February 2000

Auditing Conference Offers Update on POB Panel

Audit Effectiveness Report Expected in March

At FAE's Auditing Conference on January 6, Shaun O'Malley, chair of the Public Oversight Board's Panel on Audit Effectiveness, reported that the panel has substantially completed its investigative work and plans to issue a draft report in March.

O'Malley said that the panel reviewed CPA firm policies for hiring, promoting, and rewarding auditors; studied firm methodologies for performing audits; conducted expanded peer reviews of audit work papers; held public hearings and focus groups of auditors and those audited; and solicited information about audit problem areas using a comprehensive questionnaire. The panel also examined the structure and effectiveness of various standards setters including the Financial Accounting Standards Board, AICPA's Accounting Standards Executive Committee and Auditing Standards Board, Securities and Exchange Commission, and Independence Standards Board. O'Malley noted that the SEC issued the charge to review the effectiveness of the Independence Standards Board, which the SEC and AICPA created in 1997 and is still in its infancy, having issued only one standard.

The POB created the Panel on Audit Effectiveness in response to SEC Chair Arthur Levitt's initiatives to address perceived abuses in the financial reporting process. Levitt asked the POB to form a high-level panel--part of a 10-point action plan he announced in September 1998--to examine the current audit model because of fears that the "risk-based" approach now in vogue has diminished the audit's effectiveness at catching financial wrong-doings by management. The POB asked O'Malley, former chair and senior partner of Price Waterhouse LLP, to chair the panel, which consists of seven other members from the business, academic, and legal sectors, including two former SEC commissioners.

O'Malley said that the panel paid particular attention to the linkage between the risk assessments and the extent of audit work actually done in risk-based audits. He said these audits are highly leveraged, and that without the proper linkage by experienced auditors, their effectiveness is in jeopardy.

O'Malley emphasized the benefits obtained from the enhanced peer review the panel's staff used to examine current audit practices.

"One of our recommendations may be to the SECPS [the AICPA's SEC Practice Section] to modify its peer review procedures along the lines of what the panel did," he said.

The panel expects to issue a draft report in late February or early March. It will state findings and make recommendations to the various constituencies in the financial reporting process, much like the POB's In the Public Interest report did in the early 1990s. For example, O'Malley said the report will include recommendations to the SEC, AICPA, and auditing firms.

The panel expects to hold hearings in March and issue its final report to the POB shortly thereafter.

"We did not find a silver bullet for improving the audit process where fraud exists," O'Malley said.

He did state, however, that one likely suggestion will be to expand the peer review process to include reviews of audits during off years--firms currently have peer reviews every three years--but with no public reporting of the results. *