PCAOB Reproposes Standards on Assessing Risk for Additional Comment

The PCAOB has reproposed for comment seven auditing standards and related amendments on the requirements for assessing risk during an audit. The reproposed standards respond to the comment letters that were submitted on the initial October 21, 2008 proposal. The Board has described these standards as the foundation for future standard setting. The standards cover the initial planning stages of an audit through the evaluation of the audit results that form the opinion in the auditor’s report. Comments are due March 2, 2010.

The proposed standards address audit risk; audit planning and supervision; the consideration of materiality in planning and performing an audit; identifying and assessing risks of material misstatement; the auditor’s responses to the risks of material misstatement; the evaluation of audit results, and audit evidence. The standards will replace six interim standards.

One of the revised standards is on the consideration of materiality in planning and performing an audit. The standard describes the auditor’s responsibilities for applying the concept of materiality, as described by the courts in interpreting the federal securities laws, in planning the audit and determining the scope of audit procedures. The original proposal on materiality was taken from a FASB concept statement that was not included in FASB’s codification of accounting standards. Acting PCAOB Chair Daniel Goelzer agreed with the change, noting that the PCAOB is not the definer of materiality. That is a judicial or legislative responsibility, he said.

Goelzer noted that the standards have been better aligned with Auditing Standard No. 5 governing the audits of internal control over financial reporting. The revised standards emphasize the need to evaluate financial statement disclosures as part of assessing the risk of material misstatement, he added. The standards also emphasize the auditor’s responsibility to consider the potential for management bias and risks related to missing or incomplete disclosure.

Goelzer addressed a number of commenters who said that the Board has not gone far enough in aligning the standards with international standards on auditing. He said the revisions further reduce the differences and an appendix provides a comparison between the revised proposals and the ISAs. Depending on the next set of comments, Goelzer said he hopes the Board will have the opportunity to discuss the revisions with its Standing Advisory Group before the standards are finalized. The next SAG meeting is in April 2010.

Board member Charles Niemeier said he was not completely comfortable with all of the revisions, but was comfortable with going back out for additional comments. He said the Board should focus on weaknesses in the standards as identified in staff inspections. The inspections should inform the Board on the most important issues for future projects, in his view.

When the Board adopts new standards, it has the opportunity to make them simpler, he said. Niemeier said the Board has not thought through how its projects relate to each other, which can case more complexity in the standards. The Board should explain what it is trying to achieve, he added. Most of the comments it receives are from auditors. It may be difficult for others to understand the importance and effect of its proposals, he said.

Board member Steven Harris noted that, since the standards were first proposed, the consequences of ineffective risk management were made clear. Investors lost trillions of dollars due, in part, to weak or nonexistent management oversight in the financial services industry. The standards that were approved for comment on December 17 more clearly outline the auditor’s responsibility to consider business risks as an important element of audit risk, according to Harris.

Harris believes an important improvement to the proposed standards is the integration of and emphasis on the auditor’s responsibility to consider the risk of fraud throughout the audit process. This type of integration is needed, he said, based on observations made during the inspection process.

Goelzer noted that a number of commenters suggested that the Board codify its standards. Chief Auditor Martin Baumann said the integration and codification of new standards with interim standards makes sense. He said there are a lot of areas where audit quality needs to be improved. The Board published its standards setting agenda in October. As it gets through that agenda, Baumann said it should look to the integration of standards and a codification. The concept is worth thinking about going forward, he said, but the top priority is improving audit quality. Baumann said the staff will follow the risk assessment format in future standard setting projects.

Harris said he would like to see the adoption of the standards as soon as possible after the end of the comment period, given their high priority. He asked the staff when it expected the project to be finalized. The staff would like to see the standards become effective for audits for fiscal years ending on or after December 15, 2010.