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PCAOB Release No. 2012-003

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Information for Audit Committees about the PCAOB Inspection Process

As noted in the release, Sarbanes-Oxley Act of 2002 changed oversight of public company auditing in two fundamental respects by creating the Public Company Accounting Oversight Board ("PCAOB" or the "Board") to regulate the auditors, and by amending the Securities Exchange Act of 1934 to place responsibility for the appointment, compensation, and oversight of any listed public company's auditor with a committee of independent directors. The PCAOB issued Release No. 2012-003 to assist audit committees in understanding the Board's inspections of their audit firms and in gathering useful information from their audit firms about those inspections.

Part I of the release discusses the meaning and significance of audit deficiencies described in the public portion of an inspection report. Part II provides a basic description of the way that quality control criticisms are framed in portions of reports that are, at least initially, nonpublic. Part III of the release suggests some specific approaches that an audit committee might consider for fostering inspection-related discussions with an audit firm. The Appendix to the release provides further information concerning the PCAOB inspection process and additional details on other related matters.

I - The Board collects and generates information that could be useful to audit committees in carrying out their role. Some of that information is publicly available on the Board's web site. Because of restrictions in the Act, many PCAOB inspection reports include a portion that is nonpublic. By law, the Board cannot disclose to an audit committee the nonpublic portion of an inspection report or other nonpublic inspection information. However, the audit firms themselves have copies of this part of the report and are not prohibited by law from releasing this information at any time. Beyond the public portion of an inspection report, voluntary disclosure by the inspected audit firm is an audit committee's only means of obtaining information concerning a PCAOB inspection. During its inspections, audit work is selected for review largely on the basis of an analysis of factors that, in the PCAOB inspection staff's view, heighten the possibility that auditing deficiencies are present, rather than through a process intended to identify a representative sample of the audit firm's work. Accordingly, the Board cautions against extrapolating from the results presented in the public portion of the report to broader conclusions about the frequency of deficiencies throughout a firm's practice.

II -Any criticisms of a firm's system of quality control are included in the nonpublic portion of the report. The Act restricts the Board from making those criticisms public, although the Act lifts that restriction and the Board makes the criticism public if the firm does not address the criticism to the Board's satisfaction within 12 months after the issuance of the inspection report. Some quality control criticisms are based on inspectors' observations of deficiencies in the performance of audit procedures. A firm's system of quality control should, among other things, provide reasonable assurance that the firm's audit work will meet professional standards. An inspection report may include concerns about the firm's approach to supervision and review, application of due care and professional skepticism or the firm’s work on specific areas such as auditing management's estimates, auditing revenue recognition, using substantive analytical procedures, or procedures relating to consideration of fraud. Other areas of concern may focus on the firm's management of its audit practice, how its tone at the top affects audit quality, or how the firm's partner management practices, including evaluation, compensation, admission, and disciplinary practices as well as client acceptance and retention decisions.

III - In the Board's view, an audit firm's candid discussion of its PCAOB inspection results with an audit committee can have value for an audit committee not only in relation to the audit committee's oversight and evaluation of the audit engagement generally, but also in relation to the audit committee's role in the oversight of the company's financial reporting process. Committees may want real time updates about whether their audit has been selected, what is being looked at, and any deficiencies identified by the PCAOB in the audit. If deficiencies were identified in other audits, committees may wish to understand whether similar deficiencies exist in the company's audit and, if so, what has been done in response. Committees may want to understand whether the audit firm agreed with the PCAOB’s findings and, if not, why not. The public portion of a report can be a useful starting point for discussion between an audit committee and the audit firm it oversees about the inspection. The public portion of a report includes any portion of a firm's response to the draft report that the firm chooses to have made public. The firms’ responses sometimes include assertions. The Board highlights three common types of assertions that occur with sufficient frequency in firms' written responses that audit committees may benefit from the Board's perspective on them. These assertions should be viewed with skepticism.

1. Assertions that Characterize Criticisms as Documentation Deficiencies Rather than as Deficiencies in the Performance of Procedures to

   Obtain Audit Evidence

The Board’s perspective notes that deficiency findings are based on an absence of available evidence in the audit files or elsewhere to support that adequate work was done to support an audit opinion, not just a failure to document work that was in fact done.

2. Assertions that Characterize Criticisms as Differences in Professional Judgment

The Board notes that it bases deficiency findings only on failures to obtain sufficient audit evidence, not on disagreements when reasonable judgments appear to have been made about such matters.

3. Assertions that the Firm Has Addressed the Criticisms in Accordance with PCAOB Standards

The Board reminds audit committees that professional standards require that when a required auditing procedure was omitted, certain remedial steps must be taken.

Appendix - The appendix to this release provides additional detailed background concerning the PCAOB inspection process and additional details on other related matters, such as the inspection process, inspection reports, disclosure of reports and information to other authorities, public disclosure, the process for firms to address quality control criticisms, and the relationship between inspection and other PCAOB functions.

The full text of PCAOB Release No. 2012-003 is available at

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