the 1 counting Oversight Board, the bylaws of the Public Company Ac ADOPTED BY THE BOARD /s/ Phoebe W. Brown Phoebe W. Brown Secretary July 1, 2015
36 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -1 AL AUDIT QUALITY IND ICATORS APPENDIX A: POTENTI The description of each potential audit quality indicator ( ) that appears "AQI" below has three parts. The first explains the nature of the indicator. The second illustrates how the indicator could be calculated at the audit engagement and audit firm levels. The third discusses briefly the reason the indicator has been suggested, and, in some cases, issues the indicator may raise. The il lustrative calculations offered below for defining each indicator are only one approach to doing so; the Board expects that other approaches may also be appropriate. In addition, as discussed in the concept release itself, all of the indicators are only as good as the context in which they operate; a measurement that is a valuable indicator in one situation may, because of specific facts, be of little significance in another. The description of the indicators has been kept as general as possible, in keepi ng with the purpose of a concept release. Thus, for example, technical definitions of various classes of firm personnel would likely be refined as part of a continuing AQI project. The same is true of measures outside of firm -wide (for example measures by industry, by region, or by office). The goal now is to outline the general concepts around which each indicator operates. month period, unless the description The indicators focus on data for a 12- specifically indicates otherwise. The concept release, o f which this appendix is a part, contains general questions about AQIs and their potential uses. This appendix contains a second set of questions focused more specifically on the language of the 28 potential indicators themselves and hey could operate. As before, readers of the release are the manner in which t encouraged to comment on any matters not covered by specific questions. They are especially encouraged to provide suggestions for other approaches to particular issues relating to operation of the i ndicators. Question 40 . How might the description of each indicator and the illustrative calculation be improved or replaced by other approaches that would be more effective or easier to use? Question 41 . To what extent should the description of one or more indicators and its illustrative calculation be revised to make clear that all indicators are evaluated in context? Question 42 . To what extent could any suggested indicators produce uninformative results either because of the context in which they operate or because the variables they involve can be managed for results that emphasized form over substance?
37 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -2 . Question 43 How should the indicators be applied at the firm level? Are "firm" -wide, region, office, industry practi ce) different perspectives (firm -wide data always appropriate appropriate for different indicators? Is firm -level data? for those indicators that call for firm AUDIT PROFESSIONALS Availability Staffing Leverage 1. indicator measures the time of . The "staffing leverage" experienced senior personnel relative to the volume of audit work they oversee. 1 Illustrative Calculations: 2 Firm Level Engagement Level a. Ratio of firm audit partners' chargeable Ratio of audit partners' chargeable a. hours to chargeable hours of all other hours for the engagement to l other engagement personnel chargeable hours of al engagement personnel ers' chargeable b. Ratio of firm audit partn b. hours to firm audit managers' Ratio of audit partners' chargeable chargeable hours hours for the engagement to chargeable hours of audit managers' Ratio of firm audit managers' c. on the engagement chargeable hours to chargeable hours of all staff below manager Ratio of audit managers' chargeable c. hours for the engagement to chargeable hours of all staff below manager on the engagement Partners and managers are responsible for oversight of the audit and the audit team, which will include less experienced staff. Sufficient time to oversee the work of the audit staff is typically critical to quality. The lower the amount of partners' tim e per audit managers and audit staff time, the wider the scope of partners' and managers' supervision and review responsibilities, and the greater the risk that partners and 1 Hours spent by partners as engagement quality reviewers would not be counted for purposes of these calculations. 2 The definition of "engagement level" in the case of global audits is an open question on which comment has been specifically requested. See Concept Release, Question 14 a), at page 16.
38 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A -3 Page A managers may not have sufficient time to supervise and review staff work and evaluate audit judgments. Less extensive supervision raises the risk of less effective audit procedures and a reduction in audit quality. . Would addition of a calculation of staffing leverage Question 44 er hours to total indicators that measures the ratio of partner and manag audit hours be helpful? Partner Workload . The "partner workload" indicator generates data about the 2. level of work for which the audit engagement partner is responsible and the number of claims on his or her attention. Illustrative Calcu lations: Engagement Level Firm Level Chargeable hours managed by audit a. Average chargeable hours managed a. engagement partner for all public and by public company audit engagement private clients for the current year partners for all public and private r (planned) clients for the current yea (planned) and prior year (actual) and prior year (actual) b. Number of public clients, and number Public company audit engagement b. of private clients, whose audits are managed by the audit engagement partners' average utilization percentage for the current year partner and audits for which that (planned) and prior year (actual) partner is a quality control reviewer, -ends, noting those with calendar year for the current year (planned) and r year (actual) prio Audit engagement partner's c. 3 utilization percentage for the current year (planned) and prior year (actual) Heavy workloads could distract an engagement partner from giving adequate and focused attention to an audit engagement. The figures generated by this indicator can help bring that issue to light and aid understanding of the implications of division of a partner's attention among several audit clients and competing client deadlines. (In addition, the data can provide perspective on the leverage calculation if it shows, for 3 The term "utilization," used in this Appendix A, means a fraction whose numerator is the number of all chargeable hours ( i.e. for both public and private clients) in a year and whose denominator is the number of working hours in a year.
39 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -4 example, that senior personnel in fact devote large amounts of time to an audit with high staffing leverage or relatively low amounts of time to an audit with a low staffing leverage.) However, workload figures may have different meanings. For example, partners may supervise relatively few audit engagements because their time is devoted to firm management or other firm leadership positions. 3. . This indicator would provide information about Manager and Staff Workload the workload of audit managers and audit staff . Illustrative Calculation: Firm Level Engagement Level t staff, a. and audit staff average Manager For managers and audi utilization, respectively respectively: b. Manager and audit staff average Utilization percentage for the a. chargeable hours at different periods current year (planned) and prior within the year ( e.g., during periods of year (actual) peak audit workload) b. Average hours worked per week measured from day after clients' end date through audit - year opinion date, for all engagements, by personnel level The greater the workload, the greater the risk staff may have insufficient time to perform appropriately the necessary audit procedures and take the other steps that create a quality audit. Staff may become less effective when working long hours, and an environment may affect the level of due professional care they exercise. For such example, a heavy workload may create pressure on the staff to focus more on efficiency in executing auditing procedures than on ensuring the effectiveness of those procedures and of supervision of more junior engagement team members. In applying this indicator, measurements may be made on a person- by-person basis in the case of relatively small audit firms but on an average basis for larger firms.
40 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -5 4. . This indicator measures the Technical Accounting and Auditing Resources level of a firm's central personnel (or other resources engaged by the firm) available to provide engagement teams with advice on complex, unusual, or unfamiliar issues and 4 the extent to which they are used in a particular engagement. Illustrative Calculations: Engagement Level Firm Level " or other Technical resource chargeable a. Size of a firm's a. National Office " hours as a percentage of total technical audit resources as a percentage of its total audit personnel, using a " engagement hours full- time -equivalent " measurement to account for individuals who spend only part of their time on technical resource matters An audit firm's technical accounting and auditing ( , national office) resources e.g. (or their equivalent) can enable it to deal with complex questions during an audit. The measurement in this indicator provides a sense of a firm's capacity to resolve complex accounting and auditing issues in an effective way. It may also provide a sense of whether and how a firm promotes consultation and collaboration with others for the benefit of audit quality. Question . How should technical accounting and auditing resources be 45 measured in a situation i n which those resources are retained from outside the firm conducting the audit? 5. Persons with Specialized Skill or Knowledge . This indicator measures the use in an audit engagement of persons with " specialized skill and knowledge, " other than accounting a nd auditing personnel counted as technical accounting and auditing resources under indicator 4. These individuals may be firm personnel or they may be 5 retained by the firm. 4 Governing professional standards require that a firm’s policies provide reasonable as surance that engagement teams can consult with individuals outside the engagement when appropriate. See Quality Control Standard 20.19. In most larger firms the individuals are part of a "national office" staff, but they may be retained from firm especially in the case of smaller audit firms. Cf . Paragraph 15 of outside the Auditing Standard No. 16. 5 See Paragraphs 16 and 17 of Auditing Standard No. 9.
41 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -6 Illustrative Calculations: Engagement Level Firm Level a. Chargeable hours by persons with eable hours of persons with Charg a. specialized skill or knowledge specialized skill or knowledge (except (except as counted as technical as counted as technical resources resources under indicator 4) in total under indicator 4), in total and by and by functional specialty, as a functional specialty, as a percentage percentage of a firm's actual of an engagement's current year (planned) and prior year's total (actual) chargeable hours chargeable hours An audit firm's capacity to provide valuation, actuarial, forensic, tax, technology, financial instrument, legal, and other experts is increasingly necessary to plan and perform complex audits. Recognition of the need to use experts, and their careful deployment, can show a commitment to robust auditing in those industries in which their use is beneficial. In light of the different ways firms obtain the assistance of persons with specialized skills or knowledge, the application of this indicator should measure effort, d or revenue generated, to take account of the importance of not simply hours expende the role experts can play, but also, for example, the situation of experts who are retained on a fixed- fee basis. Thus, appropriate measures could in some cases involve hours, but in other cases reflect the percentage of total fees paid to experts. Question 4 6 . How should this indicator count participation by audit firm personnel and managers who have dual skills ( i.e., as accountants or auditors but also as experts in another relevant discipline)? Competence 6. Experience of Audit Personnel . This indicator measures the level of experience of members of a particular engagement team and the weighted average experience of firm personnel generally.
42 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -7 Illustrative Calculations: Engagement Level Firm Level a. Average experience for total For partners, managers, staff auditors, 6 audit personnel specialists, and engagement quality reviewers : Weighted average years of b. a. Number of years on the engagement experience for partners, managers, staff auditors, and b. Number of years in present assignment and specialists respectively personnel level Number of years: (i) with the firm and (ii) in c. profession the auditing Auditors with relevant experience, both in general and with a particular client, But may be able to approach the audit in a more knowledgeable and effective manner. auditors who spend too much time on a particular team may begin to lose their capacity for skepticism through simple familiarity. Thus, there may be a need to retain a balance preserving between the benefit of an audit team's experience with a particular client and adding new auditors who may provide a fresh look at audit issues. Evaluation of data produced by this indicator should take that balance into account. 7. Expertise of Audit Personnel . This indicator addresses the Industry experience of senior members of the audit team, as well as specialists, in the industry in which the audited company operates. Illustrative Calculations: Engagement Level Firm Level a. Number of years of cumulative experience of None partners, audit managers, specialists, and engagement quality reviewers, respectively, in the audited public company's industry Experience with a particular industry helps an auditor understand the industry's operat ing practices, the critical audit and accounting issues confronting companies in 6 For purposes of the AQIs in Appendix A, the term "specialist" means persons with specialized skill and knowledge, described in Indicator 5, who are part of the engagement team. Thus, the term excludes technical accounting and auditing resources discussed in Indicator 4.
43 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -8 that industry, and the best ways to resolve those issues to further audit quality. This computation indicates the extent to which the firm has encouraged the development of industry specialization and assigns partners, managers, specialists, and engagement quality reviewers to audit engagements based on that specialization. Question 4 7 . In measuring experience, would overall experience ence) in the relevant industry be (including auditing and accounting experi the best measure? Would such a measure disadvantage smaller firms? Would a measure based on number of audits performed in a particular industry be a better indicator for smaller firms? 8 . Are there ways to measure the industry expertise of a firm's Question 4 audit staff against its public company client base? How? Question 4 9 . Would adoption of the commonly -used Standard Industrial Classification ( ") codes issued by the U.S. Department of Labor be "SIC 7 appropriate to define industries for purposes on the indicators ? 8. Turnover of Audit Personnel . This indicator measures turnover, that is, transfers to other engagements or movement to other firms, at the engagement and, more generally, at the firm, level. Illustrative Calculations: Engagement Level Firm Level a. Percentage of prior year's partners, a. Percentage of partners, managers, audit staff, and specialists, managers, audit staff, specialists, and engagement quality reviewers, respectively, that have left the firm or respectively, that have left the firm left the firm's audit practice, in the preceding 12 months een reassigned to another audit or b 8 engagement within the firm The degree and nature of the changes in a company's audit team from year to year help measure the readiness and ability of the team to perform a quality audit. Some level of attrition is expected within audit firms. But a comparatively high rate of turnover or auditor transfer within a firm may adversely affect audit quality. 7 The SIC code structure can be found at https://www.osha.gov/pls/imis/sic _manual.html 8 The calculation should note separately the number of audit partners whose rotation was required by Regulation S -X Rule 2 -01(c)(6).
44 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -9 As noted in the discussion of indicator 6 (experience of audit personnel), the benefit of retaining an audit team's experience with a particular client needs to be carefully balanced with the benefit of adding new auditors who may provide a fresh look at audit issues. Evaluation of data produced by this indicator in particular cases, and issues of context and comparability, should take that balance into account. Question . Should a distinction be made between partner retirements 50 and other turnover in applying this indicator? Amount of Audit Work Centralized at Service Centers . This indicator 9. measures the degree to which audit work is centralized by the audit firm at service 9 centers . Illustrative Calculations: Engagement Level Firm Level a. Percentage of total engagement audit Percentage of audit work (by a. chargeable hours) whose work (by chargeable hours) whose performance is carried out on a performance is carried out on a centralized basis at service centers centralized basis at service centers The degree to which work on the audit is carried out at service centers can be an important element in audit quality. Centralizing audit work at service centers here and abroad widens t he geographic scope of the audit partner's supervision and review responsibility. Centralization of this sort can have a positive impact. It may concentrate processing of audit work in the hands of people skilled in that processing and, by doing ree experienced engagement personnel to focus on more complex or so, may f judgmental areas of the audit. On the other hand, centralization may introduce risks of insufficient or ineffective communication among engagement team members and create obstacles to effective supervision and staffing, for junior auditors especially. Centralization can also limit junior auditors' exposure to basic audit processes and could reduce the ability of firms to train their staffs about those processes, weakening the model under w hich staff auditor training has historically taken place. 9 Centralizing audit work means assigning lower risk audit work to domestic or foreign service centers established by the firm conducting the audit.
45 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A -10 Page A Despite the debate about centralization, however, the indicator can provide an understanding of the extent to which audit tasks are or may be centralized in service centers. Audit Professional . This indicator focuses on the hours of 10. Training Hours per —including industry —that members of the engagement relevant training -specific training team, and of the team's firm, have received. Illustrative Calculations: Engagement Level Firm Level counting and auditing a. Annual ac a. Average annual accounting and auditing training hours, and industry training hours, and industry - - specific training hours, in total and for specific training hours for partners, partners, managers, staff auditors, audit managers, staff auditors, specialists, and engagement quality specialists, and engagement reviewers, respectively quality reviewers, respectively b. Average independence and ethics Total independence and ethics b. r personnel groups in training hours fo training hours for personnel groups " " in " a " a The amount of continuing training auditors receive should increase their capacity to perform effective audits. While the number of training hours is easily measured, the quality of training is harder to gauge; the training must be relevant to raising audit quality by, for example, focusing in some cases on back -to-basics audit issues that have constituted inspection deficiencies and in other cases on more sophisticated accounting and auditing issues specific to the industry in which audit clients of those being trained operate. Independence and ethics issues are an important part of the training curriculum as well, and the evolution and evaluation of training in that area might also be followed. The application of this indicator may depend on the size of the audit involved. -person calculations may be appropriate for smaller audits, while averages Thus per might be used, by class, for larger audit teams. Question 51 . Should training hours be computed on a per -person basis, by per sonnel class, or as an average by class? Should the size of the firm involved make a difference in this regard? Question 52 . How can the effectiveness of a firm's training program best be measured?
46 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -11 . Should the effect of the way training is delivered ( e.g., live, Question 53 -study) be factored into the evaluation of a firm's web -based, or self training program? How? Focus 11. . This indicator measures the time spent by Audit Hours and Risk Areas members of the audit team at all levels on risk areas identified by the firm during audit planning. Illustrative Calculations: Engagement Level Firm Level a. For audits by industry, computed Total chargeable hours, and . a separately, average chargeable hours percentage of hours, by significant risk 10 overall and by significant risk area for for partners, managers, audit area partners, managers, audit staff, staff, technical accounting and technical accounting and auditing , auditing resource personnel resource personnel, specialists, and specialists, and the engagement the engagement quality reviewer quality reviewer, respectively, for the s, current year (planned) and the prior respectively, for the prior year (actual) year (actual) Measuring the hours that levels of an audit team devote to risk areas can whether audit managers have staffed the audit appropriately to reflect the risk suggest areas identified during the planning phase of the audit and the extent to which senior The data produced by members of the team have focused sufficiently on those areas. nd the following indicator should complement the picture of senior -level attention this a to audit supervision created by indicators 1 through 3. Measuring hours that other engagement teams from the same audit firm devote to risk areas in audits of other public c ompanies in the same industry as the engagement client may provide grounds for a greater understanding of the nature of the risks the firm identifies in audits of that industry, how it staffs to deal with them generally, and the degree of focus its audit t eams give them. This is another situation in which context may be very important : different companies in the same industry may present different risks due to, for example, systems, people, or process issues at one or more of those companies. 10 See Paragraphs 70- 71 of Auditing Standard No. 12 and Paragraph 9 of Auditing Standard No. 16.
47 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -12 12. Audit Hours to Phases of the Audit . This indicator measures Allocation of the effort and staffing the audit devotes to audit planning, interim field work, and audit completion. Illustrative Calculations Engagement Level Firm Level Current year's (planned) and prior Percentage of hours of the firm devoted a. a. hours respectively to planning, quarterly year's (actual) total chargeable reviews, interim field work, final field for each related audit phase ( i.e., work up until report release date, and planning, quarterly reviews, interim post - field work, final field work up until report field work until audit release date, and post field work until - documentation completion date for audit documentation completion date) partners, managers, the audit staff, technical resources staff, specialists, for partners, managers, the audit staff, technical resources staff, specialists, and engagement quality reviewers and the engagement quality reviewer, respectively Audit quality depends in part on proper planning and execution and on the way the overall audit hours are phased to construct a successful process. The amount of time allocated to planning for the audit can be critical, and it can be equally important participates in the planning process. The same is true with the other stages of the who process. 54 Question percentage of hours " metric at the firm level of . Does the " this indicator provide a meaningful basis for comparison with the engagement level of t he metric? Would it help to disaggregate the numbers by audit client size? Question 55 . Is there any way to expand this indicator to quantify audit personnel experience with audit clients, to provide additional context? AUDIT PROCESS Tone at the Top and Leadership 13. Results of Independent Survey of Firm Personnel . This indicator measures an audit firm's "tone at the top " through use of a survey tool.
48 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -13 Illustrative Calculations: Engagement Level Firm Level 11 a. surveys of current and Anonymous independent None tone at the top, former firm personnel about " " quality of supervision and training, and the extent to which the firm promotes an environment that favors speaking up about potential issues, and promotes icism and rewards professional skept An appropriate " tone at the top " and the way the firm communicates and stands behind that tone is generally essential to foster professional skepticism, objectivity, and independence in the firm's personnel. Data from anonymous independent survey s of audit firm personnel could provide unique insights about staff perceptions of their firm's 12 commitment to critical elements of quality. 6 Question 5 . Who should administer the survey described in this indicator? What steps would be necessary to ass ure that the results of anonymous surveys were comparable? Would the same set of questions be necessary? Would the same individual or organization have to administer each of the surveys? 7 Question 5 . How often would a survey of this type have to be admi nistered to retain its validity? Question 5 8 . What other logistical issues might arise from a survey of this sort? Incentives 14. . This indicator measures the potential Quality Ratings and Compensation correlation between high quality ratings and compensation increases and the comparative relationship between low quality ratings and compensation increases or decreases. 11 An indep endent survey would require independently -determined methodology, independently -drafted questions, and anonymity. 12 Comments on other ways to measure "tone at the top" are also specifically requested.
49 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -14 Illustrative Calculations: Engagement Level Firm Level Percentage of partners and managers, respectively, a. None with exceptional performance ratings on audit quality b. Percentage of partners and managers, respectively, with exceptional quality ratings who receive above- average increases in compensation c. Percentage of partners and managers, respectively with low quality ratings d. Avera ge percentage compensation increase or decrease for partners and managers, respectively, with low quality ratings Comparing internal firm quality ratings and compensation levels can provide an important signal of the value a firm places on quality. This indicator would capture the extent to which a firm's personnel evaluation process distinguishes among personnel at each level of the firm based on audit quality and awards compensation accordingly. Linking compensation to quality may provide strong evidence of the firm's commitment to that goal and may create equally strong incentives for audit personnel. 9 Question 5 . Can this indicator be applied to produce comparability among firms, e .g. in terms of definitions of " exceptional performance ratings " and "low quality ratings "? How? 15. Audit Fees , Effort, and Client Risk . This indicator provides insight into the relationship between engagement or firm audit fees and hours, on the one hand, and levels of client risk, on the other. Illustrative Calculatio ns: Engagement Level Firm Level Percentage change from prior a. Percentage change from prior year year in a. in each of: (i) audit fees and (ii) each of: (i) total audit revenues charged to chargeable hours for partners and public company clients and (ii) managers, respectively, together chargeable hours for partners and with whether client was identified managers, respectively, together with by firm as high risk. percentage of firm's public company clients assessed as high risk.
50 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -15 The combination of falling audit fees and decreased audit effort can lead to reduced audit quality. That combination can be especially serious for a high risk public company audit client. This indicator attempts to highlight situations in which economic pressures can create such a relationship. It may provide perspectives on: (i) how audit fees vary with audit risk ( e.g., to reflect a risk premium or higher audit effort) and (ii) whether work is reallocated from senior to more junior auditors as fees change. 60 Question One issue that this indicator raises is how to fashion a . workable definition of " " that allows comparability among firms or high risk even among engagements within a firm. Comment is specifically requested on that subject. Independence Compliance with Independence Requirements 16. This indicator measures . several elements of a firm's independence training and monitoring program and the importance it assigns to that program. Illustrative Calculations: Engagement Level Firm Level a. a. Percentage of firm personnel subject to firm's Percentage of personal independence compliance reviews engagement personnel annually. subject to firm's personal independence b. Average of compliance reviews. mandatory independence training hours per audit employee and other firm professional employees covered by Commission Average of mandatory b. independence training independence rules (whether or not involved in the hours per engagement firm's audit practice), respectively team member c. Percentage of issuer audit engagements subject to firm internal quality control reviews over independence compliance annually. d. Level of investment in centralized support for , and monitoring of compliance with, independence requirements per 100 public company audit clients (for firms with 500 such clients ) e. Percentage of public company audit clients lost due to independence violations.
51 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -16 Auditor objectivity is a critical precondition for audit quality, and several indicators indirectly address that condition. The survey of firm personnel —indicator 13 (Process) is an example. Other independence issues are equally important, including ngements involving mutuality of interest between the auditor and client, an auditor's arra performing as a member of a client company's management, and an auditor's providing prohibited nonaudit services. Investment in training, a firm's independence function generally, and internal compliance reviews can all illustrate a firm's commitment to objectivity and to producing quality audits. The level of investment called for by this indicator may need to take account of both personnel costs and the cost of technology. 61 . Question What other measures of independence, or independence issues, would be appropriate? Would information generated by this indicator be more meaningful if measurements were stratified by personnel level? Infrastructure 17. Investment in Infrastructure Supporting Quality Auditing . This indicator measures the amounts audit firms invest, in people, process, and technology, to support the base on which quality auditing depends. Illustrative Calculations: Firm Level Engagement Level Investment in engagement team as a a. a. Investment in audit practice as a percentage of revenue generated on percentage of firm revenue engagement A firm's investment in auditing practice infrastructure (that is, in its people, processes, and technology) can demonstrate its commitment to audit quality. Defining the expenditures that represent such investment, however, is difficult. Firm -sponsored advanced training in auditing and accounting certainly qualifies, but not all training is consistent with that fo cus. Investment in audit technology can produce better audits, but it is sometimes designed to streamline procedures to improve efficiency in a way that does not improve audit effectiveness. Question 62 . In what ways can investments in infrastructure that are relevant to improving audit quality best be defined?
52 005 PCAOB Release No. 2015- July 1, 2015 Appendix A Page A -17 63 . How should such investments be measured? Is Question measurement in dollar terms (or dollars per auditor) appropriate? Can such investments be measured at the engagement team level? Monitoring and Remediation 13 Audit Firms' Internal Quality Review Results 18. This Indicator contains . information about the internal quality reviews conducted by each audit firm. Illustrative Calculations: Engagement Level Firm Level Results of any internal Percentage of public company audits subjected to a. a. quality inspections of internal quality review inspections by audit firm audits of the engagement Percentage of such inspections with one audit client, including number b. (if any) of audit deficiency of a magnitude similar to a PCAOB Part I finding deficiencies of a magnitude similar to a PCAOB Part I finding Percentage of such inspections with more than c. one such audit deficiency An audit firm's internal quality review program can show the level of attention the firm pays to monitoring and improving quality in its audit practice. Analysis of audit quality review findings requires care, however. Although a higher volume of findings may raise questions about aspects of a firm's oper ations, a record of timely identification and appropriate remediation could indicate a robust approach to internal quality review that signals a firm's commitment to improved quality. In addition, a comparison of firm and PCAOB findings may cast light on strengths and weaknesses of quality control efforts more generally. Question . How should internal quality inspection findings be 64 compared to or analyzed alongside PCAOB inspection results in applying indicators 18 and 19? 13 PCAOB inspection results and audit firm internal quality review results are counted as audit process indicators, but they possess elements of both audit process and audit results indicators.
53 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -18 14 . This indicator contains information about 19. PCAOB Inspection Results PCAOB inspection results relating to the engagement or the audit firm involved. Illustrative Calculations: Engagement Level Firm Level a. Results of any PCAOB Number and percentage of PCAOB a. - inspections of audits of the inspected audits that result in a " Part I finding " engagement issuer as well as the number and nature of any Part I findings identified b. Number and percentage of PCAOB inspected audits that result in more than one "Part I finding " c. Number and percentage of PCAOB inspected audits that led to a restatement d. Number, nature, and dates of quality control defects dealt with in released Part II PCAOB inspection reports (and dates of such releases), if any, combined with information about firm's subseq uent remediation efforts The Board's own inspections focus on whether audits are conducted in accordance with the Board's rules and standards. They can provide insight, in their Part I findings (and any quality control defects, described in Part II of an inspection report, that becomes available if adequate remediation by firms with quality control defects does not occur), about breakdowns that may cause audit deficiencies. Public inspection findings may provide a baseline for evaluating other indicators (e .g., comparing staff utilization rates, or use of persons with specialized skill and knowledge, with inspection findings) and testing the efficacy of firms' internal quality control systems. 20. . This indicator seeks to measure the level of Technical Competency Testing technical competence of a firm's audit personnel, and the success of efforts to keep up that level of competence. 14 See Information for Audit Committees about the PCAOB Inspection Process , PCAOB Release 2012- 003 ( August 1, 2012) .
54 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -19 Illustrative Calculations: Engagement Level Firm Level Content requires study a. Content requires study a. Audit firms recognize that technical competence is critical for maintaining quality in a rapidly changing business and financial environment. But there is at present no recertification examination for auditors, as there is, for example, for medical specialties in some states and for most members of the securities industry. State boards of public accountancy typically impose continuing education requirements but do not require retesting. Comment is specifically requested on ways audit firms m ight measure technical competence, encourage its development and maintenance, and report on the result. AUDIT RESULTS Financial Statements 21. Frequency and Impact of Financial Statement Restatements for Errors . This indicator measures the restatements for error of financial statements whose audit the audit firm has performed. Illustrative Calculations: Engagement Level Firm Level (of audited Number and magnitude of audit Number and percentage a. a. financial statements) of an audit practice's practice's restatements for errors restatements for errors, computed at engagement level, computed annually. annually, and magnitude of those restatements. The audit firm's top five annual b. restatements measured by the magnitude of those restatements. The number and impac i.e., not for changes in t of restatements for errors ( accounting principles) are generally considered a signal criterion of potential difficulties in at least parts of an auditor's practice and approach to auditing. This indicator tries to place restatements in context by focusing on their magnitude. Magnitude of restatements could be measured in a number of ways, including impact of the restatement on income, on cash flows and balance sheet, and on market capitalization.
55 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -20 65 . What are the best methods for measuring magnitude of Question restatements for errors? Is one method superior to the others? Why? Fraud and other Financial Reporting Misconduct 22. . This indicator is concerned with reporting of fraud and other financial misconduct, at both the engagement and audit firm levels. Illustrative Calculations: Engagement Level Firm Level a. equires study a. Content r equires study Content r Given the historical harm to investors from fraudulent financial reporting and auditors' responsibilities to help prevent or detect fraud that materially affects financial 15 statements, one or more AQIs on the auditor's work in the fraud area may be useful. Although the content of specific AQIs requires further study, ideas include: Positive indicators: Number of significant deficiencies or material weaknesses in controls 1. designed to address the risk of material misstatement due to fraud, raised by the audit firm in the absence of an error or fraud that has already occurred 2. Number and severity of material or immaterial errors in financial reporting from fraud or other financial reporting misconduct discovered by the audit firm early enough to avoid errors in pu blished financial statements 15 AU Section 110.02 states, "The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. [footnote omitted]." A U Section 316 establishes requirements and provides direction relevant to fulfilling that responsibility, as it relates to fraud, in an audit of financial statements. Auditing Standard No. 5 states when planning and performing the audit of internal control over financial reporting, the auditor should take into account the results of his or her fraud risk assessment. "As part of identifying and testing entity -level controls... and selecting other controls to test... the auditor should evaluate whether the compa ny's controls sufficiently address identified risks of material misstatement due to fraud and controls intended to address the risk of management override of other controls." See Paragraph .14 of Auditing Standard No. 5.
56 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -21 Negative indicators: Number of restatements for errors resulting from fraud or other 1. financial reporting misconduct with no previously reported material weakness in internal control Number and severity of material error 2. s in financial reporting from fraud or other financial reporting misconduct that the audit firm did not detect prior to restatements of financial statements Developing AQIs related to these ideas is challenging. Data needed for the AQIs may be difficult t o obtain as it would require determining whether an internal control deficiency related to fraud prevention, or determining whether errors in financial reporting, resulted from fraud or other financial reporting misconduct. Also, the AQIs listed above could reflect the riskiness of an audit firm's client base rather than the quality of the audit firm's work. Question 6 6 . Would one or more AQIs related to fraud and other financial reporting misconduct be helpful to discussions of audit quality? If so, what AQIs would best inform those discussions? How could the challenges listed above be overcome? . Inferring Audit Qua lity from Measures of Financial Reporting Quality . 23 This potential indicator focuses on whether (and which) measures of financial reporting quality used by investment analysts, academics, and regulators can also be used as measures of audit quality. Illustrative Calculations: Engagement Level Firm Level a. Content requires study a. Content requires study Academics, analysts, and regulators have developed measures of financial reporting quality. The measures are used by academics in their research, analysts, and investors for investment decisions and by regulators to identify risky situations to scrutinize . Examples include measures of the nature and size of accounting accruals, the extent to which companies consistently and narrowly beat earnings targets, and the complexity or relevance of financial disclosures. Using reporting quality measures as AQIs r equires answers to two questions: (i) do the financial reporting measures reliably gauge reporting quality and, if so, (ii) do they also provide useful inferences about audit quality? If the answers to those
57 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -22 her the measures provide insight into audit questions are positive, a related issue is whet quality at the audit firm level, at the specific engagement level, or both. For example, if measures suggest the reporting quality for an audit firm's portfolio of clients differs from companies, does that suggest that the audit firm is performing the average for all public stronger or weaker audits? Or, at an engagement level, if measures suggest that the specific company's financial reporting quality differs from the average, does that suggest ent team's performance is strong or should improve? that the engagem If the measures are reliable, and if users can infer audit quality from them, then there are at least two ways forward for related AQIs: 1. Identify specific AQIs related to financial reporting quality ( i.e. specific AQI measures) 2. Ask auditors to report whether their firm uses measures of financial reporting quality to measure risk and, if so, what those measures suggest about the firm's and engagement team's audit quality ( i.e. allow the firm process to determine the AQI) Question 67 . Comment is requested on each of the issues raised about this indicator. Would it be preferable to identify specific indicators related to financial reporting quality or to focus on audit firms' measures of reporting quality to measure risk? How would the latter approach control for differences among firms? Internal Control 24 Timely Reporting of Internal Control Weaknesses . This measure captures the extent to which an audit firm identifies material weaknesses in an issuer's internal ial reporting on a timely basis. controls over financ Illustrative Calculations: Engagement Level Firm Level a. Same as firm level but Percentage of findings of material weakness in a. concerning audit internal control over financial reporting with no reports for the corresponding: (i) restatements for errors or (ii) known errors engagement client b. Percentage of: (i) restatements for errors, or (ii) known errors, with no corresponding material weakness in internal controls over financial reporting identified in the prior year
58 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -23 "effective In th e words of Auditing Standard No. 5, and relevant SEC guidance, internal control over financial reporting provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external 16 purposes. " A firm's failures to identify material internal control weaknesses may raise issues about staffing, training, or audit focus for these important issues. It is unclear whether such material weaknesses serve as leading indicators (i.e., risks of future reporting flaws i.e., evidence that evidence of ), lagging indicators ( reporting flaws may already have occurred) , or both. Data assembled by the AQI project can help illuminate that issue. Going Concern . Timely Reporting of Going Concern Issues . This indicator focuses on the 25 timeliness of the auditor's use of a going concern paragraph in its opinions. Illustrative Calculations: Engagement Level Firm Level The number an a. " a, " but d percentage of audit reports Same as firm level a. concerning audit reports for the with no going concern reference in the year preceding an engagement client's financial engagement client e.g. distress, , bankruptcy, troubled debt restructuring, troubled buyout, or bailout b. The five largest issuers by market capitalization from the above indicator Failure to include a going concern paragraph within an audit report in the face of an issuer's reasonably foreseeable business distress (whether the distress results in bankruptcy, a technical default, or a troubled buyout or bai lout) can indicate issues about the effectiveness of the auditing involved. This measure captures the extent to which an audit firm identifies on a timely basis companies whose ability to continue as a going concern is subject to substantial doubt. All t he same, any indicator focused on going concern issues can raise issues of context and unintended consequences. Business difficulties are not always reasonably 16 Paragraph 2 of Auditing Standard No. 5 and Exchange Act Rules 13a- 15(f) and 15d- 15(f). Paragraph 2 of Auditing Standard No. 5 provides that "[i]f one or more material weaknesses exist, the company's internal control over financial reporting cannot be considered effective," citing to It em 308 of Regulation S -K.
59 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -24 foreseeable even by the most experienced audit team. And some going concern not experience financial distress; an indicator warnings are given for companies that do should not provide an incentive for an auditor to consider giving a going concern warning where one is not truly called for. Question 6 8 . How should factors such as difficulties in foreseeing business difficulties, or the risk of providing an incentive for unnecessary going concern warnings be reflected in an indicator of this kind? Communications Between Auditors and Audit Committees 26. Results of Independent Surveys of Audit Committe e Members . This indicator measures the effectiveness of the communication between auditors and audit committees through use of a survey tool. Illustrative Calculations: Firm Level Engagement Level 17 a. Anonymous independent survey of audit None committee members overseeing one or more of a firm's audit engagements, to evaluate level and quality of communication between auditors and clients Communication between auditors and audit committees is at the center of the audit process . Auditing Standard No. 16, states the " objectives of the auditor " to communicate with the audit committee about the engagement and the auditor's role, "timely observations arising from the audit that are audit strategy and timing, and 18 significant to the f inancial reporting process. " Data from anonymous independent surveys of audit committee members could provide uniquely valuable information about the way auditors actually interact with audit committees. Such surveys pose logistical issues about which c omments are sought. 17 See discussion of independent surveys, infra at note 11. 18 Paragraph 3.a. -d. of Auditing Standard No. 16. A note following the quoted language emphasizes the purpose of Auditing Standard No. 16 is "to encourage effective two -way communication between the auditor and the audit committee throughout the audit to assist in understanding matters relevant to the audit."
60 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -25 . Who should administer the survey described in this Question 6 9 indicator? What steps would be necessary to assure that the results of anonymous surveys were comparable? Would the same set of questions be necessary? Would the same i ndividual or organization have to administer each of the surveys? Question . How often would a survey of this type have to be 70 administered to retain its validity? 71 Question . What other logistical issues might arise from a survey of this sort? Enforce ment and Litigation 27. PCAOB and SEC Enforcement Proceedings . This indicator Trends in measures Board or SEC proceedings in audit and audit -related matters against an audit firm. Illustrative Calculations: Engagement Level Firm Level Public , SEC or Board enforcement a. , SEC, or Board enforcement a. Public proceedings, measured over the preceding proceedings, measured over the five years, against the firm or its partners, preceding five years, against the with respect to audit matters firm or its partners, with respect to the engagement client The frequency, nature, magnitude, and results of Board and SEC litigation in audit and audit -related matters might help reveal weaknesses or strengths of a firm's practice. Information generated by this indicator may include quality issues affecting either particular firms or auditing in general. The length of the period required for litigation, however, may create problems of timeliness of information. Question . Should tabulation of cases for purposes of this indicator 72 include all cases filed or only cases that result in findings against an accountant or accounting firm? What about settlements entered into without an admission of wrongdoing? 28. Trends in Private Litigation . This indicator focuses on private litigation involving the audit firm.
61 PCAOB Release No. 2015- 005 July 1, 2015 Appendix A Page A -26 Illustrative Calculations: Firm Level Engagement Level a. Frequency, nature, and results of a. Frequency, nature, and results of private litigation relating to firm's private litigation relating to firm's audit work for the engagement client public company audit practice The frequency, nature, magnitude, and results of private litigation against audit firms might reveal either weaknesses or strengths of a firm's public company practice. Again, the information generated by this indicator may include quality iss ues affecting either particular firms or auditing in general. But the quality of the information is uncertain, given the fact that a particular litigation may or may not result in findings of liability, and the amount of information derived from settled l itigation is ambiguous. Question 73 . Should tabulation of cases for purposes of this indicator include all cases filed or only cases that result in findings against an accountant or accounting firm? What about settlements?