Panel on Audit Effectiveness: Recommendations

The situation

In response to technological advances and other changes in the business environment, the financial statement audit has been placed under unprecedented pressures, resulting in unique challenges to audit firms. Recognizing these developments, the Securities and Exchange Commission (SEC) has become increasingly concerned about the efficacy of the audit process and the role of the independent auditor. Consequently, at the request of the SEC, the Public Oversight Board (POB) sponsored a thorough and objective examination of auditing, charging a special Panel on Audit Effectiveness with this responsibility.

In September, the POB Panel released its final report, concluding, "both the profession and the quality of audits are fundamentally sound." The report detailed improvements and changes recommended for audits of public companies. Recommendations were based on a review of 126 audits of publicly held companies by the eight largest auditing firms, a review of the current governance and standard setting structure, and recent international initiatives to strengthen audit effectiveness on a global basis.

Most of the recommendations are addressed to the three major bodies that are in a position to improve audits: the Auditing Standards Board (ASB), the firms that audit the financial statements of public entities, and the SEC Practice Section (SECPS) of the AICPA. The Panel also made recommendations to other constituencies, including audit committees.

It is important to note that these are only recommendations. They will be considered by the appropriate standard setting bodies, and as appropriate, subject to full due process. Members are encouraged to review the recommendations and consider the issues within the context of their firms.

Importance to members

Although many of the recommendations are addressed to those entities that develop standards and monitor firm compliance, the report also discusses the technical skills and personal attributes that independent auditors must possess to serve the public interest.

The report recommends that firms take action in four key areas: professional leadership, professional development, personnel management and easing time pressures on auditors. Specifically, firms are urged to reaffirm to the outside world the importance of auditing and ensure that performing high-quality audits is recognized as the highest priority in their professional development activities, performance evaluations, and promotion, retention, and compensation decisions.

To assist smaller firms in auditing practices, the Panel recommended that the AICPA provide greater technical support and practical tools for client acceptance and continuance decisions. The AICPA Audit and Accounting Hotline provides technical support in these areas to members.

Committee involved

The POB is an independent, private sector body that monitors and reports on the self-regulatory programs and activities of the AICPA's SECPS of the Division for CPA Firms. The POB created the Panel on Audit Effectiveness in October 1998 at the request of SEC Chair Arthur Levitt. The Panel obtained input from the AICPA's ASB and Accounting Standards Executive Committee. It also received significant input from the SECPS. AICPA professionals in charge of this effort are David Brumbeloe (SECPS) and Susan Jones (ASB).

Core issues

The POB's report contained many recommendations to the AICPA, addressing a number of areas including assessing inherent and control risks, analytical procedures, auditing revenue, estimates and judgments, considering materiality and waived adjustments, and communicating with audit committees. In a number of instances they call for a deeper understanding by auditors of business processes, risks and controls, including the client's use of information technology. Recommendations also suggest increased IT skills and more effective participation in audits by IT specialists. A number of recommendations call for more specific and definitive auditing standards to guide auditors in using their professional judgment more consistently and effectively.

Other recommendations made to the AICPA include the following:

The ASB should consider whether auditors should perform some "forensic-type" procedures on every audit to enhance the prospects of detecting material financial statement fraud.
The POB, AICPA, SECPS and SEC should agree on a unified system of governance under a strengthened POB that would oversee standard setting (for auditing, independence, and quality control), monitoring, discipline and special reviews.
The SECPS should strengthen its peer review and disciplinary processes.

Recommendations to other groups included:

A majority of the members of the Independence Standards Board should be from outside the profession and the SEC should encourage and support the ISB in carrying out its mission.
Audit committees should pre-approve non-audit services that exceed a threshold amount and consider certain specified factors when doing so.
The International Federation of Accountants should establish an international self-regulatory system for the international auditing profession.

The ASB and SECPS are considering all the recommendations in accordance with due process procedures, and, in many areas, have already identified the issues raised by the SEC. The full report may be viewed at www.pobauditpanel.org.

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