For the first time since the [PCAOB’s] creation in 2003, we have a completely new board. Its new strategic plan, which was approved on November 15, has five goals. The first is, as always, to improve audit quality. To do this, we must focus not only on detecting audit deficiencies, but also on preventing them from occurring in the first place. For this, we will need to take a forward-looking and balanced approach as we carry out our oversight activities. We will also conduct inspection activities to facilitate more timely and relevant feedback to our stakeholders. The information the PCAOB provides to the public and its stakeholders must be relevant, and to be relevant it has to be timely. An inspection report that is published two years after an audit is completed is not relevant.
The second goal is to anticipate and respond to emerging technologies and related risks and opportunities. Advancements in technology are continuously affecting how and when financial information is being generated and used. We understand how innovative auditing firms are being and how important it is for the PCAOB to understand the impact of that innovation on the quality of audit services. We do not want to inadvertently impede innovation as we work to accomplish our mission.
In addition, we need to better understand the needs of our stake-holders. A substantial opportunity exists for the board to engage more often and effectively with investors, audit committees, preparers, registered firms, standards-setting organizations, academia, and other audit regulators. Therefore, we have set a goal to enhance transparency and accessibility through proactive stakeholder engagement.
The board’s fourth goal is to pursue operational excellence through efficient and effective use of resources. This includes increasing and optimizing our information technology investments. Almost anyone who’s worked with me since I started at the PCAOB earlier this year will tell you that I’m passionate about increasing the PCAOB’s investment in information technology. We must improve the user experience; we must technology-enable our workforce and go mobile.
Our final goal is to develop, empower, and reward our people. This is key to any effective organization. The PCAOB staff is deeply committed to our mission. Going forward, we will collectively reinforce a culture that expects integrity, pursues excellence, operates with effectiveness, embraces collaboration, and demands accountability.
At the same time we approved our strategic plan, we also approved our 2019 budget, which will enable us to meet the regulatory demands of driving continuous improvement in audit quality while also being fiscally accountable and transparent to all our stakeholders.
As you know, the largest source of our funding comes from fees paid by the companies whose financial statements must be audited by PCAOB-registered firms. As stewards of these fees, it is important that we operate as effectively and efficiently as possible.
The budget also includes an investment in human capital, in the form of increased training opportunities as well as increased head count. Some of that comes in the form of newly created positions such as a chief compliance officer, a chief information security officer, and a chief risk officer. The budget will also liaise positions that will conduct outreach to stakeholders.
Transforming the PCAOB
As I mentioned, we’re an entirely new board. In composing us, the SEC was very thoughtful, making sure we represented a broad spectrum of viewpoints, competencies, and experience. Our backgrounds include investors, preparers, registered firms, academia, financial regulation, and legislation and policy-making. These are all relevant to our mission of improving audit quality.
To fully realize the potential of such a broad spectrum of viewpoints and experience, Chairman [William] Duhnke has created board champions to facilitate transformation in specific areas. For example, I’m a board champion for inspections, standards setting, and technology.
There are numerous projects within the inspections transformation initiative. Some of them are more short-term, while others are more long-term. Currently, the transformation efforts contain 16 projects or workstreams with dedicated inspection staff. We have assigned over 30 staff to the projects; select staff have been assigned full-time for a period of two years. Additionally, a new senior-level position within inspections has been established to lead the transformation initiative.
We believe now is an excellent time to take a hard look at how we approach our inspections and report their results. If there are changes we can make to more effectively promote audit quality through our inspections program, we will actively and carefully consider them.
We are reviewing the entire inspections ecosystem. It is back to basics, from the very purpose of inspections to the inspections approach and process. This includes planning, report writing, remediation, root cause analysis, the QC standards, and procedures.
We are reviewing the entire inspections ecosystem. It is back to basics, from the very purpose of inspections to the inspections approach and process.
For example, we would like to be more timely, relevant, and balanced in our inspection reports and other communications. This is particularly important as we advance our desire to be not just detective but preventative as well. I believe one way to achieve this would be to develop an agreed-upon set of audit quality indicators, or AQIs. Including standard AQIs in future inspection reports could make those reports more balanced than they are today. A series of outreach meetings with other regulators, both domestic and foreign, will be conducted to understand their approaches.
Technology impacts the way audits are done. It also impacts the way we do inspections. We will update our inspections technology platform. Finally, we will adapt our approach based on the nature and size of the firm.
We will also use resources outside the PCAOB to assist with certain transformation initiatives. This will maximize learning and the effect of the transformation as well as increase innovation and foster continuous improvement.
We expect to increase our interaction with audit committees. This will be achieved during the inspection process. We view an informed and engaged audit committee as crucial to achieving continuous improvement of audit quality.
There are also transformation initiatives within our standards setting function. Today, the development of a new standard can take three years or longer. I believe we should conduct a review of this process; it will not only focus on the time to develop a standard but also how we communicate the pronouncement.
In addition, I believe we should use other forms of board communications in our standards setting space. This could include more frequently published guidance, staff reports, and practice alerts. Currently, we provide informal consultations on how to interpret our standards; we may need to consider a more formal consultation process.
I believe we should use other forms of board communications in our standards setting space. This could include more frequently published guidance, staff reports, and practice alerts.
Another way the board has begun to transform is through senior management. We recently appointed three new directors: George Botic is our director of the Division of Registration and Inspections. Liza McAndrew Moberg will lead our Office of International Affairs, and Ryan Sack will lead our Office of Internal Oversight and Performance Assurance.
We have also created a new Office of External Affairs, and appointed Torrie Miller Matous to lead it. This new office combines the preexisting offices of Public Affairs, Government Relations and Outreach, and Small Business Liaison. It will also include new liaison staff for the investor and business communities.
We still have a number of senior leadership roles to fill. We are being careful and considerate in the hiring process. We hope to complete this process shortly. In the meanwhile, we have the utmost confidence in the staff that has stepped into those roles on an acting basis.
2017 Inspection Report
As we reassess some of the areas of our inspections program, our staff have been busy conducting business as usual. In 2017, they examined portions of nearly 800 issuer audits and reviewed the system of quality control at more than 190 firms. Overall, the number of audit deficiencies identified in the engagements inspected in 2017 appears to be about the same for some firms and increasing for others.
Not all firms are in the same place; there seems to be a plateauing of deficiencies since 2016. The 2017 inspection results also indicate continued audit deficiencies in audit work regarding multinational audits, noncompliance with PCAOB rules or SEC rules, and regulations related to auditor independence and areas affected by economic risk.
The most frequent audit deficiencies continue to be in the same three key areas: auditing internal control over financial reporting, or ICFR; assessing and responding to risk of material misstatement; and auditing and accounting estimates, including fair value measurements. Audit deficiencies have been most frequently observed in auditing of the following financial reporting areas: revenue, impairment of long-lived assets, inventory, financial instruments, and allowance for loan losses, as well as business combinations and debt and equity instruments.
Let me turn to our broker-dealer inspection program. 2018 is the fourth year since the PCAOB standards have applied to broker-dealer audit firms. Our 2017 report and highlights summary are on our website. Deficiencies continue to remain very high, and many of those observed were consistent with prior years. Deficiencies were identified in 91% of the firms inspected; that’s down only slightly from 97% in 2016.
What is the PCAOB doing to improve audit quality in the broker-dealer space? We know that our inspections approach and frequency of inspection make a difference. Firms that have been inspected before have better results than those that have never been inspected. Also, generally, more touch points with the PCAOB correspond with better inspection results, meaning fewer deficiencies.
So we planned our inspections to cover new firms in 2017. Approximately two-thirds of the firms selected have never been inspected before. In addition, in the last couple of years we’ve escalated the level of QC-related inspection procedures we perform. This includes a wider scope of procedures and performing these expanded procedures at more firms. Finally, we are trying to educate this segment of stakeholders. The PCAOB hosts in-person meetings, called BD forums, and online sessions for auditors of broker-dealers. These are offered at no cost to the attendees and give participants the chance to learn and discuss relevant issues. The forums also provide a platform for firms to meet with the board and the board staff.
The interim inspections program for auditors of brokers and dealers informs the board’s consideration of establishing a permanent inspections program. In particular, it helps the board to assess whether to differentiate among classes of brokers and dealers. It also assists the board’s decision whether to exempt any category of public accounting firm, and whether to establish a minimum inspection frequency.
Under the current interim program, we perform all procedures that we would likely perform under a permanent program, except the issuance of firm-specific reports. Firm-specific reports would trigger the related remediation process.
This is a very exciting time to be a PCAOB board member. We are committed to collaboration. We aim to be as transparent as possible through outreach and increased communication. You will hear from us and we want to hear from you. The changes that happened to get us where we are today did not happen overnight, nor will the changes that are necessary to bring us into the future.
Q&A Session
Douglas Carmichael, moderator:
There are a few areas you touched on that I thought would be helpful to expand on. On CAMs [critical audit matters], what is the PCAOB is doing to drive the implementation of that standard?
James G. Kaiser:
Sure. We took a longer implementation period for a reason. All of you who are auditors and auditors of accelerated filers, I imagine you are going through dry runs with your clients. We want to take advantage of that and take the feedback that firms are observing in their dry runs, the implementation issues that the firms are identifying, and understand them and react to them. We’ve begun the dialogue with CAQ [Center for Audit Quality]; we had an initial meeting at the end of October. There’s another one scheduled, with the hope that, as firms go through their dry runs, we can learn from that and interpret the standard before it becomes effective, and also give some sense of focus as we move into the inspections process.
We might have some further guidance and interpretation this spring, before the standard goes effective in June for accelerated filers. The other thing I would add is that we’re also coordinating with the SEC and the various offices and divisions as we go through this implementation process.
Carmichael:
One of the strategic objectives in the board’s plan is a focus on stakeholder engagement. Could you tell us a bit about what the board’s doing to implement that for investors and audit committee members and preparers?
Kaiser:
The board is trying to get out and meet with our various stakeholders, whether they be the firms, investors, audit committees, other regulators, or academia. I’ve spent a lot of time with each of those groups this year, and we’re thinking about how we have more interconnection with various groups, like audit committees and preparers. It hasn’t been as easy for us to have a direct interface. We’re finding ways to do that. I’ve met with three or four preparer groups this fall, one last week.
And we’re also focused on how we communicate. Our communication with firms versus our communications with audit committees or preparers or investors may be a bit different; they’re different audiences and want to hear different messages.
Carmichael:
I’ve got a series of questions on the future of the profession. Last summer, the PCAOB announced 332 scholarships—can you tell us more about that program?
Kaiser:
The fines that we levy go to fund scholarships for students coming into the profession. We have awarded, since 2011, 1,100 scholarships to students, about $9.5 million. But we have not created a lot of stakeholder awareness around it. One of our focuses will be to create some more stakeholder awareness around the program and evaluate how effective it is.
Carmichael:
How do you think the profession is going to evolve, and what advice would you give to Baruch students, the next generation of auditors?
Kaiser:
I think the data and analytics skills are key to the students coming into the profession. I still don’t think you can ignore the other skills to be a successful auditor. Having professional skepticism and leadership skills, as well as being able to effectively communicate, are still very important skills that students need to have today.
I think the data and analytics skills are key to the students coming into the profession.
Carmichael:
You’re a champion within the PCAOB for information technology. Do you have anything to add to your remarks?
Kaiser:
The data task force that we put together with 11 members—five from firms, four from the SAG and two academics—they’ve really taken the priorities to be data and artificial intelligence. I think those are the right areas to focus on and determine what initial guidance we need to provide, and communications we need to provide, to the firms.
Since the board’s come on, we’ve developed a program to meet with firms to understand where they are in the technology journey, what they’re developing, and how they think it will impact the audit. The key question we ask is: Are the current standards a constraint in your development of technology? I think the consistent answer is that the standards today aren’t a constraint, but that doesn’t mean that, as we move forward, they won’t be. I think that’s something we have to continuously focus on: how do we need to evolve the standards?
I think the other thing to think about is that much of the talent we have within our organization have backgrounds similar to myself, that is, as auditors. We may need to get some external points of view to help us from a data science standpoint. If you look at what firms have done, I think we need to think about doing something similar.
