Audit Insider | May 2023

Audit partners continue to be pessimistic about the outlook for the U.S. economy (hello, debt ceiling). For the first time, the PCAOB has inspection results for organizations from mainland China. We continue to monitor for the SEC’s final climate rule.

And as developers of artificial intelligence (AI) fret over the existential threat to humanity that their own technology has created, I’m looking at and answering questions about AI’s potential to transform the accounting profession.

Read on for the latest issues I’m tracking and resources from the profession to assist audit practitioners.

May was an active month for public company audit regulators and standard setters. We’re closely monitoring the following developments at the SEC, PCAOB and IESBA:

SEC

• Climate disclosure rule:  Former SEC Commissioner Robert Jackson, currently a professor at NYU Law, stated during an April 27 webinar hosted by a carbon accounting firm that “it looks like the rule is going to be pushed back a little further than many had thought . . . . It looks more like the fall of this year .” While no further confirmation of the rule’s final date has been given by the SEC, the delay isn’t surprising due to ongoing public comment and legal challenges.

PCAOB

• AS1000: In late March, the PCAOB issued a proposed new standard, AS 1000, General Responsibilities of the Auditor in Conducting an Audit. If adopted, the new standard will reorganize and consolidate a group of interim standards adopted by the PCAOB in April 2003 to address the core principles and responsibilities of the auditor, such as reasonable assurance, professional judgment, due professional care, and professional skepticism.
  • CAQ Response: The CAQ continues to be supportive of the PCAOB’s efforts to modernize and streamline audit standards. But there is a difference between modernizing existing standards and changing the auditor’s fundamental role. In the CAQ’s view, we are concerned that certain elements of the Board’s proposal would expand the auditor’s responsibilities and potentially create confusion for stakeholders, including investors and other users of auditors’ reports regarding the responsibility of the auditor within the financial reporting ecosystem and the level of assurance provided by an auditor’s report, including the potential limitations. Read our comment letter here.
• 2022 Mainland China, Hong Kong Inspection Findings: The PCAOB posted its very first inspections of Chinese-based audit firms which contained inspection findings. This comes after last August the U.S. and China came to an agreement allowing the PCAOB to inspect audits of U.S. – listed Chinese companies conducted by Chinese based audit firms.
  • Our take: Despite the inspection findings, the PCAOB’s deal with China allowing them to inspect audits of U.S.-listed firms conducted by Chinese- based audit firms was ultimately a positive outcome that will protect investor interests and maintain the efficient operation of our capital markets. The ability for the PCAOB to inspect PCAOB-registered firms in mainland China and Hong Kong will bring greater trust to companies accessing our capital markets, no matter where they are headquartered.
• Standard-Setting Agenda: The PCAOB posted a revised standard-setting agenda that includes the addition of two projects slated for short-term action. The PCAOB also announced four new projects aimed at improving PCAOB rules to protect investors. Changes include:
  • Two projects moved to the agenda for short-term action: The PCAOB’s short-term list shows those standard-setting projects where a Board action (e.g., proposal or adoption) is anticipated in fewer than 12 months. The short-term list now includes Firm and Engagement Performance Metrics, which previously was listed on the PCAOB’s Research agenda. Substantive Analytical Procedures was moved to the short-term list from the mid-term category. There is now a total of nine projects on the PCAOB’s short-term list.
  • Two projects added to mid-term category: Mid-term projects are those projects where PCAOB staff is actively engaged but Board action is not anticipated in the next 12 months. On the mid-term list, the PCAOB added projects on Use of a Service Organization and Interim Financial Information Reviews.
• Transparency reports: The PCAOB released eight new inspection reports that include “transparency enhancements.” Among other things, new inspection reports will include:
  • A new section of the report focused on independence violations
  • More information related to fraud procedures and identification and assessment of the risks of material misstatement
  • More commentary
  • New graph
    • Our take: Through these changes, the PCAOB continues to demonstrate their commitment to increased transparency for investors.

IESBA

Staff releases database of public interest entity definitions by jurisdiction: The IESBA released a database of Public Interest Entity (PIE) definitions by jurisdiction (jurisdictional PIE database) to further support the adoption and effective implementation of the revisions to the definitions of listed entity and PIE (PIE revisions) in the International Code of Ethics for Professional Accountants (including International Independence Standards) (the Code). The revised PIE provisions specify a broader list of categories of entities as PIEs whose audits should be subject to additional independence requirements to meet stakeholders’ heightened expectations concerning auditor independence when an entity is a PIE.

Audit Quality

Audit quality in the U.S. has never been higher, but in light of economic uncertainty, emerging developments, and demands on talent, audit practitioners should remain up to speed on the latest developments impacting audit quality. Read on for recent news, tools, and resources.

CAQ Publishes Analysis of PCAOB Quality Control Comment Letters

The CAQ published an analysis of comment letters submitted in response to the PCAOB’s request for comment on its proposal, A Firm’s System of Quality Control and Other Proposed Amendments to PCAOB Standards, Rules and Forms.

As of the publishing, the PCAOB received 43 comment letters in response to QC 1000. The following are a few of the key themes we observed:

• Scalability
  • Investors appear to favor more prescriptive requirements, while accounting firms and related organizations want more scalability to allow them to tailor responses to their specific risk assessments.
  • Academics advocate for a balance of prescriptiveness and flexibility.
• QC 1000 and ISQM 1
  • Accounting firms and related organizations want more alignment with ISQM 1 on key areas such as definitions that impact the operation and evaluation of the QC system.
  • Some investors believe close alignment with ISQM 1 is not in the best interest of investors as it does not sufficiently reflect the unique market considerations and needs of US investors.
• Investors want public disclosure – and state reporting to the audit committee is not enough 
  • Investors strongly encourage a requirement for public disclosures related to a firm’s system of quality control. Only reporting to the audit committee does not meet their needs. Accounting firms and accounting-related organizations generally support disclosure to the audit committee with some modifications to what is reported to provide meaningful and decision-useful information.

The way we see it: Unnecessary differences between the PCAOB’s QC standard and IAASB’s ISQM 1 are not in the best interest of audit quality. Many firms are subject to multiple QC standards, including ISQM 1. A key component of alignment is that the standards are built on a common foundation. Whether the final standard will incorporate further requirements for public disclosure related to a firm’s system of quality control remains to be seen. In the meantime, public accounting firms are already voluntarily communicating valuable information about their systems of quality control. Check out this CAQ resource, Audit Quality Reports Analysis: A Year in Review to learn more.​

The Evolving Role of the Auditor

As investor demand evolves, so does the role of public company auditors. The CAQ is dedicated to providing resources to keep you up-to-date on trending topics in corporate reporting.

CAQ Publishes Spring 2023 Audit Partner Survey

The nature of their work gives audit partners unique insights across a broad spectrum of industries and corporate trends. The CAQ surveys audit partners from its’ member firms biannually to understand their perspectives on a range of topics, including the overall health of the economy and business transformation. The following are a few key themes from our May 2023 survey:

• Audit partners’ outlook for the economy remains pessimistic
  • Fewer than 1 in 5 audit partners are optimistic about the economy.
  • Top audit partner concerns driving this pessimism include inflation (the top concern for the second year in a row), cybersecurity threats, and regulation (a 10-point increase since Spring 2022).
• Attracting new talent no longer a focus
  • Notably, concerns over labor shortages significantly decreased since Spring 2022 (falling by 18 percentage points).
  • While top human capital actions observed by audit partners at the companies in the industries they audit a year ago were increasing flexibility in the workplace and increasing compensation, these steeply declined as priority human capital actions by Spring 2023 (a drop in 34 and 38 points, respectively).
  • Rather, audit partners surveyed responded they observerved U.S. businesses reducing headcount as the top human capital action taken in Spring 2023 (a 37-point increase since Spring 2022). Audit partners in the financial services and technology sectors most frequently observed this human capital action.
• Emerging risks and technology shifts
  • Cybersecurity remains a top risk at U.S. organizations according to 39% of audit partners surveyed. The partners observed that organizations remain only moderately prepared for a cyberattack, though 54% of partners did note that communication between boards and public company management on this topic is improving.
  • Of the partners who did respond that organizations in their industry sector had exposure to China, top risks included supply chain disruption (59%), protection of intellectual property (43%) and risks from U.S.-government-imposed restrictions (39%).
  • Audit partners observed that plans to adopt cryptocurrency as a form of payment fell by 10% across industries since Spring 2022, with steeper drop-offs observed in financial services (18 percentage points), consumer products and retail (14 percentage points), and technology (13 percentage points) industries.
  • A new survey question revealed that 47% of U.S. businesses are already using artificial intelligence (AI) to some extent. Key uses observed include processautomation (63%), customer experience, service and support (44%) and predictive analysis (31%).
• The accountant shortage
  • Amid resignations and pipeline challenges, 89% of audit partners reported U.S. businesses were greatly to somewhat affected by the accountant shortage. Audit partners in financial services and technology, as well as audit partners workingwith companies valued at less than $1 billion, were more likely to report organizations in their industry sector as being affected compared to audit partners working within different industries and with larger organizations.

Download the report, Spring 2023 CAQ Audit Partner Pulse Survey, to access the full survey results.

CAQ Publishes Digital Assets 2.0 Resource

Companies continue to engage with digital assets and blockchain technology in a variety of ways, presenting new opportunities and risks for companies incorporating these assets into their business strategy. We also have seen increased calls for digital asset regulation amidst heightened concerns about fraud and misconduct related to digital assets. Despite uncertainty in the regulatory environment, it is clear that digital assets are here to stay. The audit committee has an important responsibility on behalf of company shareholders to oversee the financial reporting process and external audit and therefore, is well-positioned to provide oversight for companies engaging in digital asset transactions.

The CAQ recently published a resource for audit committee members, Continuing Your Digital Assets Journey: A Tool for Audit Committees, with oversight of companies that hold or transact with digital assets that includes information on topics and questions for audit committees to consider, such as:

• Legal and regulatory environment: The digital asset legal and regulatory environment is rapidly evolving with domestic and international regulators and legislators prioritizing this topic.
• Risk assessment: Engaging with digital assets can introduce new or heightened risks for companies, including risks of fraud.
• Safeguarding digital assets: Custody practices are a key focus for companies holding and transacting with digital assets.
• Third-party service providers: For companies that rely on third-party service providers in the digital asset ecosystem it is important to perform due diligence on the third parties they plan to engage with.
• Accounting and auditing considerations: Engaging with digital assets introduces a number of new accounting and auditing considerations.

Interested in topics relevant to crypto native companies? Check out our initial publication that focuses on foundational digital asset topics for audit committees, Jumpstart Your Digital Assets Journey: A Tool for Audit Committees.

Talent Spotlight

The CAQ is committed to working with audit firms to address issues related to talent, including the pipeline and gaps in diverse representation. Each month, I’ll spotlight our efforts on this critical issue.

Accounting+ Launches Internship Hub

This month, Accounting+ launched an internship hub featuring internship opportunities for students interested in a career in accounting. If your organization is interested in featuring internships through our hub, please contact us at info@joinaccountingplus.com. We will be adding new internships on a rolling basis.

This month we are featuring Audit Insider, Chris Alabi, a Partner at PwC who specializes in auditing companies in the Pharmaceuticals and Life Sciences practice. Prior to becoming a Partner at PwC, I had the privilege of working with Chris while he spent 18 months at the Center for Audit Quality as our Professional Practice Fellow from July 2017 – December 2018. In that capacity, he helped guide the CAQ’s Professional Practice and public policy activities while on loan to us from PwC.

Read on for my Q&A with Chris:

• Question: What was your career path to partner at PwC? 
  Chris: I was born in Nigeria and moved to the United Kingdom as a teenager. My family encouraged me to be a doctor or an engineer. But as a kid, I wanted to be an airline pilot and decided to start my journey first as an aeronautical engineer. During my engineering degree years, I took a 1-year gap working as an intern at an airline in the UK which also exposed me to the fascinating world of finance and accounting. After graduating, I joined PwC in 2005 as an associate in the United Kingdom. My career path as an auditor has enabled me to work at PwC offices around the world, and I was admitted to the PwC partnership in 2019.
• Question: What did you enjoy most about your fellowship at the CAQ? 
  Chris: The time I spent at the CAQ enabled me to give back to a profession I care deeply about. As the pace of change in business accelerates, the critical role of auditors in protecting investors has never been more important. Something I have learned throughout my career is that you have to be open to learning every day and passing along your knowledge in developing others. During my fellowship at the CAQ I had the opportunity to learn and also provide input on audit quality matters and help the overall profession in formulating positions on standard setting activities.
• Question: The CAQ recently released our May 2023 Audit Partner Survey. As a partner, what did you find interesting about the survey results? 
  Chris: I found all of the insights in the survey interesting and think it is great that the CAQ is conducting this survey. As auditors we have unique perspectives on developments within the industries in which we audit. I thought the result indicating that, “nearly half of the partners surveyed said that companies in their primary industry sector were investing in various AI technologies either a great deal (7%) or somewhat (40%),” was very insightful. Emerging technologies like AI can bring about great opportunities and efficiencies for companies and auditors. Like any change, developing an understanding of these technologies and an awareness of the benefits and risks they present is essential for auditors, management, and audit committees.​​​​​ 

Each month, I’ll answer questions from readers. I received the following question in May:

• Question: I’m a retired assurance partner from a large firm. What are your thoughts regarding the impact of ChatGPT/OpenAI on financial reporting and the audit profession?
  • Answer: I’m seeing this question a lot, particularly given the news around ChatGPT failing, then passing, the CPA exam (at least it had to re-take the CPA exam – the same can’t be said of the bar. Take that, lawyers.). Our recent audit partner survey found that 47% of U.S. businesses are already using artificial intelligence (AI) to some extent. It is likely that AI will impact every industry and the accounting profession will not be immune (for fun, check out the Washington Post’s recent interactive article to see how AI will impact your job). While I believe the accounting profession will remain first and foremost a people profession, I also think artificial intelligence will – and already is in many extents – assist auditors with routine work so that they can focus on the more important functions of their job. Ultimately, I believe AI will help auditors:
    • Perform even higher quality audits by more quickly identifying risk areas and analyzing data sets​​​​​
    • Allow auditors to build technology solutions to better fit their engagements’ needs
    • Decrease the number of hours auditors must spend on rote work

Ultimately, I echo Chris’s thoughts above. AI has the potential to improve the profession, but auditors must be willing to evolve with the technology and be aware of the benefits and risks they present.

See you next month Audit Insider.

Dennis McGowan

Vice President, Professional Practice and Anti-Fraud Initiatives