Public Company Accounting Oversight Board; Notice of Filing of Proposed Rules on Auditing Standard No. 7, Engagement Quality Review, and Conforming Amendment, 57357-57371 [E9-26659]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 74, Number 213 (Thursday, November 5, 2009)]
[Notices]
[Pages 57357-57371]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E9-26659]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60903; File No. PCAOB-2009-02]


Public Company Accounting Oversight Board; Notice of Filing of 
Proposed Rules on Auditing Standard No. 7, Engagement Quality Review, 
and Conforming Amendment

October 29, 2009.
    Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 (the 
``Act''), notice is hereby given that on August 4, 2009, the Public 
Company Accounting Oversight Board (the ``Board'' or the ``PCAOB'') 
filed with the Securities and Exchange Commission (the ``Commission'') 
the proposed rules described in Items I and II below, which items have 
been prepared by the Board. The Commission is publishing this notice to 
solicit comments on the proposed rules from interested persons.

I. Board's Statement of the Terms of Substance of the Proposed Rules

    On July 28, 2009, the Board adopted Auditing Standard No. 7, 
Engagement Quality Review, and an amendment to the Board's Interim 
Quality Control Standards (collectively, ``the proposed rules''). The 
text of the proposed rules text is set out below. Language that is 
added by the amendment to the Board's Interim Quality Control Standards 
is italicized.
    Auditing Standard No. 7
    Supersedes SECPS Requirements of Membership Sec.  1000.08(f).
    Engagement Quality Review:
    Applicability of Standard:
    1. An engagement quality review and concurring approval of issuance 
are required for each audit engagement and for each engagement to 
review interim financial information conducted pursuant to the 
standards of the Public Company Accounting Oversight Board (``PCAOB'').
    Objective:
    2. The objective of the engagement quality reviewer is to perform 
an evaluation of the significant judgments made by the engagement team 
and the related conclusions reached in forming the overall conclusion 
on the engagement and in preparing the engagement report, if a report 
is to be issued, in order to determine whether to provide concurring 
approval of issuance.\1\
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    \1\ In the context of an audit, ``engagement report'' refers to 
the audit report (or reports if, in an integrated audit, the auditor 
issues separate reports on the financial statements and internal 
control over financial reporting). In the context of an engagement 
to review interim financial information, the term refers to the 
report on interim financial information. An engagement report might 
not be issued in connection with a review of interim financial 
information. See paragraph .03 of AU section (``sec.'') 722, Interim 
Financial Information.
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    Qualifications of an Engagement Quality Reviewer:
    3. The engagement quality reviewer must be an associated person of 
a registered public accounting firm. An engagement quality reviewer 
from the firm that issues the engagement report (or communicates an 
engagement conclusion, if no report is issued) must be a partner or 
another individual in an equivalent position. The engagement quality 
reviewer may also be an individual from outside the firm.\2\
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    \2\ An outside reviewer who is not already associated with a 
registered public accounting firm would become associated with the 
firm issuing the report if he or she (rather than, or in addition 
to, his or her firm or other employer): (1) Receives compensation 
from the firm issuing the report for performing the review or (2) 
performs the review as agent for the firm issuing the report. See 
PCAOB Rule 1001(p)(i) for the definition of an associated person of 
a registered public accounting firm.
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    4. As described below, an engagement quality reviewer must have 
competence, independence, integrity, and objectivity.


    Note:  The firm's quality control policies and procedures should 
include provisions to provide the firm with reasonable assurance 
that the engagement quality reviewer has sufficient competence, 
independence, integrity, and objectivity to perform the engagement 
quality review in accordance with the standards of the PCAOB.



[[Page 57358]]



Competence

    5. The engagement quality reviewer must possess the level of 
knowledge and competence related to accounting, auditing, and financial 
reporting required to serve as the engagement partner on the engagement 
under review.\3\
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    \3\ The term ``engagement partner'' has the same meaning as the 
phrases ``auditor with final responsibility for the audit'' in AU 
sec. 311, Planning and Supervision, and ``practitioner-in-charge of 
an engagement'' in PCAOB interim quality control standard QC sec. 
40, The Personnel Management Element of a Firm's System of Quality 
Control-Competencies Required by a Practitioner-in-Charge of an 
Attest Engagement. QC sec. 40 describes the competencies required of 
a practitioner-in-charge of an attest engagement.
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Independence, Integrity, and Objectivity

    6. The engagement quality reviewer must be independent of the 
company, perform the engagement quality review with integrity, and 
maintain objectivity in performing the review.


    Note: The reviewer may use assistants in performing the 
engagement quality review. Personnel assisting the engagement 
quality reviewer also must be independent, perform the assigned 
procedures with integrity, and maintain objectivity in performing 
the review.


    7. To maintain objectivity, the engagement quality reviewer and 
others who assist the reviewer should not make decisions on behalf of 
the engagement team or assume any of the responsibilities of the 
engagement team. The engagement partner remains responsible for the 
engagement and its performance, notwithstanding the involvement of the 
engagement quality reviewer and others who assist the reviewer.
    8. The person who served as the engagement partner during either of 
the two audits preceding the audit subject to the engagement quality 
review may not be the engagement quality reviewer. Registered firms 
that qualify for the exemption under Rule 2-01(c)(6)(ii) of Regulation 
S-X, 17 CFR 210.2-01(c)(6)(ii), are exempt from the requirement in this 
paragraph.
    Engagement Quality Review for an Audit:

Engagement Quality Review Process

    9. In an audit engagement, the engagement quality reviewer should 
evaluate the significant judgments made by the engagement team and the 
related conclusions reached in forming the overall conclusion on the 
engagement and in preparing the engagement report. To evaluate such 
judgments and conclusions, the engagement quality reviewer should, to 
the extent necessary to satisfy the requirements of paragraphs 10 and 
11: (1) Hold discussions with the engagement partner and other members 
of the engagement team, and (2) review documentation.
    10. In an audit, the engagement quality reviewer should:
    a. Evaluate the significant judgments that relate to engagement 
planning, including--

--The consideration of the firm's recent engagement experience with the 
company and risks identified in connection with the firm's client 
acceptance and retention process,
--The consideration of the company's business, recent significant 
activities, and related financial reporting issues and risks, and
--The judgments made about materiality and the effect of those 
judgments on the engagement strategy.

    b. Evaluate the engagement team's assessment of, and audit 
responses to--

--Significant risks identified by the engagement team, including fraud 
risks, and
--Other significant risks identified by the engagement quality reviewer 
through performance of the procedures required by this standard.


    Note: A significant risk is a risk of material misstatement that 
is important enough to require special audit consideration.


    c. Evaluate the significant judgments made about (1) the 
materiality and disposition of corrected and uncorrected identified 
misstatements and (2) the severity and disposition of identified 
control deficiencies.
    d. Review the engagement team's evaluation of the firm's 
independence in relation to the engagement.
    e. Review the engagement completion document \4\ and confirm with 
the engagement partner that there are no significant unresolved 
matters.
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    \4\ Paragraph 13 of PCAOB Auditing Standard No. 3, Audit 
Documentation, requires the auditor to identify all significant 
findings or issues in an engagement completion document.
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    f. Review the financial statements, management's report on internal 
control, and the related engagement report.
    g. Read other information in documents containing the financial 
statements to be filed with the Securities and Exchange Commission 
(``SEC'') \5\ and evaluate whether the engagement team has taken 
appropriate action with respect to any material inconsistencies with 
the financial statements or material misstatements of fact of which the 
engagement quality reviewer is aware.
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    \5\ See paragraphs .04-.06 of AU sec. 550, Other Information in 
Documents Containing Audited Financial Statements; AU sec. 711, 
Filings Under Federal Securities Statutes.
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    h. Based on the procedures required by this standard, evaluate 
whether appropriate consultations have taken place on difficult or 
contentious matters. Review the documentation, including conclusions, 
of such consultations.
    i. Based on the procedures required by this standard, evaluate 
whether appropriate matters have been communicated, or identified for 
communication, to the audit committee, management, and other parties, 
such as regulatory bodies.

Evaluation of Engagement Documentation

    11. In an audit, the engagement quality reviewer should evaluate 
whether the engagement documentation that he or she reviewed when 
performing the procedures required by paragraph 10--
    a. Indicates that the engagement team responded appropriately to 
significant risks, and
    b. Supports the conclusions reached by the engagement team with 
respect to the matters reviewed.

Concurring Approval of Issuance

    12. In an audit, the engagement quality reviewer may provide 
concurring approval of issuance only if, after performing with due 
professional care \6\ the review required by this standard, he or she 
is not aware of a significant engagement deficiency.
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    \6\ See AU sec. 230, Due Professional Care in the Performance of 
Work.

    Note: A significant engagement deficiency in an audit exists 
when (1) the engagement team failed to obtain sufficient appropriate 
evidence in accordance with the standards of the PCAOB, (2) the 
engagement team reached an inappropriate overall conclusion on the 
subject matter of the engagement, (3) the engagement report is not 
appropriate in the circumstances, or (4) the firm is not independent 
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of its client.

    13. In an audit, the firm may grant permission to the client to use 
the engagement report only after the engagement quality reviewer 
provides concurring approval of issuance.\7\
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    \7\ Concurring approval of issuance by the engagement quality 
reviewer also is required when reissuance of an engagement report 
requires the auditor to update his or her procedures for subsequent 
events. In that case, the engagement quality reviewer should update 
the engagement quality review by addressing those matters related to 
the subsequent events procedures.

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[[Page 57359]]

    Engagement Quality Review for a Review of Interim Financial 
Information:

Engagement Quality Review Process

    14. In an engagement to review interim financial information, the 
engagement quality reviewer should evaluate the significant judgments 
made by the engagement team and the related conclusions reached in 
forming the overall conclusion on the engagement and in preparing the 
engagement report, if a report is to be issued. To evaluate such 
judgments and conclusions, the engagement quality reviewer should, to 
the extent necessary to satisfy the requirements of paragraphs 15 and 
16: (1) Hold discussions with the engagement partner and other members 
of the engagement team, and (2) review documentation.
    15. In a review of interim financial information, the engagement 
quality reviewer should:
    a. Evaluate the significant judgments that relate to engagement 
planning, including the consideration of--

--The firm's recent engagement experience with the company and risks 
identified in connection with the firm's client acceptance and 
retention process,
--The company's business, recent significant activities, and related 
financial reporting issues and risks, and
--The nature of identified risks of material misstatement due to fraud.

    b. Evaluate the significant judgments made about (1) the 
materiality and disposition of corrected and uncorrected identified 
misstatements and (2) any material modifications that should be made to 
the disclosures about changes in internal control over financial 
reporting.
    c. Perform the procedures described in paragraphs 10.d and 10.e.
    d. Review the interim financial information for all periods 
presented and for the immediately preceding interim period, 
management's disclosure for the period under review, if any, about 
changes in internal control over financial reporting, and the related 
engagement report, if a report is to be issued.
    e. Read other information in documents containing interim financial 
information to be filed with the SEC \8\ and evaluate whether the 
engagement team has taken appropriate action with respect to material 
inconsistencies with the interim financial information or material 
misstatements of fact of which the engagement quality reviewer is 
aware.
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    \8\ See AU sec. 722.18f; AU sec. 711.
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    f. Perform the procedures in paragraphs 10.h and 10.i.

Evaluation of Engagement Documentation

    16. In a review of interim financial information, the engagement 
quality reviewer should evaluate whether the engagement documentation 
that he or she reviewed when performing the procedures required by 
paragraph 15 supports the conclusions reached by the engagement team 
with respect to the matters reviewed.

Concurring Approval of Issuance

    17. In a review of interim financial information, the engagement 
quality reviewer may provide concurring approval of issuance only if, 
after performing with due professional care the review required by this 
standard, he or she is not aware of a significant engagement 
deficiency.

    Note: A significant engagement deficiency in a review of interim 
financial information exists when (1) the engagement team failed to 
perform interim review procedures necessary in the circumstances of 
the engagement, (2) the engagement team reached an inappropriate 
overall conclusion on the subject matter of the engagement, (3) the 
engagement report is not appropriate in the circumstances, or (4) 
the firm is not independent of its client.

    18. In a review of interim financial information, the firm may 
grant permission to the client to use the engagement report (or 
communicate an engagement conclusion to its client, if no report is 
issued) only after the engagement quality reviewer provides concurring 
approval of issuance.
    Documentation of an Engagement Quality Review:
    19. Documentation of an engagement quality review should contain 
sufficient information to enable an experienced auditor, having no 
previous connection with the engagement, to understand the procedures 
performed by the engagement quality reviewer, and others who assisted 
the reviewer, to comply with the provisions of this standard, including 
information that identifies:
    a. The engagement quality reviewer, and others who assisted the 
reviewer,
    b. The documents reviewed by the engagement quality reviewer, and 
others who assisted the reviewer,
    c. The date the engagement quality reviewer provided concurring 
approval of issuance or, if no concurring approval of issuance was 
provided, the reasons for not providing the approval.
    20. Documentation of an engagement quality review should be 
included in the engagement documentation.
    21. The requirements related to retention of and subsequent changes 
to audit documentation in PCAOB Auditing Standard No. 3, Audit 
Documentation, apply with respect to the documentation of the 
engagement quality review.

Conforming Amendment to PCAOB Interim Quality Control Standards

    QC sec. 20, ``System of Quality Control for a CPA Firm's Accounting 
and Auditing Practice''
    QC section (``sec.'') 20, ``System of Quality Control for a CPA 
Firm's Accounting and Auditing Practice'' of the Board's interim 
quality control standards is amended as follows--
    The third sentence of paragraph .18 of QC sec. 20 is replaced with 
the following sentence:
    These policies and procedures also should address engagement 
quality reviews pursuant to PCAOB Auditing Standard No. 7, Engagement 
Quality Review.

II. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rules

    In its filing with the Commission, the Board included statements 
concerning the purpose of, and basis for, the proposed rules and 
discussed any comments it received on the proposed rules. The text of 
these statements may be examined at the places specified in Item IV 
below. The Board has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements.

A. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rules

(a) Purpose
    Section 103 of the Sarbanes-Oxley Act (the ``Act'') directs the 
Board, among other things, to set standards for public company audits, 
including a requirement for each registered public accounting firm to 
``provide a concurring or second partner review and approval of [each] 
audit report (and other related information), and concurring approval 
in its issuance * * * .''
    As discussed more fully in Exhibit 3, the Board adopted Auditing 
Standard No. 7 because it believed that a well-performed engagement 
quality review (``EQR'') can serve as an important safeguard against 
erroneous or insufficiently supported audit opinions and, accordingly, 
can contribute to audit quality. The proposed rules are intended to 
enhance the quality of the EQR by strengthening the existing

[[Page 57360]]

requirements. Auditing Standard No. 7 provides for a rigorous review 
that will serve as a meaningful check on the work performed by the 
engagement team and, the Board believes, should increase the likelihood 
that a registered public accounting firm will catch any significant 
engagement deficiencies before it issues its audit report. As a result, 
the Board recognizes that more work may be necessary under Auditing 
Standard No. 7 than was performed in some concurring reviews under the 
existing requirements.
    Auditing Standard No. 7 requires the engagement quality reviewer 
(or the ``reviewer'') to evaluate the significant judgments made and 
related conclusions reached by the engagement team in forming the 
overall conclusion on the engagement and in preparing the engagement 
report. Auditing Standard No. 7 also requires the engagement quality 
reviewer to perform certain procedures designed to focus the reviewer 
on those judgments and conclusions. The procedures required of the 
reviewer by Auditing Standard No. 7 are different in nature from the 
procedures required of the engagement team. Unlike the engagement team, 
a reviewer does not perform substantive procedures or obtain sufficient 
evidence to support an opinion on the financial statements or internal 
control over financial reporting. If more audit work is necessary 
before the reviewer may provide concurring approval of issuance, the 
engagement team--not the reviewer--is responsible under PCAOB standards 
for performing the work. In contrast, the reviewer fulfills his or her 
responsibility to perform an effective review of the engagement under 
the EQR standard by holding discussions with the engagement team, 
reviewing documentation, and determining whether he or she can provide 
concurring approval of issuance.
    The proposed rules also amend the Board's interim quality control 
standards by replacing the third sentence of paragraph .18 in QC 
section 20, ``System of Quality Control for a CPA Firm's Accounting and 
Auditing Practice'' with a statement indicating that these policies and 
procedures also should address engagement quality reviews pursuant to 
PCAOB Auditing Standard No. 7.
(b) Statutory Basis
    The statutory basis for the proposed rules is Title I of the Act.

B. Board's Statement on Burden on Competition

    The Board does not believe that the proposed rule changes will 
result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act. The proposed 
rule changes would apply equally to all registered public accounting 
firms.

C. Board's Statement on Comments on the Proposed Rules Received From 
Members, Participants or Others

    The Board released the proposed rules for public comment in PCAOB 
Release No. 2008-002 (February 26, 2008). The Board received 38 written 
comments. The Board considered these comments and made significant 
changes to the initial proposed rules. As a result, the Board again 
sought public comment in PCOAB Release No. 2009-001 (March 4, 2009). 
The Board received 30 written comment letters relating to its 
reproposal of the proposed rules. A copy of PCAOB Release Nos. 2008-002 
and 2009-001 and the comment letters received in response to the 
PCAOB's request for comment in both releases are available on the 
PCAOB's Web site at www.pcaobus.org.
    The Board has carefully considered all comments it has received. In 
response to the written comments received on both the initial and 
reproposal of the proposed rules, the Board has clarified and modified 
certain aspects of the proposed rules, as discussed below.
    Overview of Auditing Standard No. 7:
    Overall, commenters preferred the reproposed standard to the 
original proposal, though some continued to believe that certain 
provisions were unclear and suggested certain changes to the standard. 
After considering commenters' feedback, the Board has made several 
modifications to the EQR standard to provide additional clarity. This 
section describes the comments received, the Board's response, and 
changes made in AS No. 7.\9\
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    \9\ The Board received some comments related to its standard-
setting process in general. The Board continuously endeavors to 
improve its processes, including its standard-setting process, and 
is considering these comments as it does so.
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Applicability of the EQR Requirement

    Paragraph 1 of the reproposed standard required an EQR for audit 
engagements and reviews of interim financial information (``interim 
reviews''), but not for other engagements performed according to the 
standards of the PCAOB. For the most part, commenters believed that 
this provision was appropriate.\10\ One commenter, however, suggested 
including the EQR requirements for interim reviews in AU section 
(``sec.'') 722, Interim Financial Information, instead of including 
them as part of the EQR standard to ``make it clear that the scope of 
the procedures performed remain under the umbrella of the objective of 
a review of interim financial information (which is much different than 
the scope and objective of an audit).'' Because the requirements for 
the EQR of interim reviews in AS No. 7 are closely related to and 
described by reference to the requirements for the EQR of an audit, the 
Board believes it is more appropriate to locate both sets of 
requirements in the same standard. Accordingly, the Board is adopting 
the provisions regarding applicability of the EQR standard as 
reproposed.
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    \10\ One commenter did not believe that an EQR should be 
required for interim reviews because of concerns about the scope of 
the EQR for interim reviews. The section entitled Specifically 
Required Procedures in the EQR of an Interim Review discusses the 
EQR requirements for interim reviews.
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Statement of Objective

    The reproposed standard included a statement of objective intended 
to focus reviewers on the overall purpose of the standard as they carry 
out the more specific EQR requirements. As reproposed, the objective of 
the engagement quality reviewer was ``to perform an evaluation of the 
significant judgments made by the engagement team and the conclusions 
reached in forming the overall conclusion on the engagement and in 
preparing the engagement report, if a report is to be issued, in order 
to determine whether to provide concurring approval of issuance.''
    Most commenters agreed that the EQR standard should include a 
statement of objective. While some believed the objective was 
appropriate as reproposed, several suggested substituting the phrase 
``related conclusions reached'' for ``the conclusions reached'' to 
indicate that the reviewer is required to evaluate conclusions relating 
to significant judgments, rather than all conclusions. In addition, 
some commenters suggested making the objective less vague, while others 
wanted the Board to broaden it or make it less procedural.
    After considering these comments, the Board has, as suggested by 
commenters, revised the objective so that it refers to ``significant 
judgments made by the engagement team \11\ and the related

[[Page 57361]]

conclusions reached * * * .'' (emphasis added). This change should help 
reviewers maintain their focus on areas of the engagement that are most 
likely to contain a significant engagement deficiency. With this 
revision, the Board believes the statement of objective establishes, at 
the appropriate level of detail, a framework for the performance of the 
EQR that is consistent with the specific requirements in AS No. 7. 
Corresponding changes have been made in paragraphs 9 and 14, which 
describe the scope of the EQR for audits and interim reviews, 
respectively. The reviewer achieves his or her objective by complying 
with the specific requirements of the standard.
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    \11\ Because the engagement partner has final responsibility for 
the engagement, he or she has final responsibility for the 
significant judgments made during the engagement, notwithstanding 
any involvement in or responsibility for those judgments by firm 
personnel outside of the engagement team, such as members of the 
firm's national office. Accordingly the ``significant judgments made 
by the engagement team'' include all of the significant judgments 
made during the engagement.
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Qualifications of the Engagement Quality Reviewer

    In order to provide for a high-quality EQR, the reproposed standard 
described the qualifications that any reviewer would be required to 
meet. These provisions were designed to provide assurance that the 
reviewer could effectively perform an EQR of the particular engagement 
under review. At the same time, the provisions recognized that smaller 
firms may have few partners--and, in the case of sole practitioners, no 
additional partners--available in-house to perform the EQR.
    Accordingly, the reproposed standard required an engagement quality 
reviewer from within the firm issuing the engagement report to be a 
partner or another individual in an equivalent position, but also 
allowed a qualified individual from outside the firm to perform the 
EQR. In either event, the reproposed standard required the reviewer to 
be an associated person \12\ of a registered public accounting 
firm.\13\ The reproposed standard also included a general competence 
requirement and requirements related to the reviewer's independence, 
integrity, and objectivity.
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    \12\ For clarity, in paragraph 3 of AS No. 7, the Board added a 
reference to Rule1001(p)(i), which defines the term ``associated 
person of a registered public accounting firm.'' A person not 
already associated with a registered firm can enter into a 
relationship with the firm issuing the report such that the person 
would become associated with that firm by performing the review. 
Specifically, a person not already associated with a firm would 
become associated with the firm issuing the report if he or she 
(rather than, or in addition to, his or her firm or other employer): 
(1) Receives compensation from the firm issuing the report for 
performing the review or (2) performs the review as agent for the 
firm issuing the report. For example, if the firm issuing the report 
contracts directly with an employee of an unregistered accounting 
firm to perform the engagement quality review, that person would 
become associated with the firm issuing the report by virtue of that 
independent contractor relationship.
    \13\ A registered public accounting firm has an obligation to 
secure and enforce consents to cooperate with the Board from each 
associated person of the firm, see Section 102(b)(3) of the Act, 
including those who become associated with the firm by performing 
the review. The Board also may directly sanction any such person who 
fails to cooperate in an investigation or inspection. See Section 
105(b)(3) of the Act and PCAOB Rules 5110 and 4006.
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    In-House Reviewer: Partner or an Individual in an Equivalent 
Position:
    The requirement in the reproposed standard for a reviewer from 
within the firm to be a partner or an individual in an equivalent 
position was intended to address concerns expressed by some commenters 
on the original proposal about the authority of the engagement quality 
reviewer relative to that of the engagement partner. Because the EQR is 
intended to be an objective second look at work performed by the 
engagement team, the reviewer should be able to withstand pressure from 
the engagement partner or other firm personnel, such as members of the 
firm's national office. As described in the reproposing release, the 
Board believed that concerns about authority will most often arise when 
the reviewer and the engagement partner work at the same firm. The 
Board also believed that a standard based on perceptions of relative 
authority within a firm would not be sufficiently clear to be workable. 
Accordingly, the Board attempted to address these concerns with a 
requirement that an in-house reviewer--but not one from outside the 
firm--be a partner or person in an equivalent position.
    While some commenters supported the reproposed requirement, others 
disagreed with it, generally because, in their view, being a partner or 
person in an equivalent position would not necessarily ensure that the 
reviewer possesses the qualities required to perform the EQR. These 
commenters noted that partners as well as non-partners may be subject 
to internal pressure within the firm to provide concurring approval of 
issuance. In addition, in one commenter's view, it would be burdensome 
for one-partner firms to hire an outside reviewer to comply with this 
requirement. Finally, some commenters also asked the Board to define 
the term ``equivalent position.''
    While both partners and non-partners may experience pressure within 
the firm to provide concurring approval of issuance, the Board 
continues to believe that the reproposed requirement is the most 
appropriate way to address this issue. Partnership is not a perfect 
proxy for authority, but a partner is more likely to possess sufficient 
authority to conduct the EQR than a non-partner. The Board continues to 
believe that a requirement based on perceptions of authority would not 
be workable. Accordingly, the Board is adopting this requirement 
substantially as reproposed.\14\ At a firm that is not organized as a 
partnership, ``an individual in an equivalent position'' is someone 
with the degree of authority and responsibility of a partner in a firm 
that is organized as a partnership.
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    \14\ One commenter suggested that the phrasing of the reproposed 
standard did not establish a requirement for the in-house reviewer 
to be a partner because it stated that the reviewer ``may be'' a 
partner, a person in an equivalent position, or an individual 
outside the firm. While the use of ``may'' in that context imposed a 
requirement, to avoid any confusion on this point the Board has 
rephrased the requirement in paragraph 3 of AS No. 7 to use the word 
``must.''
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    Qualified Reviewer from Outside the Firm:
    As noted above, the reproposed standard also allowed a qualified 
reviewer from outside the firm to conduct the review. In the 
reproposing release, the Board expressed the view that allowing a 
sufficiently qualified professor or other individual not employed by an 
accounting firm to perform the EQR should not negatively affect audit 
quality and may mitigate the compliance burden on sole practitioners 
and smaller firms. The Board sought comment on whether a qualified 
accountant who is not employed by an accounting firm should be allowed 
to conduct the EQR.\15\
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    \15\ As noted in the reproposing release, under the existing 
requirement a firm may seek a waiver to engage an outside 
experienced individual to perform the EQR. Because AS No. 7 allows a 
firm to use an outside reviewer, such a waiver is not necessary 
under AS No. 7.
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    The majority of commenters on this topic did not oppose the 
reproposed provision. Some commenters, however, cautioned that 
reviewers from outside an accounting firm may not necessarily have the 
required technical expertise or recent audit experience. One commenter 
believed that allowing the use of such outside reviewers could ``hamper 
the existing independence rules,'' \16\ increase costs, and limit the 
potential growth of partners.
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    \16\ The comment did not explain how the independence rules 
would be hampered.
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    After considering these comments, the Board continues to believe 
that the EQR standard can--and should--allow firms the proposed 
flexibility in choosing a reviewer, provided that reviewer meets the 
competence and other qualification requirements. According to these 
requirements, as discussed below, any reviewer would have to have the 
level of knowledge and competence related to accounting, auditing, and 
financial reporting required to serve as the person

[[Page 57362]]

who has overall responsibility for the engagement under review. 
Accordingly, while some persons from outside a firm might not have the 
required qualifications, those who do can effectively perform the 
EQR.\17\
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    \17\ Similarly, a reviewer does not meet all of the 
qualification requirements in AS No. 7 by virtue of his or her 
status as a partner or employee of an accounting firm.
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    The Board also does not agree that allowing the use of a reviewer 
from outside the firm issuing the report would negatively affect the 
application or enforcement of the independence rules. As the Board 
noted in the reproposing release, it will continue to consider anyone 
who performs the EQR to be an ``audit partner'' and a member of the 
``audit engagement team'' for purposes of independence 
requirements.\18\ In addition, because AS No. 7 would not require a 
firm to use an outside reviewer, allowing a firm to do so should not 
increase costs or limit the potential growth of partners. Any firm that 
is concerned that invoking the flexibility provided by the EQR standard 
would raise its costs or impede the development of its partners could, 
simply, decline to do so and use a reviewer from within the firm if one 
is available.
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    \18\ See Rule 2-01(f) of Regulation S-X, 17 CFR 210.2-01(f), for 
the definitions of ``audit partner'' and ``audit engagement team.''
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    When considering an outside individual for the role of the 
engagement quality reviewer, the firm will likely need to make 
additional inquiries to obtain necessary information about the 
individual's qualifications. For example, while information about 
independence of the firm's partners is typically collected and 
evaluated as part of the periodic independence review, information 
about the independence of an outside reviewer will likely need to be 
requested and evaluated as part of the reviewer selection process. 
Firms also likely know more about the competence of their own partners 
than of an outside reviewer.
    General Competence Requirement:
    As noted above, the reproposed standard, like the original 
proposal, included a requirement for the reviewer to ``possess the 
level of knowledge and competence related to accounting, auditing, and 
financial reporting required to serve as the person who has overall 
responsibility for the same type of engagement.'' This provision was 
intended to set a minimum requirement for those who would perform the 
EQR. In response to comments on the original proposal, the reproposing 
release explained that this provision, by its terms, did not require 
the engagement quality reviewer's knowledge and competence to match 
those of the engagement partner, or for the reviewer to be a ``clone'' 
of the engagement partner.\19\
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    \19\ Specifically, the reproposing release noted:
    The general competence provision merely sets a minimum 
requirement for those who would perform the EQR, but it does not 
require the reviewer's competence to match that of the engagement 
partner. In many cases, both individuals' competence will exceed the 
minimum level prescribed, but there is no requirement that they do 
so in tandem, or even at all.
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    Some commenters reiterated their concerns that the engagement 
quality reviewer's skills would be expected to match those of the 
engagement partner, and that such a requirement could cause resource 
constraints for smaller firms. Other commenters suggested modifying the 
general competence provision by stating that the reviewer's competence 
should be established based on the facts and circumstances of the 
engagement, or describing the required qualifications from the 
reviewer's perspective, rather than by comparing them to the 
qualifications of the engagement partner. Finally, some commenters 
suggested including in the EQR standard a statement that the reviewer 
may obtain the required level of knowledge and competence through 
utilizing assistants.
    The Board continues to believe that if a minimum level of knowledge 
and competence in accounting, auditing, and financial reporting is 
required to conduct an audit, it is similarly necessary to effectively 
review that audit.\20\ The reviewer is not required to possess other 
competencies, e.g., those related to communication or management 
skills, that the engagement partner may have.
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    \20\ While a reviewer may use assistants in performing the EQR, 
the reviewer's own skills should meet the requirements of AS No. 7.
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    Accordingly, the Board is adopting the general competence provision 
substantially as proposed. The Board is, however, modifying the 
requirement to clarify further that the determination of what 
constitutes the appropriate level of knowledge and competence should be 
based on the circumstances of the engagement, including the size and 
complexity of the business under audit or under interim review.\21\ In 
AS No. 7, the Board replaced the phrase ``the same type of engagement'' 
with ``the engagement.'' The new phrasing focuses the reviewer on the 
particular engagement under review, rather than that ``type'' of 
engagement.\22\ Firms that do not have partners that meet this general 
competence requirement available to perform the EQR may engage an 
outside reviewer to perform an EQR.
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    \21\ Footnote 18 on page 9 of the original release stated, ``The 
determination of what constitutes the appropriate level of knowledge 
and competence should be based on the circumstances of the 
engagement, including the size or complexity of the business.''
    \22\ In addition, to simplify the text of AS No. 7, the Board 
replaced the phrase ``person with overall responsibility for the 
engagement'' with the term ``engagement partner.'' Footnote 3 of AS 
No. 7 explains that the term ``engagement partner'' has the same 
meaning as the phrases the ``auditor with final responsibility for 
the audit,'' as described in AU sec. 311, Planning and Supervision, 
and the ``practitioner-in-charge of an engagement,'' as described in 
PCAOB interim quality control standard QC sec. 40, The Personnel 
Management Element of a Firm's System of Quality Control-
Competencies Required by a Practitioner-in-Charge of an Attest 
Engagement. Because all of these terms refer to the same person, 
this change does not alter the meaning of the EQR standard.
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    Independence, Integrity, and Objectivity:
    Like the original proposal, the reproposed standard required the 
reviewer to be independent of the company, perform the review with 
integrity, and maintain objectivity. Comments on the reproposal focused 
on two provisions regarding objectivity--the prohibition against the 
reviewer supervising the engagement team and the two-year ``cooling-
off'' period before the engagement partner could perform the EQR.
    Supervision of the Engagement Team:
    The reproposed standard provided that to maintain objectivity the 
engagement quality reviewer should not, among other things, ``supervise 
the engagement team with respect to the engagement subject to the 
engagement quality review.'' The phrase ``subject to the engagement 
quality review'' was intended to clarify that partners with leadership 
responsibilities in a firm, region, service, or industry practice are 
not, solely because of those responsibilities, precluded from reviewing 
any engagement performed by their subordinates in the firm. Some 
commenters believed that the phrase ``subject to the engagement quality 
review'' was not sufficient to clarify this point.
    After considering these comments, the Board has decided that the 
express prohibition against ``supervis[ing] the engagement team with 
respect to the engagement subject to the engagement quality review'' is 
not necessary to effectuate the Board's intent. The remaining two 
criteria for maintaining objectivity in paragraph 7 of AS No. 7--not 
making decisions on behalf of the engagement team and not assuming any 
responsibilities of the engagement team--are sufficient to preclude 
those involved in the engagement from

[[Page 57363]]

serving as the engagement quality reviewer.\23\ For example, partners 
(including the engagement partner and other partners on larger 
engagements), managers, and others who supervise engagement personnel 
on the audit under review would not qualify under the remaining 
criteria because they have assumed responsibilities of the engagement 
team. At the same time, removing the phrase ``supervise the engagement 
team'' from AS No. 7 should further clarify that those in leadership 
positions in the firm who did not make decisions for or assume 
responsibilities of the engagement team may perform the EQR.
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    \23\ AS No. 7 does not prohibit the engagement team from 
consulting with the reviewer, as long as the reviewer maintains his 
or her objectivity in accordance with paragraph 7. As noted in the 
reproposing release, such consultations may contribute to audit 
quality. In addition, one commenter asked the Board to clarify 
whether a reviewer may consult with the same personnel who 
previously consulted with the engagement team. The EQR standard does 
not prohibit the reviewer from holding discussions with such 
personnel. The reviewer may not, however, use personnel who 
previously consulted with the engagement team as assistants in 
performing the review unless they meet the objectivity and other 
qualification requirements of AS No. 7. To emphasize the requirement 
that assistants maintain objectivity, the Board added to paragraph 7 
of AS No. 7 the phrase ``and others who assist the reviewer.''
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    The Two-Year ``Cooling-Off'' Period:
    The reproposed standard included a provision prohibiting an 
engagement partner from serving as the engagement quality reviewer for 
at least two years following his or her last year as the engagement 
partner.\24\ The Board included the ``cooling-off'' period because it 
believed that it would be harder for an engagement partner who has had 
overall responsibility for the audit for at least a year to perform the 
review with the necessary level of objectivity. While a number of 
commenters expressed general support for a two-year ``cooling-off'' 
period, some believed that it could impose an undue hardship on smaller 
firms, and suggested a shorter ``cooling-off'' period.
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    \24\ SEC independence rules allow engagement partners and 
concurring partners to serve for five consecutive years, after which 
they may not serve in either role for another period of five years. 
Within a five-year period, SEC independence rules do not impose a 
``cooling-off'' period before the engagement partner can serve as 
the concurring partner. See Rule 2--01(c)(6)(i)(A) of Regulation S-
X.
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    After considering these comments, the Board continues to believe 
that a ``cooling-off'' period will be beneficial to audit quality and 
that a two-year period appropriately safeguards objectivity without 
imposing unnecessary hardship on most firms. At the same time, the 
Board recognizes that compliance with this requirement could be 
difficult for smaller firms with fewer personnel. In its independence 
rules, the Securities and Exchange Commission (``SEC'') exempted 
certain smaller firms from the audit partner rotation requirements. 
Specifically, Rule 2-01(c)(6)(ii) of Regulation S-X provides an 
exemption for firms with fewer than five issuer audit clients and fewer 
than ten partners, provided the Board ``conducts a review at least once 
every three years of each of the audit client engagements that would 
result in a lack of auditor independence under'' the SEC partner 
rotation requirements. The Board believes that this exemption--
including the provision regarding Board inspections--also describes an 
appropriate exemption from the ``cooling-off'' requirement in the EQR 
standard. Accordingly, firms that qualify for the exemption from the 
SEC partner rotation requirements will also be exempt from the 
``cooling-off'' period under AS No. 7.

EQR Process

    The Board's goal in proposing an EQR standard was to strengthen the 
existing requirements for concurring reviews in order to promote a more 
meaningful review of the work performed by the engagement team. 
Accordingly, the original proposal described certain procedures that 
the reviewer was required to perform that were more specific than those 
in the existing requirements. In response to comments received on the 
original proposal, the Board clarified some of the specifically 
required procedures and included, in a separate section in the 
reproposed standard, tailored requirements for an EQR of an interim 
review.
    In general, commenters believed that the reproposed standard 
described the requirements of the EQR more clearly than the original 
proposal. However, a number of commenters suggested additional 
modifications that, in their view, would further clarify the Board's 
intent and ensure consistency of the requirements with the statement of 
objective. As described below, after considering these comments, the 
Board has modified certain of these requirements.

Terminology Used To Describe the Required Procedures

    Several commenters noted that the specifically required procedures 
in paragraphs 9, 10, 14, and 15 of the reproposed standard were 
described using different, but in some cases similar, terms such as 
``determine,'' ``evaluate,'' ``identify,'' ``read,'' and ``review,'' 
which some commenters found confusing. In one commenter's view, the 
terms ``determine,'' ``identify,'' and ``evaluate'' may require the 
reviewer to perform procedures that are similar in scope to the 
procedures performed by the engagement partner. The commenters asked 
the Board to clarify the terminology in these sections of the EQR 
standard.
    While the Board does not believe that this terminology required the 
reviewer to perform procedures that are appropriately performed by the 
engagement partner, it does agree that the terminology should not be 
confusing. Accordingly, the Board reduced the number of terms used in 
AS No. 7, so that the required procedures in paragraphs 9, 10, 14, and 
15 are described using two terms, ``evaluate'' and ``review''--with one 
exception. Because AU sec. 550, Other Information in Documents 
Containing Audited Financial Statements, requires the auditor to read 
other information in documents containing the financial statements to 
be filed with the SEC, paragraphs 10.g and 15.e of AS No. 7, like in 
the original and reproposed standards, also require the reviewer to 
read such other information and evaluate whether the engagement team 
has taken appropriate action with respect to any material 
inconsistencies with the financial statements or interim financial 
information, respectively, or material misstatements of fact of which 
the engagement quality reviewer is aware.
    Review of Documentation:
    A number of commenters viewed the statement in paragraphs 9 and 14 
of the reproposed standard that ``the reviewer should perform the 
procedures * * * by reviewing documentation'' as too open-ended.\25\ 
Commenters were concerned that this provision could be interpreted to 
require the review of all of the engagement documentation.
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    \25\ That statement was intended, along with other changes in 
the reproposed standard, to clarify that the EQR is a review of the 
engagement team's work rather than a second audit. See page 17 of 
the reproposing release.
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    The Board did not intend to require--and the reproposed provision 
did not require--the reviewer to review all of the engagement 
documentation. Nevertheless, to clarify this point, the Board has added 
the phrase ``to the extent necessary to satisfy the requirements'' of 
paragraphs 10 and 11, in an EQR of an audit, and 15 and 16, in an EQR 
of an interim review. As a practical matter, the reviewer cannot comply 
with the requirements of the EQR standard without holding discussions 
with the engagement partner and reviewing documentation. AS No. 7 
requires the reviewer to hold

[[Page 57364]]

sufficient discussions with the engagement partner and other members of 
the engagement team and review sufficient documentation to perform the 
required procedures with due professional care. What is sufficient will 
necessarily depend on the facts and circumstances of the particular 
engagement under review. Auditors often document their significant 
judgments and conclusions in various summary documents, which could 
serve as a starting point for the reviewer's evaluation of the 
engagement team's work.
    Paragraph 11 of the reproposed standard required the reviewer, in 
an EQR of an audit, to evaluate whether the engagement documentation 
that he or she reviewed when performing the procedures required by 
paragraph 10 indicates that the engagement team responded appropriately 
to significant risks and supports the conclusions reached by the 
engagement team with respect to the matters reviewed. One commenter 
suggested adding a requirement to paragraph 11 to evaluate engagement 
documentation for compliance with the requirements of Auditing Standard 
No. 3, Audit Documentation (``AS No. 3''). The Board originally 
proposed such a requirement but, in response to comments, did not 
include it in the reproposed standard.\26\ The Board continues to 
believe that the documentation review requirements of paragraph 11 of 
the reproposed standard are appropriate and is adopting them as 
reproposed.
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    \26\ Commenters suggested that such a requirement would 
duplicate the documentation review performed by the engagement 
partner.
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    In an EQR of an interim review, paragraph 16 of the reproposed 
standard required the reviewer to evaluate whether the engagement 
documentation that he or she reviewed ``[i]ndicates that the engagement 
team responded appropriately to significant risks,'' and ``[s]upports 
the conclusions reached by the engagement team with respect to the 
matters reviewed.'' Some commenters noted that the auditor is not 
required to identify significant risks in a review of interim financial 
information and suggested not including a corresponding requirement in 
the EQR standard. The Board agrees and has not included this 
requirement in AS No. 7.
    Specifically Required Procedures in the EQR of an Audit:
    Like the original proposal, the reproposed standard required 
certain procedures designed to give the reviewer the necessary 
information to evaluate the engagement team's significant judgments and 
conclusions. In response to comments on the original proposal, the 
Board made changes to these provisions in the reproposed standard that 
were intended to clarify that the reviewer performs the EQR by 
reviewing the engagement team's work, rather than by auditing the 
company himself or herself. Some commenters suggested that the 
specifically required procedures in the reproposed standard needed 
additional clarification.
    In the view of several commenters, the reproposed standard did not 
clearly articulate the requirement for the reviewer to focus on the 
significant judgments made and the related conclusions reached by the 
engagement team. These commenters believed that the reproposed standard 
might be interpreted as requiring the review of all of the engagement 
team's judgments and conclusions. In response, AS No. 7 refers to 
``significant judgments'' instead of ``judgments'' in describing 
certain of the required procedures.
    The Board also clarified the wording of paragraph 10.b of the 
reproposed standard, which required the reviewer to ``evaluate the risk 
assessments and audit responses. * * *'' Some commenters expressed 
concern that this formulation required a review of audit responses for 
all areas of the audit. In response, AS No. 7 more specifically 
requires the reviewer to evaluate the engagement team's audit responses 
to significant risks identified by the engagement team and other 
significant risks identified by the engagement quality reviewer through 
performance of the procedures required by the EQR standard.\27\ This 
change should help focus reviewers on areas of the audit that are more 
likely to contain a significant engagement deficiency.
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    \27\ The term ``significant risk'' is defined in the Board's 
recently proposed auditing standard on identifying and assessing 
risks of material misstatement to mean a ``risk of material 
misstatement that is important enough to require special audit 
consideration.'' PCAOB Release No. 2008-006, Proposed Auditing 
Standards Related to the Auditor's Assessment of and Response to 
Risk and Conforming Amendments to PCAOB Standards (October 21, 
2008). The Board intends that definition to apply to the EQR 
standard as well. The Board included this definition in a note to 
paragraph 10.b of AS No. 7. If, at the conclusion of the above 
mentioned rulemaking, the Board adopts a definition of significant 
risk that is different from that proposed, the Board will make a 
conforming change to the EQR standard.
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    Some commenters also expressed concern about the requirements in 
paragraphs 10.e and 10.f of the reproposed standard to determine 
whether appropriate matters have been communicated to the audit 
committee, management, and others; and to determine whether appropriate 
consultations have taken place on difficult or contentious matters. 
According to these commenters, a requirement to determine whether all 
of the communications or consultations have taken place rather than to 
evaluate the engagement team's communications and consultations was 
inconsistent with the objective of the EQR. In response, the Board 
replaced the phrase ``determine if'' with ``based on the procedures 
required by this standard, evaluate whether.'' This change should 
tailor the specific requirements more closely to the overall objective. 
The Board also placed these paragraphs after the other required 
procedures in paragraph 10 to emphasize that the reviewer performs the 
evaluation required by these paragraphs based on the information 
obtained through the other procedures required by the EQR standard, and 
made a corresponding change in paragraph 15 for the EQR of an interim 
review.
    Specifically Required Procedures in the EQR of an Interim Review:
    In response to comments on the original proposal, the Board 
included in the reproposed standard separate requirements for reviewing 
audits and interim reviews. The EQR requirements for interim reviews 
were based on the requirements for an EQR of an audit but were tailored 
to the different procedures performed in an interim review. A number of 
commenters were supportive of including separate requirements for the 
EQR of interim reviews in the reproposed standard. Some commenters, as 
discussed below, suggested modifications to those requirements.
    Paragraph 15.a of the reproposed standard required the evaluation 
of engagement planning, including the consideration of the firm's 
recent engagement experience with the company and risks identified in 
connection with the firm's client acceptance and retention process; the 
company's business, recent significant activities, and related 
financial reporting issues and risks; and the nature of identified 
risks of material misstatement due to fraud. In one commenter's view, 
that paragraph might suggest that an interim review should include the 
same type of risk assessment as an audit. After considering this 
comment, the Board disagrees. Paragraph 15.a does not impose a 
requirement on the engagement team to identify risks as part of an 
interim review. Rather, it requires the reviewer to evaluate the 
engagement team's consideration of risks that have already been 
identified, e.g., during the preceding year's audit.

[[Page 57365]]

    Additionally, three commenters recommended not requiring the EQR of 
an interim review to include an evaluation of judgments made about the 
severity and disposition of identified control deficiencies. In one 
commenter's view, such an evaluation would be inconsistent with the 
scope of an interim review. AU sec. 722.07, provides that the auditor:

should perform limited procedures quarterly to provide a basis for 
determining whether he or she has become aware of any material 
modifications that, in the auditor's judgment, should be made to the 
disclosures about changes in internal control over financial 
reporting in order for the certifications to be accurate and to 
comply with the requirements of Section 302 of the Act.

    In response, the Board modified the requirement in paragraph 15.b 
in AS No. 7 to be more consistent with the requirements of AU sec. 722. 
Accordingly, AS No. 7 requires the reviewer, among other things, to 
evaluate significant judgments made about any material modifications 
that should be made to the disclosures about changes in internal 
control over financial reporting.
    Paragraph 15.c of the reproposed standard required the reviewer, in 
the EQR of an interim review, to ``[r]ead the interim financial 
information for all periods presented and for the immediately preceding 
interim period, management's disclosure for the period under review, if 
any, about changes in internal control over financial reporting, and 
the related engagement report, if a report is to be filed with the 
SEC.'' Some commenters suggested that the reviewer should be required 
to read the engagement report even when the issuer is not required to 
include the report in an SEC filing. The Board agrees and, accordingly, 
changed ``to be filed with the SEC'' to ``to be issued.'' \28\
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    \28\ Additionally, one commenter recommended not requiring the 
reviewer to read interim financial information ``for the immediately 
preceding interim period'' because it was not clear, to this 
commenter, what one would review when performing the EQR for the 
first quarter. AU sec. 722.16 requires the accountant to apply 
analytical procedures to the interim financial information, which 
should include, among other things, comparing the quarterly interim 
financial information with comparable information for the 
immediately preceding interim period (i.e., the fourth quarter of 
the prior year, in a first quarter interim review). Because the 
Board believes the reproposed requirement is appropriately within 
the scope of an EQR for an interim review, it has retained it in AS 
No. 7.
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Concurring Approval of Issuance

    For an EQR of an audit, paragraph 12 of the reproposed standard 
provided that the reviewer ``may provide concurring approval of 
issuance only if, after performing with due professional care the 
review required by this standard, he or she is not aware of a 
significant engageme