SEC Approves Engagement Quality Review Standard

Engagement quality reviews will now be held to a higher standard, thanks to the recent approval by Securities and Exchange Commission (SEC) of Auditing Standard No. 7.

The SEC’s approval in January means the standard takes effect for engagement quality reviews (EQR) of audits and interim reviews for fiscal years that began on or after Dec. 15, 2009.  Under AS7, audit firms must take a more rigorous approach when reviewing their own audit work internally before issuing audit reports.

“This standard should improve the reliability of audited financial statements by increasing the likelihood that reviewers will identify significant engagement deficiencies before audit reports are issued to the investing public,” said PCAOB Acting Chairman Daniel L. Goelzer.

Under the new standard, the engagement quality reviewer must evaluate the significant judgments made by the engagement team and the related conclusions reached in forming the overall conclusion on the engagement and in preparing the engagement report.  This includes:

• Consideration of the firm's recent engagement experience with the company and risks identified in connection with the firm's client acceptance and retention process
• Consideration of the company's business, recent significant activities and related financial reporting issues and risks, and
• Judgments made about materiality and the effect of those judgments on the engagement strategy.

It also calls for an evaluation of the engagement team’s assessment of, and audit responses to, any significant risks, including fraud, that were identified.  Significant judgments made about the materiality and disposition of corrected and uncorrected identified misstatements and the severity and disposition of identified control deficiencies are also to be evaluated.  The engagement team’s evaluation of the firm’s independence in relation to the engagement as well as all completion documentation will also be scrutinized.

“A well-performed EQR can serve as an important safeguard against erroneous or insufficiently supported audit opinions and, accordingly, can contribute to audit quality,” said Martin F. Baumann, Chief Auditor and Director of Professional Standards.

In its order approving AS7, the SEC noted that it had received nine comment letters on the proposed rules.  While the authors “generally agreed” with the standard’s requirements, many also indicated that there is a lack of clarity resulting from perceived inconsistencies between AS7 and text in PCAOB’s adopting release.

Other concerns were raised regarding an example in the PCAOB’s adopting release that describes the documentation requirement for significant engagement deficiencies identified by the engagement quality reviewer.  The release states that “the EQR documentation should contain sufficient information to enable an experienced auditor, having no previous connection with the engagement, to understand, e.g., the significant deficiency identified, how the reviewer communicated the deficiency to the engagement team, why such matter was important, and how the reviewer evaluated the engagement team’s response.”

Commentators were concerned that the example in the release could be read to be inconsistent with the requirement in the standard and could result in unintended consequences in terms of performance.  The primary concern was that the engagement quality reviewer may be compelled to document every interaction with the engagement team, not knowing whether a matter would ultimately be identified as a significant engagement deficiency.  This was viewed as a documentation requirement for an EQR that is incremental to the requirements of PCAOB Auditing Standard No. 3, Audit Documentation.  That standard does not require the auditor to document each discussion and preliminary conclusion.

The SEC noted that it did not find any inconsistencies between AS7 and AS3, adding that “since several comments were related to this point, we encourage the PCAOB to provide further implementation guidance on the documentation requirement.”

PCAOB indicated it will do so, publishing “Staff Questions and Answers on implementation of the standard in the near future.”
 

Also In This Month's Issue:

Keeping Up With the Continuous Audit

Employee Retention Key to Surviving Economic Recovery