Home -> Law Blog Directory -> Corporate & Securities Law Blogs -> Jim Hamilton's World of Securities Regulation

Corporate & Securities Law

: Jim Hamilton's World of Securities Regulation

Int?l Audit Groups Say PCAOB Proposed Confirmation Standard Falls Short on Convergence

By Jim Hamilton

International comments on the PCAOB?s proposed external audit confirmation standard, while praising the Board for its effort in converging the standard with IAS 505, indicate that ultimately the Board fell short in the effort to converge with global standards. The general consensus of international commenters is that the only time the Board is justified to diverge from an international standard is when it needs to satisfy US federal securities laws and SEC regulations. One area of concern is that international auditing standards tend to be principles-based while the Board?s standards lean towards rule-based. Both international audit organizations and the Big Four audit firms have commented that the proposed confirmation standard is overly prescriptive.

The German Institute of Auditors, Institut der Wirtschaftsprüfer, is not convinced that alignment of the PCAOB and IAASB confirmation standards has been achieved to the maximum extent possible. The Institute also noted that the Board?s draft standard does not contain sufficient guidance to facilitate consistent application of the requirements in all cases. The Institute urged the Board to make further progress in these respects before finalizing its standard.

The Institute also reminded the Board that its standards do not apply exclusively to audits performed in the United States, and thus must also be capable of application in many different jurisdictions and many different industries around the world. Indeed, in a number of past letters to the PCAOB, the Institute has expressed concern that the standards issued by the Board are overly rules-based with the concomitant restriction on the exercise of professional judgment by an auditor, which in turn leads auditors to adopt a checklist approach rather than use what the Institute called the ?thinking mentality? essential to exercising appropriate professional judgment. It is this approach more than anything else, said the Institute, that causes the PCAOB?s standards to differ from those of the IAASB.

The Federation of European Accountants noted that the confirmation standard generally contains rules and requirements rather than explanatory material. The Federation also noted that external audit confirmation should not be conducted routinely without the use of professional judgment.

More specifically, the Federation said that the presumed mandatory requirement for audit confirmations in the draft, which does not even carry forward the current exceptions for not confirming receivables, reflects a rules-based approach that could discourage the use of professional judgment. The PCAOB?s approach stands in sharp contrast to the IAASB standard, which employs a risk-based approach to determine when external audit confirmation ought to be performed.

The German Auditor Institute is also concerned that the presumption that the auditor?s confirmation procedures will apply to accounts receivable without exception will foster a checklist approach. While conceding that in the vast majority of audit circumstances confirmations may well be the most effective audit procedure, and that their extensive use would be common in many jurisdictions, the Institute emphasized that the presumption as currently proposed means that even in those circumstances where an auditor anticipates that confirmation procedures will be ineffective, such as when the auditor has had past experience with the client encountering especially low response rates, the confirmation requests will still have to be made without exception.

In its letter to the Board, the Institute of Chartered Accountants in England and Wales described the PCAOB as a de facto global auditing standard-setter because the effects of its standard-setting activities extend far beyond its shores. As such, the Institute believes that the PCAOB must take into account the likely effect of its actions outside the US in order to fulfill its mandate to protect US investors. With the best of intentions, the PCAOB?s standards may be applied in a way different to that intended when transplanted into different cultural and legal contexts. In order to be effective, the PCAOB must necessarily seek a balance; noted the Institute, its standards must be set at a sufficiently high level so as to be translatable into different contexts but they must also be sufficiently detailed.

In the Institute?s view, the proposed standard on confirmations could achieve this balance better. The lack of balance is exemplified by the statement in the Release to the effect that auditors considering confirmation procedures to be ineffective should determine why they are ineffective and look for ways to improve their effectiveness. To an extent, this misses the point and urges auditors to work harder, instead of smarter. The Institute believes that gearing up and fine tuning processes will not compensate for or address human error on the part of auditors, the carelessness of third party respondents, or very low response rates. The Institute does not believe that it will improve audit quality for auditors to be required to send audit confirmation requests where expected response rates to any sort of request is very low.

Full post as published by Jim Hamilton's World of Securities Regulation on November 09, 2010 (boomark / email).