June 2000

POB Report Recommends Steps for Better Audits

The Public Oversight Board's panel on audit effectiveness released an exposure draft on June 6 that recommends several measures to improve audit quality.

The POB, which appointed the eight-member panel currently chaired by Shaun F. O'Malley in 1998 at the request of Securities and Exchange Commission Chair Arthur Levitt, charged the group with thoroughly examining the current audit model. The panel's recommendations would impact the SEC, standards setters, CPA firms, the AICPA, corporate audit committees, and others.

While the report offers specific actions to enhance audit effectiveness, O'Malley said that it also demonstrates that both the accounting profession and the quality of its audits are fundamentally sound. The panel's major recommendations include the following:

* Auditors should perform some "forensic-type" procedures on every audit to enhance the prospects of detecting material financial statement fraud.

* The Auditing Standards Board should make auditing and quality control standards more specific and definitive. Also, in certain specified areas, audit firms should review and where appropriate enhance their audit methodologies, guidance, and training materials and use peer reviewers to "close the loop" by reviewing those materials and their implementation on audit engagements and then report their findings.

* Audit firms should put greater emphasis on high-quality audits in communications from top management, performance evaluations, training, and compensation and promotion decisions.

* The AICPA and its SEC Practice Section (SECPS), the POB, and the SEC should agree on a unified governance system under a strengthened, independent POB that would oversee standards setting (for auditing, independence, and quality control), monitoring, discipline, and special reviews.

* 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 to carry out its mission.

* SECPS should strengthen the peer review process, including requiring annual reviews of the largest firms, and the POB should increase its oversight of those reviews.

* SECPS should strengthen its disciplinary process.

* Audit committees should preapprove nonaudit services that exceed a threshold amount and should consider certain specified factors when doing so. The ISB should identify the factors.

* The International Federation of Accountants should establish an international self-regulatory system for the auditing profession.

"The panel is satisfied that the model underpinning financial-statement audits generally is appropriate, although in need of updating, enhancing, and implementing more consistently," O'Malley said. "The panel's perspective, however, is that even in the face of strengthened auditing standards in recent years the audit firms may have reduced the scope of their audits and level of testing at least in part as a result of redesigning their audit methodologies. The panel is concerned that the auditing profession has not kept pace with a rapidly changing environment and that the profession needs to address vigorously the issue of fraudulent financial reporting, including fraud in the form of illegitimate earnings management."

AICPA President Barry Melancon referenced the then pending report in his speech at the NYSSCPA Annual Conference on June 5. Acknowledging the POB's criticism of one aspect of the profession's self-regulatory system, Melancon discussed the current provision that allows members to request a deferral of an ethics investigation if the member is involved in related litigation. The POB is concerned because the member may still practice during this deferral. Melancon said the AICPA is changing its procedures to require that before a member receives a deferral, he or she must take a leave of absence or some other temporary action to remove himself or herself from the practice area giving rise to the ethics complaint.

Levitt and POB Chair Charles Bowsher each issued statements commending the panel for its work and indicating that they look forward to working with the various organizations and constituencies to implement the proposals.

The POB will hold public hearings on the exposure draft in New York City on July 10 and 11. The deadline for notice of intention to speak is June 28, and the deadline for receipt of written comments is July 21. See www.pobauditpanel.org for a copy of the report. Watch the August issue of The CPA Journal for an in-depth article on the panel's recommendations. The Trusted Professional and www.nysscpa.org also will report on future developments. *