Update on the current board issues: June 2015

June 2015
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BoardroomDirect®<br><span>Update on the current board issues: June 2015</span>

At a glance

Ask board members to rank the importance of strategic risk oversight and the response is almost always a resounding 'No. 1'. It is also an area on which most directors want to spend more boardroom time, according to PwC’s 2014 Annual Corporate Directors Survey. The focus is not surprising when you consider the following responses to a PwC and Strategy& survey asking 2,800 executives about their company’s strategy.

Issue in focus

Audit committee member perspectives on the PCAOB’s Audit Committee Dialogue and the Audit Committee Collaboration’s External Auditor Assessment Tool

As their responsibilities grow, audit committees continue to focus on overseeing the company’s financial statements and external auditor while ensuring the quality of the audit. To aid audit committees in carrying out these responsibilities, two publications were recently released: the Audit Committee Collaboration’s External Auditor Assessment Tool and the PCAOB‘s Audit Committee Dialogue.

To gain practical feedback around the usefulness of these publications for audit committees, PwC’s Center for Board Governance had conversations with Dennis Beresford, NACD board member and Executive in Residence at Terry College of Business, University of Georgia (and former FASB chair and audit committee chair for various companies), and Vanessa Chang, audit committee chair of Edison International and American Funds.

In the conversations, both Beresford and Chang indicated that audit committees should review these new resources and consider how they could use them in their oversight role.

Regarding both documents, Beresford commented: “Each of them in their own way contributes to what the audit committee should be aware of.”

Chang also thought that both are very helpful. “There are some good questions suggested in the PCAOB Audit Committee Dialogue paper and I like the fact that it was linked to the frequency of issues found in their inspections,” she said. “These tools provide a framework, which could guide how an audit committee assesses their service provider [audit firm].”

External Auditor Assessment Tool

The External Auditor Assessment Tool (US) is a 16-page compilation of questionnaires and forms meant to be used by audit committees to help them discharge their responsibilities, including their oversight of the external auditor. The Audit Committee Collaboration, which issued the tool in May, is an organization made up of eight corporate governance groups that is led by the Center for Audit Quality. The organization also released an international version of the tool. (The UK’s Financial Reporting Council issued a similar practice aid to assist UK audit committees. See Audit committee issues in this newsletter.)

The tool’s introduction provides guidance regarding the external auditor assessment process: “Audit committees should regularly (at least annually) evaluate the external auditor in fulfilling their duty to make an informed recommendation to the board whether to retain the auditor. Also, it noted, “It makes good sense for audit committee members to continuously evaluate, through formal and informal assessments, the auditor’s performance throughout the audit process.”

In addition to the audit committee’s assessment of the external auditor, the tool suggests the audit committee review PCAOB audit inspection reports and peer review findings.

The questionnaires focus on quality of services, communication and interaction with the auditor, auditor independence, and objectivity. There is also a sample form for audit committees to use to obtain input from company personnel about the external auditor.

Both Beresford and Chang noted that evaluating the external auditor is a critical element of the audit committee’s role.

That evaluation is not something Chang thinks about once a year. Rather, she said that the process is continuous, using various criteria and observations throughout the year to help the committee frame its views on the external auditor’s performance. Annually, her audit committee steps back, thinks about the interactions with the external auditor during the year and evaluates the audit firm’s overall performance, including many of the points raised in the assessment tool. But she also incorporates some quantitative factors, such as benchmarking. For example, she compares the degree of leverage on the audit team (partner/staff ratio) for the audits of her boards’ companies to the leverage within a particular industry sector.

Beresford was already familiar with many elements of the Audit Committee Collaboration’s tool since he said the first draft was based on a form used by one of his audit committees. “They [Audit Committee Collaboration] built on it to improve it quite a bit. I’m sure my board was not the only one that was already doing this,” he said.

Audit Committee Dialogue

The PCAOB, which regulates external auditors, issued Audit Committee Dialogue. The 15-page publication is the first in a new series intended to provide audit committees with insights from PCAOB inspections that may be helpful to audit committee members in their ongoing dialogue with and oversight of their auditors. The Dialogue is part of the PCAOB’s strategy to extend its outreach to, and interaction with, audit committees.

The publication is divided into two sections: (1) key recurring areas of concern, and (2) new risks the PCAOB is monitoring. The first section outlines areas with historical audit deficiencies, including the auditor’s assessment of internal control over financial reporting, the risks of material misstatement, accounting estimates, including fair value measurements, and referred work in cross-border audits. The second section also provides some of the indicators of potential emerging risks that are informing the Board's inspection planning this year, including increases in M&A activity, the impact of falling oil prices, conclusions about undistributed foreign earnings, and audit firms’ challenge to maintain audit quality while growing other lines of business.

In each section, the Audit Committee Dialogue suggests relevant questions the audit committee might ask the audit firm.

In reflecting on the Dialogue, Chang said that the publication was not meant to be official guidance but rather provides insights gleaned from the regulator’s annual inspections of audit firms to help audit committees understand areas that may need additional focus.

“They did a good job in the introduction,” she said. “They articulated two broad questions -- What recurring audit concerns identified in past inspections are expected to be significant? and What emerging audit risks might require increased focus by auditors and audit committees in the future?”

She felt that the PCAOB was careful not to make edicts to audit committee members, but rather share its experiences.

Beresford was somewhat critical of the publication, but does not question the information that it shared with audit committees. His concern relates to the “number, nature, and level of detail of many of the questions.”

“It suggests a degree of oversight involvement by the audit committee that is beyond what I believe the reasonable person would expect,” Beresford said. ”In defense of the PCAOB, I am sure they meant this as a list of questions, not all of which, but a few of which, would ever be asked.”

“If I had been asked to review the document before it was published, I would have suggested that the PCAOB include some caveats in the paper that the questions included were just examples and that the regulator wouldn’t expect audit committees to ask all the questions,” Beresford added.

Both Beresford and Chang each indicated they are very supportive of a continuous dialogue between the PCAOB and audit committees. Beresford notes that the PCAOB allows for comments from anyone on their proposed standards. However, the primary commenters are the audit firms and companies.

Chang noted that if you look at the list of comment letters on the PCAOB website, there are very few from audit committee members. “It should be a two-way street between audit committees and the Board,” she said.

Beresford did write a letter directly to PCAOB members Jeanette Franzel and Jay Hanson outlining his views regarding the Audit Committee Dialogue. In that letter, he suggests that the PCAOB might want to consider developing an advisory committee made up of audit committee members who could provide feedback to the PCAOB on significant topics, including commenting on future editions of Audit Committee Dialogue prior to issuance.

Chang agreed that there would be value to forming this type of an advisory committee.

The Dialogue states that “we look forward to continuing our conversation as you [audit committee members] are key stakeholders in the strengthening audit quality.”

When asked what other topics he would like the PCAOB to address in future communications, Beresford’s response was concise and direct: “Let’s form the advisory committee and let the audit committee members steer the conversation.”