Public Company Accounting Oversight Board; Notice of Filing of Proposed Rules on Amendments to Auditing Standards for Auditor's Use of the Work of Specialists, 13442-13484 [2019-06425]
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Federal Register / Vol. 84, No. 65 / Thursday, April 4, 2019 / Notices
A. Board’s Statement of the Purpose of,
and Statutory Basis for, the Proposed
Rules
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–85435; File No. PCAOB–
2019–03]
(a) Purpose
Public Company Accounting Oversight
Board; Notice of Filing of Proposed
Rules on Amendments to Auditing
Standards for Auditor’s Use of the
Work of Specialists
March 28, 2019.
Pursuant to Section 107(b) of the
Sarbanes-Oxley Act of 2002 (the ‘‘Act’’
or ‘‘Sarbanes-Oxley Act’’), notice is
hereby given that on March 20, 2019,
the Public Company Accounting
Oversight Board (the ‘‘Board’’ or
‘‘PCAOB’’) filed with the Securities and
Exchange Commission (the
‘‘Commission’’ or ‘‘SEC’’) 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.
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I. Board’s Statement of the Terms of
Substance of the Proposed Rules
On December 20, 2018, the Board
adopted amendments to auditing
standards for using the work of
specialists (collectively, the ‘‘proposed
rules’’), including amendments to two
existing auditing standards and the
retitling and replacement of a third
standard with an updated standard. The
text of the proposed rules appears in
Exhibit A to the SEC Filing Form
19b–4 and is available on the Board’s
website at https://pcaobus.org/
Rulemaking/Pages/docket-044-auditorsuse-work-specialists.aspx and at the
Commission’s Public Reference Room.
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. In addition,
the Board is requesting that, pursuant to
Section 103(a)(3)(C) of the SarbanesOxley Act, the Commission approve the
proposed rules for application to audits
of emerging growth companies
(‘‘EGCs’’).1 The Board’s request is set
forth in section D.
1 The term ‘‘emerging growth company’’ is
defined in Section 3(a)(80) of the Securities
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Summary
The Board has adopted amendments
to its standards for using the work of
specialists (i.e., a person or firm
possessing special skill or knowledge in
a particular field other than accounting
or auditing), including amendments to
two existing auditing standards and the
retitling and replacement of a third
standard with an updated standard. The
amendments are intended to enhance
investor protection by strengthening the
requirements for evaluating the work of
a company’s specialist, whether
employed or engaged by the company,
and applying a supervisory approach to
both auditor-employed and auditorengaged specialists. The amendments
are also designed to be risk-based and
scalable, so that the auditor’s work effort
to evaluate the specialist’s work is
commensurate with the risk of material
misstatement associated with the
financial statement assertion to which
the specialist’s work relates and the
significance of the specialist’s work to
that assertion. These amendments
should lead to more uniformly rigorous
practices among audit firms of all sizes
and enhance audit quality and the
credibility of information provided in
financial statements.
Companies across many industries
use specialists to assist in developing
accounting estimates in their financial
statements. Companies may also use
specialists to interpret laws, regulations,
and contracts or to evaluate the
characteristics of certain physical assets.
Those companies may use a variety of
specialists, including actuaries,
appraisers, other valuation specialists,
legal specialists, environmental
engineers, and petroleum engineers.
Auditors often use the work of these
companies’ specialists as audit
evidence. Additionally, auditors
frequently use the work of auditors’
specialists to assist in their evaluation of
significant accounts and disclosures,
including accounting estimates in those
accounts and disclosures.
As financial reporting frameworks
continue to evolve and require greater
use of estimates, including those based
on fair value measurements, accounting
estimates have become both more
prevalent and significant. As a result,
Exchange Act of 1934 (the ‘‘Exchange Act’’) (15
U.S.C. 78c(a)(80)). See also Inflation Adjustments
and Other Technical Amendments Under Titles I
and III of the JOBS Act, Release No. 33–10332 (Mar.
31, 2017), 82 FR 17545 (Apr. 12, 2017).
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the use of the work of specialists also
continues to increase in both frequency
and significance. If a specialist’s work is
not properly overseen or evaluated by
the auditor, there may be a heightened
risk that the auditor’s work will not be
sufficient to detect a material
misstatement in accounting estimates.
To address this challenge, the Board
has adopted amendments to its auditing
standards that primarily relate to
auditors’ use of the work of specialists.
First, AS 1105, Audit Evidence, is being
amended to add a new Appendix A that
addresses using the work of a
company’s specialist as audit evidence,
based on the risk-based approach of the
risk assessment standards.
New Appendix A of AS 1105
• Supplements the requirements in
AS 1105 for circumstances when the
auditor uses the work of the company’s
specialist as audit evidence, including
requirements related to:
• Obtaining an understanding of the
work and report(s), or equivalent
communication, of the company’s
specialist(s) and related company
processes and controls;
• Obtaining an understanding of, and
assessing, the knowledge, skill, and
ability of a company’s specialist and the
entity that employs the specialist (if
other than the company) and the
relationship to the company of the
specialist and the entity that employs
the specialist (if other than the
company); and
• Performing procedures to evaluate
the work of a company’s specialist,
including evaluating: (i) The data,
significant assumptions, and methods
(which may include models) used by
the specialist, and (ii) the relevance and
reliability of the specialist’s work and
its relationship to the relevant assertion.
• Aligns the requirements for using
the work of a company’s specialist with
the risk assessment standards and the
standard and related amendments
adopted by the Board on auditing
accounting estimates, including fair
value measurements.
• Sets forth factors for determining
the necessary evidence to support the
auditor’s conclusion regarding a
relevant assertion when using the work
of a company’s specialist.
Second, the Board has also amended
AS 1201, Supervision of the Audit
Engagement, by adding a new Appendix
C on supervising the work of auditoremployed specialists, and retitling and
replacing AS 1210, Using the Work of a
Specialist (‘‘existing AS 1210’’), with
new AS 1210, Using the Work of an
Auditor-Engaged Specialist (‘‘AS 1210,
as amended’’), which sets forth
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requirements for using the work of
auditor-engaged specialists.
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New Appendix C of AS 1201
• Supplements the requirements for
applying the supervisory principles in
AS 1201.05–.06 when using the work of
an auditor-employed specialist to assist
the auditor in obtaining or evaluating
audit evidence, including requirements
related to:
• Informing the auditor-employed
specialist of the work to be performed;
• Coordinating the work of the
auditor-employed specialists with the
work of other engagement team
members; and
• Reviewing and evaluating whether
the work of the auditor-employed
specialist provides sufficient
appropriate evidence. Evaluating the
work of the specialist includes
evaluating whether the work is in
accordance with the auditor’s
understanding with the specialist and
whether the specialist’s findings and
conclusions are consistent with, among
other things, the work performed by the
specialist.
• Sets forth factors for determining
the necessary extent of supervision of
the work of the auditor-employed
specialist.
AS 1210, as Amended
• Establishes requirements for using
the work of an auditor-engaged
specialist to assist the auditor in
obtaining or evaluating audit evidence;
• Includes requirements for reaching
an understanding with an auditorengaged specialist on the work to be
performed and reviewing and evaluating
the specialist’s work that parallel the
final amendments to AS 1201 for
auditor-employed specialists;
• Sets forth factors for determining
the necessary extent of review of the
work of the auditor-engaged specialist;
• Amends requirements related to
assessing the knowledge, skill, ability,
and objectivity of the auditor-engaged
specialist; and
• Describes objectivity, for these
purposes, as the auditor-engaged
specialist’s ability to exercise impartial
judgment on all issues encompassed by
the specialist’s work related to the audit,
and specifies the auditor’s obligations
when the specialist or the entity that
employs the specialist has a relationship
with the company that affects the
specialist’s objectivity.
The final amendments strengthen the
requirements for evaluating the work of
a company’s specialist and for
supervising and evaluating the work of
both auditor-employed and auditorengaged specialists. The amendments
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also eliminate certain provisions of
existing PCAOB standards, under
which:
• The auditor has the same
responsibilities under existing AS 1210
with respect to both a company’s
specialist and an auditor-engaged
specialist, even though those specialists
have fundamentally different roles (i.e.,
the company uses the work of its
specialist in the preparation of the
financial statements); and
• Auditor-employed specialists, but
not auditor-engaged specialists, are
subject to risk-based supervision, even
though both serve similar roles in
helping auditors obtain and evaluate
audit evidence.
The Board adopted the final
amendments after substantial outreach,
including two rounds of public
comment. In May 2015, the PCAOB
issued a staff consultation paper to
solicit views on various issues,
including the potential need for
standard setting. In June 2017, the Board
requested comments on proposed
amendments to the standards on using
the work of specialists. The Board
received comments on the staff
consultation paper and the proposal.
The Board’s Standing Advisory Group
(‘‘SAG’’) also discussed this issue at
several meetings. Commenters generally
supported the Board’s objective of
improving the quality of audits
involving specialists, and suggested
areas to further improve the
amendments, modify proposed
requirements that would not likely
improve audit quality, and clarify the
application of the amendments. In
adopting these amendments, the Board
has taken into account all of these
comments and discussions, as well as
observations from PCAOB oversight
activities.
In its consideration of the final
amendments, the Board is mindful of
the significant advances in technology
that have occurred in recent years,
including increased use of data analysis
tools and emerging technologies. An
increased use of technology-based tools,
together with future developments in
the use of data and technology, could
have a fundamental impact on the audit
process. The Board is actively exploring
these potential impacts through ongoing
staff research and outreach. For
example, the PCAOB staff is currently
researching the effects on auditing of
data analytics, artificial intelligence,
distributed ledger technology, and other
emerging technology, assisted by a task
force of the SAG.2
In the context of this rulemaking, the
Board considered how changes in
technology could affect the use of
specialists by companies, the use of the
work of companies’ specialists by
auditors as audit evidence, and the use
of auditor-employed and auditorengaged specialists by auditors to obtain
and evaluate audit evidence. The Board
believes that the final amendments are
sufficiently principles-based and
flexible to accommodate continued
advances in the use of data and
technology by both companies and
auditors. The Board will continue to
monitor advances in this area and any
effect they may have on the application
of the final amendments.
The amendments will apply to all
audits conducted under PCAOB
standards. Subject to approval by the
Commission, the amendments take
effect for audits for fiscal years ending
on or after December 15, 2020.
2 See PCAOB, Changes in Use of Data and
Technology in the Conduct of Audits, available at
https://pcaobus.org/Standards/research-standardsetting-projects/Pages/data-technology.aspx.
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(b) Statutory Basis
The statutory basis for the proposed
rules is Title I of the Act.
B. Board’s Statement on Burden on
Competition
Not applicable. The Board’s
consideration of the economic impacts
of the proposed rules is discussed in
section D below.
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 Proposed
Amendments to Auditing Standards for
Auditor’s Use of the Work of Specialists,
PCAOB Release No. 2017–003 (June 1,
2017) (‘‘Proposal’’). The PCAOB also
issued for public comment Staff
Consultation Paper No. 2015–01, The
Auditor’s Use of the Work of Specialists
(May 28, 2015) (‘‘SCP’’). Copies of
Release No. 2017–003, the SCP, and the
comment letters received in response to
the PCAOB’s requests for comment are
available on the PCAOB’s website at
https://pcaobus.org/Rulemaking/Pages/
docket-044-auditors-use-workspecialists.aspx. The PCAOB received
80 written comment letters. The Board’s
response to the comments received and
the changes made to the rules in
response to the comments received are
discussed below.
Background
Companies across many industries
use various types of specialists to assist
in developing accounting estimates in
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their financial statements.3 Companies
may also use specialists to interpret
laws, regulations, and contracts or to
evaluate the characteristics of certain
physical assets. Those companies may
use a variety of specialists, including
actuaries, appraisers, other valuation
specialists, legal specialists,
environmental engineers, and petroleum
engineers. Auditors often use the work
of these companies’ specialists as audit
evidence. In addition, auditors
frequently use the work of auditors’
specialists to assist in their evaluation of
significant accounts and disclosures,
including accounting estimates in those
accounts and disclosures.
The use of fair value measurements
and other accounting estimates
continues to grow in financial reporting
with, for example, increasing
complexity in business transactions and
changes in the financial reporting
frameworks. As a result, the use of the
work of specialists continues to increase
in both frequency and significance.4 If a
specialist’s work is not properly
overseen or evaluated, however, there is
heightened risk that the auditor’s work
will not be sufficient to detect a material
misstatement in accounting estimates.
The amendments to the standards for
using the work of specialists are
intended to improve audit quality by
strengthening the requirements for
evaluating the work of a company’s
specialist and applying a risk-based
supervisory approach to both auditoremployed and auditor-engaged
specialists. These enhancements should
also lead to improvements in practices,
commensurate with the associated risk,
among audit firms of all sizes. The
expected increase in audit quality
should also enhance the credibility of
information provided to investors.
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Rulemaking History
The amendments to the auditing
standards adopted by the Board (‘‘final
amendments’’ or ‘‘final requirements’’)
reflect public comments on both the
SCP and the Proposal. In May 2015, the
PCAOB issued the SCP to solicit
comments on various issues related to
the auditor’s use of the work of a
3 As used in this notice, a specialist is a person
(or firm) possessing special skill or knowledge in
a particular field other than accounting or auditing.
4 See, e.g., Karin Barac, Elizabeth Gammie, Bryan
Howieson, and Marianne van Staden, The
Capability and Competency Requirements of
Auditors in Today’s Complex Global Business
Environment, at 83 (Mar. 2016) (report
commissioned by the Institute of Chartered
Accountants of Scotland and the Financial
Reporting Council) (stating that ‘‘audit teams now
include many more experts than in the past, and for
some industries, particularly financial services, this
was a welcome development.’’).
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company’s specialist and an auditor’s
specialist, including possible
approaches for changes to PCAOB
standards and the potential economic
impacts of those alternatives.
In June 2017, the PCAOB issued the
Proposal to solicit comments on
amendments to PCAOB standards to
strengthen the requirements for the
auditor’s use of the work of specialists.
The Proposal was informed by
comments on the SCP. The Board
received 35 comment letters on the
Proposal from commenters across a
range of affiliations. The final
amendments are informed by comments
on the Proposal. Those comments are
discussed throughout this notice.
In addition, the Board’s approach has
been informed by, among other things:
(1) Observations from PCAOB oversight
activities and SEC enforcement actions;
(2) the International Auditing and
Assurance Standards Board’s (‘‘IAASB’’)
and the American Institute of Certified
Public Accountants’ Auditing Standards
Board’s auditing standards and IAASB’s
post-implementation review; 5 (3)
substantial outreach, including
discussions with members of the SAG; 6
and (4) the results of academic research.
Overview of Existing Requirements
The primary standard that applies
when auditors use the work of auditorengaged specialists or company
specialists is existing AS 1210. The
primary standard that applies when
auditors use the work of auditoremployed specialists in an audit is AS
1201. Existing AS 1210 was adopted by
the Board in 2003 shortly after the
PCAOB’s inception.7 AS 1201 was one
of eight risk assessment standards
adopted by the Board in 2010.8
5 See IAASB, Clarified International Standards on
Auditing—Findings from the Post-Implementation
Review, at 44–45 (July 2013).
6 See SAG meeting briefing papers and webcast
archives (Nov. 29–30, 2017, Nov. 30–Dec. 1, 2016,
Nov. 12–13, 2015, June 18, 2015, Oct. 14–15, 2009,
and Feb. 9, 2006), available on the Board’s website.
7 See Establishment of Interim Professional
Auditing Standards, PCAOB Release No. 2003–006
(Apr. 18, 2003). AS 1210 was originally adopted by
the PCAOB as AU sec. 336. The PCAOB
renumbered AU sec. 336 as AS 1210 when it
reorganized its auditing standards. See
Reorganization of PCAOB Auditing Standards and
Related Amendments to PCAOB Standards and
Rules, PCAOB Release No. 2015–002 (Mar. 31,
2015).
8 See Auditing Standards Related to the Auditor’s
Assessment of and Response to Risk and Related
Amendments to PCAOB Standards, PCAOB Release
No. 2010–004 (Aug. 5, 2010). Prior to 2010, auditors
supervised employed specialists under AU sec. 311,
Planning and Supervision. Additionally, paragraph
.16 of AS 2101, Audit Planning, requires the auditor
to determine whether specialized skill or
knowledge is needed to perform appropriate risk
assessments, plan or perform audit procedures, or
evaluate audit results.
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Existing AS 1210 provides that a
specialist is ‘‘a person (or firm)
possessing special skill or knowledge in
a particular field other than accounting
or auditing.’’ 9 Existing AS 1210 also
states that income taxes and information
technology (‘‘IT’’) are specialized areas
of accounting and auditing, and
therefore are outside the scope of the
standard.10 Existing AS 1210 applies
when (1) a company engages or employs
a specialist and the auditor uses that
specialist’s work as evidence in
performing substantive tests to evaluate
material financial statement assertions
or (2) an auditor engages a specialist and
uses that specialist’s work as evidence
in performing substantive tests to
evaluate material financial statement
assertions.11
AS 1201 establishes requirements for
the supervision of the audit engagement,
including supervising the work of
engagement team members.12 The
auditor supervises a specialist employed
by the auditor’s firm who participates in
the audit under AS 1201.13 As members
of the engagement team under PCAOB
auditing standards, auditor-employed
specialists are to be assigned based on
their knowledge, skill, and ability.14 AS
1201 also applies in situations in which
persons with specialized skill or
knowledge in IT or income taxes
participate in the audit, regardless of
whether they are employed or engaged
by the auditor’s firm.15
Using the work of a company’s
specialist and an auditor-engaged
specialist under existing AS 1210.
Existing AS 1210 requires that the
auditor perform the following
procedures when using the work of a
company’s specialist or an auditorengaged specialist:
• Evaluate the professional
qualifications of the specialist; 16
• Obtain an understanding of the
nature of the specialist’s work; 17
• Evaluate the relationship of the
specialist to the company, including
circumstances that might impair the
specialist’s objectivity; 18 and
9 See
existing AS 1210.01.
footnote 1 of existing AS 1210.
11 See existing AS 1210.03.
12 See AS 1201.01.
13 See AS 1201.05–.06.
14 See paragraph .05a of AS 2301, The Auditor’s
Responses to the Risks of Material Misstatement,
and paragraph .06 of AS 1015, Due Professional
Care in the Performance of Work. In addition, the
requirements in PCAOB auditing standards for
determining compliance with independence and
ethics requirements also include assessing the
independence of auditor-employed specialists. See
AS 2101.06b.
15 See footnote 1 of existing AS 1210.
16 See existing AS 1210.08.
17 See existing AS 1210.09.
18 See existing AS 1210.10–.11.
10 See
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• In using the findings of the
specialist: 19
• Obtain an understanding of the
methods and assumptions used by the
specialist;
• Make appropriate tests of data
provided to the specialist; and
• Evaluate whether the specialist’s
findings support the financial statement
assertions.
Using the work of a company’s
specialist when auditing fair value
measurements under AS 2502.20 In
circumstances when a company’s
specialist develops assumptions used in
a fair value measurement and the
auditor tests the company’s process, the
auditor is required to evaluate the
reasonableness of those assumptions as
if the assumptions were developed by
the company,21 as well as to comply
with the requirements of existing AS
1210.
Supervising the work of auditoremployed specialists under AS 1201.
This standard establishes requirements
regarding the auditor’s supervision of an
audit engagement, including
supervising the work of auditoremployed specialists and other
members of the engagement team. AS
1201, as it relates to the supervision of
auditor-employed specialists, provides
that:
(1) The engagement partner and
others who assist the engagement
partner in supervising the audit should:
• Inform engagement team members
of their responsibilities;
• Direct engagement team members to
bring significant accounting and
auditing issues arising during the audit
to the attention of the engagement
19 See
existing AS 1210.12.
2502, Auditing Fair Value Measurements
and Disclosures, is being superseded in a separate
PCAOB release. See Auditing Accounting Estimates,
Including Fair Value Measurements and
Amendments to PCAOB Auditing Standards,
PCAOB Release No. 2018–005 (Dec. 20, 2018)
(‘‘Estimates Release’’).
21 See footnote 2 of AS 2502.
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20 AS
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partner or other engagement team
members performing supervisory
activities; and
• Review the work of engagement
team members to evaluate whether:
• The work was performed and
documented;
• The objectives of the procedures
were achieved; and
• The results of the work support the
conclusions reached.22
(2) The necessary extent of
supervision depends on, for example,
the nature of the work performed, the
associated risks of material
misstatement, and the knowledge, skill,
and ability of those being supervised.23
Existing Practice
The PCAOB’s understanding of audit
practice at both larger audit firms 24 and
smaller audit firms 25 under existing
PCAOB standards has been informed by,
among other things, the collective
experience of PCAOB staff, observations
from oversight activities of the Board,
enforcement actions of the SEC,
comments received on the Proposal, and
discussions with the SAG, audit firms,
and specialist entities.
These discussions have included
outreach by the PCAOB staff to audit
22 See
AS 1201.05.
AS 1201.06.
24 Unless otherwise indicated, the term ‘‘larger
audit firms’’ refers to U.S. audit firms that are
registered with the PCAOB and issue audit reports
for more than 100 issuers (and are therefore
annually inspected by the PCAOB). This term also
refers to non-U.S. audit firms that are registered
with the PCAOB and affiliated with one of the six
largest global networks, based on information on
network affiliations reported by non-US. audit firms
on Form 2 in 2017 and identified on the ‘‘Global
Network’’ overview page, available on the Board’s
website.
25 Unless otherwise indicated, the term ‘‘smaller
audit firms’’ refers to PCAOB-registered audit firms
that do not meet the definition of a ‘‘larger audit
firm’’ as provided in footnote 24. These firms
generally consist of firms that issued audit reports
for 100 or fewer issuers and are not affiliated with
any of the six largest global networks identified on
the ‘‘Global Network’’ overview page, available on
the Board’s website.
23 See
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firms and specialist entities to obtain
information on: (1) How auditors
evaluate the competence and objectivity
of auditor-engaged specialists and
company specialists; (2) how auditors
evaluate the work performed by an
auditor-employed specialist, an auditorengaged specialist, and a company’s
specialist; and (3) economic and
demographic considerations relating to
the market for services provided by
specialists. The outreach has informed
the PCAOB’s understanding of existing
practice at both larger and smaller audit
firms. Most commenters who addressed
the topic agreed that the Proposal
accurately described existing audit
practices regarding the use of the work
of specialists. Commenters also
generally supported the PCAOB’s
assessment that the use and importance
of specialists has increased due to
increasing complexity in business
transactions and financial reporting
requirements.
Overview of Existing Practice
When existing AS 1210 was originally
issued in the early 1970s, the use of the
work of specialists was largely confined
to pension obligations, insurance
reserves, and extractive industry
reserves. Since then, the use of the work
of specialists has increased in both
frequency and significance.
Companies across many industries
use the work of specialists to: (1) Assist
them in developing accounting
estimates, including fair value
measurements presented in the
companies’ financial statements; (2)
interpret laws, regulations, and
contracts; or (3) evaluate characteristics
of physical assets, as shown in Figure 1
below. In those circumstances, the
reliability of a company’s financial
statements may depend in part on the
quality of the work of a company’s
specialist.
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FIGURE 1: EXAMPLES OF ACTIVITIES THAT INVOLVE THE WORK OF SPECIALISTS
Auditors also increasingly use the
work of specialists in their audits.
Auditors may:
• Use the work of a company’s
specialist—employed or engaged—as
audit evidence; or
• Use the work of an auditor’s
specialist—employed or engaged—to
assist the auditor in obtaining and
evaluating audit evidence.
Figure 2 illustrates potential ways that
auditors use specialists in an audit.
The company’s specialist (A and B
above) is employed or engaged by the
company to perform work that the
company uses in preparing its financial
statements, which the auditor may use
as audit evidence with respect to
auditing significant accounts and
disclosures. The auditor’s specialist (C
and D above) performs work to assist the
auditor in obtaining and evaluating
audit evidence with respect to a relevant
assertion of a significant account or
disclosure.
The PCAOB understands that audit
practices under existing PCAOB
standards vary among smaller and larger
audit firms when auditors use the work
of a specialist in an audit.26 For
example, smaller audit firms are more
likely to use the work of a company’s
specialist than to employ or engage their
own specialist. Larger audit firms
generally require their engagement
teams to evaluate the work of the
company’s specialist, including the
specialist’s methods and assumptions,
and often employ specialists to assist
their audit personnel in evaluating that
work.27 The following paragraphs
discuss in more detail the practices of
smaller firms and larger firms in audits
of issuers, brokers, and dealers under
existing PCAOB standards.
Smaller firm practices. Smaller firm
practices generally are based on the
required procedures in existing PCAOB
standards, primarily existing AS 1210.
Smaller firms typically evaluate the
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26 As discussed in section D, an analysis of
inspection data by PCAOB staff suggests that larger
audit firms generally use the work of specialists
more often than smaller audit firms do.
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27 An analysis by PCAOB staff indicates that
smaller firms predominantly use the work of an
auditor’s specialist in valuation areas, and seldom
use the work of an auditor’s specialist in other
areas, whereas larger firms tend to use the work of
an auditor’s specialist in a wider range of audit
areas, even though they also primarily use the work
of specialists in valuation areas.
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Valuation:
Assets acquired and liabilities assumed in business combinations
Environmental remediation contingencies
Goodwill impairments
Insurance reserves
Intangible assets
Pension and other post-employment obligations
Impairment of real estate or other long-term assets
Financial instruments
Legal interpretations:
Legal title to property
Laws, regulations, or contracts
Evaluation of physical and other characteristics:
Materials stored in stockpiles
Mineral reserves and condition
Oil and gas reserves
Property, plant, and equipment useful lives and salvage values
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competence, relationships to the
company, and work of the company’s
specialist through inquiries of the
company’s specialist. For example,
smaller firms may send a company’s
specialist a questionnaire to obtain
information regarding the specialist’s
professional qualifications and the
existence of relationships with the
company that could impair the
specialist’s objectivity. Further, smaller
firms typically do not evaluate the
appropriateness of a specialist’s
methods (it is not required by existing
AS 1210), and any evaluation by smaller
firms of the assumptions of a company’s
specialist is generally confined to
circumstances when the specialist
develops assumptions used in a fair
value measurement covered by AS 2502.
In circumstances when smaller firms
engage an auditor’s specialist, some
firms perform the procedures specified
in existing AS 1210. Other firms
perform procedures similar to those in
AS 1201 for supervising members of the
engagement team. For example, some
firms evaluate whether the auditorengaged specialist’s work supports the
financial statement assertions, while
other firms go further by also evaluating
whether (1) the specialist’s work was
performed and documented, (2) the
objectives of the specialist’s procedures
were achieved, and (3) the results of the
specialist’s work support the
conclusions reached. One commenter
noted that smaller firms may also use an
auditor’s specialist in evaluating the
work of a company’s specialist.
Larger firm practices. Some larger
audit firms evaluate the methods and
assumptions used by company
specialists when they test the
company’s process for developing
accounting estimates, even though this
evaluation is currently required only for
significant assumptions developed by
the company’s specialist in conjunction
with fair value measurements and
disclosures.28 Many larger firms employ
their own specialists, who serve on
engagement teams and assist with the
evaluation of the work of company
specialists.
Auditor-employed specialists at larger
firms are generally involved early in the
audit, usually during planning meetings
with other members of the engagement
team. Also, in planning the audit,
auditors generally reach an
understanding with auditor-employed
specialists, documented in a
memorandum, regarding the scope of
work to be performed and the respective
responsibilities of the auditor and the
specialist. The items covered in that
28 See
footnote 2 of AS 2502.
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memorandum typically include: (1) The
nature, scope, and objectives of the
specialist’s work; 29 (2) the role and
responsibilities of the auditor and the
specialist; 30 and (3) the nature, timing,
and extent of communication between
the auditor and the specialist.31 The
auditor communicates with the
specialist as the work progresses to
become aware of issues as they arise.
When the specialist completes his or her
work, the auditor reviews the
specialist’s work, which is typically
documented in a separate report or
memorandum.
In some instances, larger firms may
use the work of a company’s specialist
without involving an auditor’s
specialist, particularly when the risk of
material misstatement is low or the firm
does not employ a specialist with
expertise in the particular field.
Alternatively, although infrequently,
larger firms may engage a specialist with
expertise in the particular field. When
larger firms engage specialists, some
firms perform the procedures specified
in existing AS 1210 described above.
Other firms perform procedures in such
situations that are similar to the
procedures for supervising the work of
auditor-employed specialists under AS
1201.
Observations From Audit Inspections
and Enforcement Cases
The Board’s understanding of audit
practice under existing PCAOB
standards has been informed in part by
observations from PCAOB oversight
activities and SEC enforcement actions,
including (1) audit deficiencies of both
larger and smaller firms, and related
remedial actions to address the
deficiencies and (2) enforcement actions
where the work of a specialist was used
in the audit.
Inspections observations. Over the
past several years, the observations from
PCAOB inspections have included
instances in which the auditor used the
work of a company’s specialist without
performing the procedures required by
existing PCAOB standards.32 Recent
findings include instances in which
29 Examples include whether the specialist is
testing (or assisting in testing) the company’s
process for developing an accounting estimate or
developing (or assisting in developing) an
independent expectation of the estimate.
30 For example, the documentation might identify
the respective responsibilities of the auditor and the
specialist for evaluating data, significant
assumptions, and methods used by the company or
the company’s specialist.
31 Examples include administrative matters, such
as the timing, budget, and other staffing-related
issues relevant to the specialist’s work, or the
protocols for discussing and resolving findings or
issues identified by the specialist.
32 See existing AS 1210 and AS 2502.
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auditors did not: (1) Evaluate the
reasonableness of assumptions used by
a company’s specialist in developing
fair value measurements; (2) obtain an
understanding of methods or
assumptions used by the company’s
specialist; (3) test the accuracy and
completeness of company-provided data
used by the company’s specialist; or (4)
evaluate the professional qualifications
of the company’s specialist.
Over the past several years, the
observations from PCAOB inspections
also have indicated that auditors, at
times, did not fulfill their
responsibilities under existing standards
when using the work of an auditor’s
specialist. These findings were more
common than those related to using the
work of a company’s specialist over the
same period. The observations included
instances in which auditors did not: (1)
Reach an understanding with the
specialist regarding his or her
responsibilities; (2) adequately evaluate
the work performed by the specialist; or
(3) consider contradictory evidence
identified by the specialist or resolve
discrepancies or other concerns that the
specialist identified. More recently,
PCAOB inspection staff have observed a
decline in the number of instances by
some firms in which auditors did not
perform sufficient procedures related to
the work of an auditor’s specialist.
There are indications that some firms
have undertaken remedial actions in
response to the findings related to the
auditor’s use of the work of an auditor’s
specialist. In most cases, such actions
included enhancements to firm
methodologies to improve coordination
between the auditor and the auditor’s
specialist through earlier and more
frequent communications. These
enhancements may have contributed, at
least in part, to the decline in findings
described above. Not all firms, however,
have changed their methodologies,
resulting in inconsistent practices in
this area. In addition, unlike the
findings related to the auditor’s use of
the work of an auditor’s specialist,
PCAOB inspections staff have not
observed a similar change in the
frequency of findings related to the
auditor’s use of the work of a company’s
specialist.
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Enforcement actions. Both the SEC 33
and the PCAOB 34 have brought
enforcement actions involving
situations where auditors allegedly
failed to comply with auditing
standards when using the work of
specialists. For example, such
proceedings have involved allegations
that auditors failed to (1) perform audit
procedures to address the risks of
material misstatements in a company’s
financial statements that were prepared
in part based on the work of a
company’s specialist 35 or (2) comply
with certain requirements of existing AS
1210 when using the work of a
company’s specialist (for example,
requirements to evaluate the
professional qualifications of the
specialist, obtain an understanding of
the methods and assumptions used by
the specialist, evaluate the relationship
of the specialist to the company, and
apply additional procedures to address
a material difference between the
specialist’s findings and the assertions
in the financial statements).36 Several of
those proceedings were brought in
recent years, suggesting that problems
persist in this area.
company’s specialist, an auditoremployed specialist, and an auditorengaged specialist. The Board believes
that these improvements will enhance
both audit quality and the credibility of
the information provided in a
company’s financial statements.
Areas of Improvement
The Board has identified two
important areas where improvements
are warranted to existing standards,
discussed below: (1) Strengthening the
requirements for evaluating the work of
a company’s specialist and (2) applying
a risk-based supervisory approach to
auditor-employed and auditor-engaged
specialists.
Strengthening the Requirements for
Evaluating the Work of a Company’s
Specialist
Existing AS 1210 is the primary
standard that applies when auditors use
the work of an auditor-engaged
specialist or a company’s specialist. By
its terms, existing AS 1210 applies
when (1) a company engages or employs
a specialist and the auditor uses that
specialist’s work as evidence in
performing substantive tests to evaluate
Reasons To Improve Auditing Standards material financial statement assertions
The improvements to PCAOB
or (2) an auditor engages a specialist and
standards are intended to direct auditors uses that specialist’s work as evidence
to devote more attention to the work of
in performing substantive tests to
a company’s specialist and enhance the
evaluate material financial statement
coordination between an auditor and
assertions.
the auditor’s specialist—employed or
In practice, however, a company’s
engaged. The final amendments also
specialist and an auditor-engaged
align with the Board’s risk assessment
specialist have fundamentally different
standards and acknowledge more
roles: The company uses the work of a
clearly the different roles of a
specialist in the preparation of its
financial statements, whereas an
33 See, e.g., KPMG LLP and John Riordan, CPA,
auditor’s specialist performs work to
SEC Accounting and Auditing Enforcement Release
assist the auditor in obtaining and
(‘‘AAER’’) No. 3888 (Aug. 15, 2017); Miller Energy
evaluating audit evidence. By imposing
Resources, Inc., Paul W. Boyd, CPA, David M. Hall,
and Carlton W. Vogt, III, CPA, AAER No. 3673
the same requirements for using the
(Aug. 6, 2015); Troy F. Nilson, CPA, SEC AAER No.
work of a company’s specialist and an
3264 (Apr. 8, 2011); and Accounting Consultants,
auditor-engaged specialist, existing AS
Inc., and Carol L. McAtee, CPA, SEC AAER No.
1210 does not clearly reflect the
2447 (June 27, 2006).
34 See, e.g., Tarvaran Askelson & Company, LLP,
different roles of such specialists.
Eric Askelson, and Patrick Tarvaran, PCAOB
In addition, existing AS 1210 does not
Release No. 105–2018–001 (Feb. 27, 2018); Grant
expressly require an auditor to evaluate
Thornton LLP, PCAOB Release No. 105–2017–054
the appropriateness of a company
(Dec. 19, 2017); KAP Purwantono, Sungkoro &
specialist’s methods and assumptions.37
Surja, Roy Iman Wirahardja, and James Randall
Leali, PCAOB Release No. 105–2017–002 (Feb. 9,
Instead, it requires the auditor to obtain
2017); Arturo Vargas Arellano, CPC, PCAOB
an understanding of the methods and
Release No. 105–2016–045 (Dec. 5, 2016); Gordon
assumptions used by the specialist, a
Brad Beckstead, CPA, PCAOB Release No. 105–
less rigorous procedure. Existing AS
2015–007 (Apr. 1, 2015); and Chisholm, Bierwolf,
Nilson & Morrill, LLC, Todd D. Chisholm, CPA, and
1210 also includes certain provisions
Troy F. Nilson, CPA, PCAOB Release No. 105–
that circumscribe the auditor’s
2011–003 (Apr. 8, 2011).
responsibilities related to the work of a
35 See, e.g., Gordon Brad Beckstead, CPA, PCAOB
Release No. 105–2015–007.
36 See, e.g., Grant Thornton LLP, PCAOB Release
No. 105–2017–054; KAP Purwantono, Sungkoro &
Surja, PCAOB Release No. 105–2017–002; Arturo
Vargas Arellano, CPC, PCAOB Release No. 105–
2016–045; Chisholm, Bierwolf, Nilson & Morrill,
LLC, PCAOB Release No. 105–2011–003; and Miller
Energy Resources, Inc., SEC AAER No. 3673.
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37 The evaluation of the reasonableness of
assumptions developed by a company’s specialist is
required only in circumstances when the specialist
develops assumptions used in a fair value
measurement in accordance with AS 2502. AS 2502
is being superseded in a separate PCAOB release.
See Estimates Release, supra note 20.
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specialist, including statements that: (1)
The appropriateness and reasonableness
of methods and assumptions used, and
their application, are the responsibility
of the specialist; (2) the auditor
ordinarily would use the work of the
specialist unless the auditor’s
procedures lead him or her to believe
the findings are unreasonable in the
circumstances; and (3) if the auditor
determines that the specialist’s findings
support the related assertions in the
financial statements, he or she
reasonably may conclude that sufficient
appropriate evidential matter has been
obtained.38
When an auditor uses the work of a
company’s specialist, the requirements
in existing AS 1210 allow the auditor to
plan and perform audit procedures that
may not be commensurate with the risk
of material misstatement inherent in the
work of the specialist, thereby allowing
the auditor to use the work and
conclusions of a company’s specialist
without performing procedures to
evaluate that specialist’s work. Some
audit firms, primarily larger firms, go
beyond the requirements in existing AS
1210 and generally require their
engagement teams to evaluate the work
of a company’s specialist, including the
specialist’s methods and assumptions,
and often employ specialists to assist
their audit personnel in evaluating that
work. Existing audit practices in this
regard, however, vary among firms.
The foregoing factors indicate that
improvements to PCAOB standards for
using the work of a company’s
specialists are needed and that
increasing auditors’ attention to the
work of a company’s specialists with
respect to significant accounts and
disclosures will enhance investor
protection. In the Board’s view, investor
protection will be enhanced by
requiring auditors to do more than
merely obtain an understanding of the
methods and significant assumptions
used by the specialist.
Applying a Risk-Based Supervisory
Approach to Both Auditor-Employed
and Auditor-Engaged Specialists
The primary standard that applies
when auditors use the work of an
auditor-employed specialist in an audit
is AS 1201. That standard establishes
requirements regarding the auditor’s
supervision of the audit engagement,
including supervision of a specialist
employed by the auditor’s firm who
participates in the audit. While AS 1201
is risk-based and scalable, it does not
specifically address how to apply its
supervisory procedures to promote
38 See
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effective coordination between an
auditor and a specialist and evaluation
by the auditor of the work of an auditoremployed specialist.
The primary standard that applies
when auditors use the work of an
auditor-engaged specialist in an audit is
existing AS 1210. The requirements in
this standard differ from and are less
rigorous than the requirements that
apply when using auditor-employed
specialists, even though auditoremployed and auditor-engaged
specialists serve similar roles in helping
auditors to obtain and evaluate audit
evidence. For example, existing AS
1210 provides that the auditor should
‘‘obtain an understanding’’ of the nature
of the work performed by an auditorengaged specialist, including the
objectives and scope of the specialist’s
work, whereas AS 1201 requires the
auditor to review the work of an
auditor-employed specialist to
‘‘evaluate’’ whether the work was
performed and documented, the
objectives of the procedures were
achieved, and the results of the work
support the conclusions reached.
The PCAOB’s observations regarding
existing audit practices in this area also
reveal differences in the application of
the auditing standards regarding the use
of the work of auditor-employed and
auditor-engaged specialists. For
example, in circumstances when audit
firms engage specialists, some firms
perform the procedures specified in
existing AS 1210, while other firms
perform procedures that are similar to
the procedures for supervising the work
of auditor-employed specialists under
AS 1201.
These factors indicate that investor
protection can be enhanced by
improving PCAOB standards for
applying a risk-based supervisory
approach to auditor-employed
specialists, and extending those
requirements to auditor-engaged
specialists. This should promote a more
uniform approach to the supervision of
an auditor’s specialists, whether
employed or engaged, reflecting their
similar roles. Specifically, investor
protection can be enhanced by
supplementing the existing supervision
requirements under PCAOB standards
with more specific direction on
applying those principles when
supervising the work of auditoremployed and auditor-engaged
specialists. This includes, among other
things, additional direction on reaching
an understanding with auditoremployed and auditor-engaged
specialists on the work to be performed
and on reviewing and evaluating their
work.
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Comments on the Reasons for Standard
Setting
Many commenters on the Proposal
broadly expressed support for revisions
to the Board’s standards for using the
work of specialists or stated that the
Proposal would lead to improvements
in audit quality. For example, some
commenters agreed with statements in
the Proposal that the increasing use of
specialists, due in part to the increasing
use of fair value measurements in
financial reporting frameworks and
increasing complexity of business
transactions, warranted strengthening
existing requirements. A number of
commenters also indicated that the
requirements for using specialists
should be risk-based and more closely
aligned with the Board’s risk assessment
standards than existing standards. One
of these commenters stated that the
Board should be proactive in addressing
issues relating to auditors’ use of the
work of specialists through standard
setting as an alternative to devoting
additional resources to inspections and
enforcement based on existing
standards.
In addition, a number of commenters
generally agreed with developing
separate standards for using the work of
a company’s specialist, an auditoremployed specialist, and an auditorengaged specialist. One commenter
noted that separating these requirements
could lead to better application in
practice, especially among smaller CPA
firms, while another commenter
indicated that providing separate
guidance for using the work of company
specialists, auditor-employed
specialists, and auditor-engaged
specialists would be an improvement
over existing standards. One commenter
stated that inspections of audits
involving the use of specialists had
shown a need for improvement, and that
the rationalization and enhancement of
existing requirements would improve
the efficiency and quality of audits.
A few commenters on the Proposal
questioned the reasons for revisions to
PCAOB auditing standards relating to
the use of the work of specialists.39 One
commenter stated that the Proposal
presented no clear evidence that audit
deficiencies found by the PCAOB
relating to the use of specialists resulted
from deficiencies in the auditing
standards. Another commenter stated
that inspection findings did not
39 Some commenters provided comments or
expressed concerns about specific aspects of the
proposed revisions to the Board’s existing standards
for using the work of specialists. The Board’s
consideration of these comments is discussed
further below.
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necessarily warrant revisions to auditing
standards and that it continued to
question whether a fundamental change
in audit standards was necessary. A
third commenter stated that it did not
believe that the case had been made for
having separate standards for the use of
auditor-employed and auditor-engaged
specialists. Finally, a fourth commenter
suggested that the Board should develop
additional information on potential
costs before proposing or adopting
revisions to existing auditing standards,
including through field testing of
potential changes.40
The SAG has discussed specialistrelated issues at a number of meetings.41
Many SAG members expressed support
for: (1) Greater auditor responsibility for
evaluating the work performed by a
company’s specialists; (2) similar
responsibilities when auditors use the
work of auditor-employed specialists
and auditor-engaged specialists; and (3)
better communication between auditors
and their specialists, whether employed
or engaged. Some SAG members,
however, questioned the need for
changes to the existing standards,
asserting that auditors may not always
have the necessary level of expertise to
evaluate the work of certain specialists
and, as a result, may need to rely on the
work of specialists.
In adopting the final amendments, the
Board has taken into account the
comments received on the Proposal, as
well as its other outreach activities. The
information available to the Board—
including the current regulatory
baseline, observations from the Board’s
oversight activities, and substantial
outreach—suggests that investors would
benefit from strengthened and clarified
standards for auditors in this area. The
Board notes that aspects of the required
procedures in the final amendments are
similar to current auditing practices by
some larger and smaller audit firms.
While the Board does not expect that
the final amendments will eliminate
inspection deficiencies observed in
practice, the final amendments are
intended to clarify the auditor’s
responsibilities and align the
requirements for using the work of
specialists more closely with the
Board’s risk assessment standards. The
final amendments also reflect a number
of changes that were made after the
Board’s consideration of comments
40 See below for a more detailed discussion of the
final amendments and clarifications of certain
aspects of the proposed amendments, as set forth
in the Proposal.
41 See SAG meeting briefing papers and webcast
archives (Nov. 29–30, 2017, Nov. 30–Dec. 1, 2016,
Nov. 12–13, 2015, June 18, 2015, Oct. 14–15, 2009,
and Feb. 9, 2006), available on the Board’s website.
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amendments, which are intended to
enhance the requirements in existing
standards for using the work of a
company’s specialist, an auditoremployed specialist, and an auditorengaged specialist, are discussed in this
section. The ways in which the final
amendments address the need for
change from an economic perspective
are discussed in section D.
The final amendments have been
informed by the Board’s outreach
activities. They are aligned with the
Board’s risk assessment standards, so
that the necessary audit effort is
commensurate with, among other
things, the significance of the
specialist’s work to the auditor’s
conclusion regarding the relevant
assertion and the associated risk. Many
commenters on the Proposal supported
aligning any new standards on using the
work of specialists with any new
standards related to auditing accounting
estimates, including fair value
measurements. The final amendments
are aligned with the Estimates Release.
Figure 3 summarizes the auditor’s
responsibilities and primary PCAOB
standards for using the work of
specialists applicable before and after
the effective date of the final
amendments.
In brief, the final amendments make
the following changes to PCAOB
auditing standards:
• Amend AS 1105.
• Add a new Appendix A 43 that
supplements the requirements in AS
1105 for circumstances when the
auditor uses the work of the company’s
specialist as audit evidence, related to:
• Obtaining an understanding of the
work and report(s), or equivalent
communication, of the company’s
specialist(s) and related company
processes and controls; 44
• Obtaining an understanding of and
assessing the knowledge, skill, and
ability of a company’s specialist and the
entity that employs the specialist (if
other than the company) and the
relationship to the company of the
specialist and the entity that employs
the specialist (if other than the
company); and
• Performing procedures to evaluate
the work of a company’s specialist,
including evaluating: (i) The data,
significant assumptions, and methods
(which may include models) used by
the specialist,45 and (ii) the relevance
and reliability of the specialist’s work
and its relationship to the relevant
assertion;
• Align the requirements for using the
work of a company’s specialist with the
risk assessment standards and the
42 See below for a more detailed discussion of
changes reflected in the final amendments and
section D for a more detailed discussion of
economic considerations related to the adoption of
the final amendments.
43 As proposed, these requirements would have
been set forth as Appendix B to AS 1105.
44 See AS 1105.A2, as adopted. Additionally, as
amended, AS 2110, Identifying and Assessing Risks
of Material Misstatement, sets forth requirements
for understanding company processes and controls
related to the use of specialists.
45 This evaluation is not explicitly required under
the Board’s existing standards, other than under AS
received on the Proposal about the
potential impact of the proposed
requirements on auditors, issuers, and
specialists.42
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Overview of Final Rules
The final amendments: (1) Add an
appendix to AS 1105 with supplemental
requirements for using the work of a
company’s specialist as audit evidence;
(2) add an appendix to AS 1201 with
supplemental requirements for
supervising an auditor-employed
specialist; and (3) replace existing AS
1210 with an updated standard for using
the work of an auditor-engaged
specialist. The key aspects of these
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2502 with respect to the significant assumptions of
a company’s specialist regarding fair value
measurements and disclosures.
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standard and related amendments
adopted by the Board on auditing
accounting estimates, including fair
value measurements; 46 and
• Set forth factors for determining the
necessary evidence to support the
auditor’s conclusion regarding a
relevant assertion when using the work
of a company’s specialist.
• Amend AS 1201.
• Add a new Appendix C that
supplements the requirements for
applying the supervisory principles in
AS 1201.05–.06 when using the work of
an auditor-employed specialist to assist
the auditor in obtaining or evaluating
audit evidence, including requirements
related to:
• Informing the auditor-employed
specialist of the work to be performed;
• Coordinating the work of the
auditor-employed specialists with the
work of other engagement team
members; and
• Reviewing and evaluating whether
the work of the auditor-employed
specialist provides sufficient
appropriate evidence. Evaluating the
work of the specialist includes
evaluating whether the work is in
accordance with the auditor’s
understanding with the specialist and
whether the specialist’s findings and
conclusions are consistent with, among
other things, the work performed by the
specialist.
• Set forth factors for determining the
necessary extent of supervision of the
work of the auditor-employed specialist.
• Replace existing AS 1210.
• Replace with AS 1210, as amended,
Using the Work of an Auditor-Engaged
Specialist, which establishes
requirements for using the work of an
auditor-engaged specialist to assist the
auditor in obtaining or evaluating audit
evidence;
• Include requirements for reaching
an understanding with an auditorengaged specialist on the work to be
performed and reviewing and evaluating
the specialist’s work that parallel the
final amendments to AS 1201 for
auditor-employed specialists;
• Set forth factors for determining the
necessary extent of review of the work
of the auditor-engaged specialist;
• Amend requirements related to
assessing the knowledge, skill, ability,
and objectivity 47 of the auditor-engaged
specialist; and
46 Certain provisions of the final amendments
include references to a new auditing standard AS
2501, Auditing Accounting Estimates, Including
Fair Value Measurements (‘‘AS 2501, as adopted’’),
which has been adopted by the Board in a separate
release. See Estimates Release, supra note 20.
47 Under the final amendments, the term
‘‘objectivity’’ is reserved for the auditor-engaged
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• Describe objectivity, for purposes of
the standard, as the auditor-engaged
specialist’s ability to exercise impartial
judgment on all issues encompassed by
the specialist’s work related to the audit;
and specify the auditor’s obligations
when the specialist or the entity that
employs the specialist has a relationship
with the company that affects the
specialist’s objectivity.
The Board has also adopted a single
standard to replace its existing
standards on auditing accounting
estimates and fair value measurements
and set forth a uniform, risk-based
approach designed to strengthen and
enhance the requirements for auditing
accounting estimates.48 Certain
provisions of the final amendments in
this notice include references to AS
2501, as adopted.
Most of those who commented on the
proposed requirements regarding the
use of the company’s specialist
expressed support for strengthening the
requirements for evaluating the work of
a company’s specialist and aligning
them with the Board’s risk assessment
standards. For example, one commenter
stated that it agreed with statements in
the Proposal that the proposed
requirements may result in some
auditors gaining a better understanding
of a company’s critical accounting
estimates related to relevant financial
statements and disclosures. Another
commenter stated that the application of
a risk-based approach to the testing and
evaluation of the work of a company’s
specialist would reduce the risk of an
auditor failing to sufficiently address
the risks of material misstatement.
A few commenters disagreed with the
approach, or aspects of the approach, for
evaluating the work of a company’s
specialist as described in the Proposal.
One commenter asserted that additional
clarification for using the work of a
company’s specialist was needed to
address practicability issues and avoid
unnecessary costs. Another commenter
suggested that the amendments should
place greater weight on the professional
requirements and certifications for
certain company specialists.
specialist and not used to describe the relationship
to the company of a company’s specialist or an
auditor-employed specialist. See below for further
discussion of objectivity.
48 As discussed in the Estimates Release, supra
note 20, the Board is retitling and replacing existing
AS 2501, Auditing Accounting Estimates, and
superseding AS 2502 and AS 2503, Auditing
Derivative Instruments, Hedging Activities, and
Investments in Securities. AS 2501, as adopted, also
includes a special topics appendix that addresses
certain matters relevant to auditing the fair value of
financial instruments, including the use of pricing
information from third parties as audit evidence.
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The Board recognizes that the auditor
does not have the same expertise as a
person trained or qualified to engage in
the practice of another profession. At
the same time, establishing a uniform,
risk-based approach for using the work
of a company’s specialist more clearly
acknowledges the different roles of a
company’s specialist and an auditor’s
specialist and builds upon
improvements observed in the practices
of certain firms. The final amendments
also clarify aspects of the proposed
amendments, including the procedures
for evaluating the work of a company’s
specialist, so that the required
procedures are both practical and riskbased, and reasonably designed to lead
to improvements in audit quality.49
Commenters on the proposed
requirements for using an auditor’s
specialist generally agreed with a riskbased supervisory approach for both
auditor-employed and auditor-engaged
specialists. For example, one
commenter agreed that this approach
would promote an improved, more
uniform approach to the supervision of
an auditor’s specialists. Consistent with
the view of these commenters, the final
amendments apply a risk-based
supervisory approach to both auditoremployed and auditor-engaged
specialists, which should enhance
investor protection.
The subsections that follow discuss in
more detail the final amendments. The
subsections also include a comparison
of the final requirements with the
analogous requirements of the following
standards issued by the IAASB and the
Auditing Standards Board (‘‘ASB’’) of
the American Institute of Certified
Public Accountants:
IAASB Standards
• International Standard on Auditing
500, Audit Evidence (‘‘ISA 500’’); and
• International Standard on Auditing
620, Using the Work of an Auditor’s
Expert (‘‘ISA 620’’).
ASB Standards
• AU–C Section 500, Audit Evidence
(‘‘AU–C Section 500’’); and
• AU–C Section 620, Using the Work
of an Auditor’s Specialist (‘‘AU–C
Section 620’’).
The comparison included in these
subsections may not represent the views
of the IAASB or ASB regarding the
interpretation of their standards. The
information presented in the
subsections does not cover the
application and explanatory material in
49 See below for a more detailed discussion of the
final amendments and clarifications regarding using
the work of a company’s specialist.
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the IAASB standards or ASB
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Scope of Final Amendments
The final amendments apply when an
auditor uses the work of a ‘‘specialist.’’
Thus, the scope of the requirements
hinges largely on the meaning of the
term ‘‘specialist.’’ As described in the
Proposal, the Board sought to carry
forward the meaning of the term
‘‘specialist’’ from existing AS 1210, that
is, a specialist is a person (or firm)
possessing special skill or knowledge in
a particular field other than accounting
or auditing. The Board also sought to
carry forward the concept from existing
AS 1210 that income taxes and IT are
specialized areas of accounting and
auditing and thus are outside the scope
of the final amendments.51 As discussed
below, the final amendments retain, as
proposed, the meaning of the term
‘‘specialist,’’ including the concept
regarding income taxes and IT.
Some commenters on the Proposal
agreed with retaining the existing
meaning of the term ‘‘specialist.’’ Other
commenters suggested that the Board
extend the scope of the Proposal to
include persons with specialized skill or
knowledge in certain areas of income
taxes and IT (e.g., unusual or complex
tax matters, artificial intelligence, and
blockchain). One of these commenters
also asserted that income tax and IT
professionals often support both audit
and consulting practices and, as a
practical matter, are treated as
specialists by auditors. One commenter
requested guidance for applying the
proposed requirements when a legal
specialist is involved, while another
commenter suggested that the Board
explain in the final amendments that an
individual who specializes in complex
taxation law would be a legal specialist.
One commenter suggested eliminating
the distinction between expertise
‘‘inside’’ or ‘‘outside’’ the field of
accounting and auditing with respect to
an auditor’s specialist because, in its
view, determining when fields of
expertise are outside of accounting and
auditing is becoming more difficult.
50 Paragraph A59 of ISA 200, Overall Objectives
of the Independent Auditor and the Conduct of an
Audit in Accordance with International Standards
on Auditing, indicates that the application and
other explanatory material section of the ISAs ‘‘does
not in itself impose a requirement’’ but ‘‘is relevant
to the proper application of the requirements of an
ISA.’’ Paragraph .A64 of AU–C Section 200, Overall
Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with Generally
Accepted Auditing Standards, states that, although
application and other explanatory material ‘‘does
not in itself impose a requirement, it is relevant to
the proper application of the requirements of an
AU–C section.’’
51 See footnote 1 of existing AS 1210.
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Another commenter stated that, in
practice, it can be less than
straightforward to differentiate between
expertise in auditing and accounting
and other areas. Other commenters,
however, asserted that the Board should
retain the concept in existing AS 1210
that an auditor is not expected to have
the expertise of a person trained or
qualified to engage in the practice of
another profession or occupation.
As used today, the term ‘‘specialist’’
is generally understood by auditors, and
observations from PCAOB oversight
activities do not indicate that there is
significant confusion over the meaning
of the terms ‘‘specialist’’ and
‘‘specialized area of accounting and
auditing,’’ as they have been used in the
standards. After considering the
comments received on the Proposal,
however, the final amendments retain
the meaning of the term ‘‘specialist’’ as
proposed, with certain clarifications
discussed below.
Specifically, the Board included a
note to clarify when the final
amendments apply to the work of an
attorney used by the company.52 As
under existing AS 1210, specialists
under the final amendments include
attorneys engaged by a company as
specialists, such as attorneys engaged by
the company to interpret contractual
terms or provide a legal opinion. The
final amendments apply when an
auditor uses the work of a company’s
attorney as audit evidence in other
matters relating to legal expertise, such
as when a legal interpretation of a
contractual provision or a legal opinion
regarding isolation of transferred
financial assets is necessary to
determine appropriate accounting or
disclosure under the applicable
financial reporting framework. The final
amendments also clarify that the scope
of these amendments does not apply to
information provided by a company’s
attorney concerning litigation, claims, or
assessments that is used by the auditor
pursuant to AS 2505, Inquiry of a
Client’s Lawyer Concerning Litigation,
Claims, and Assessments.
Consistent with existing AS 1210,
income taxes and IT are outside the
scope of the final amendments because
they are specialized areas of accounting
and auditing. For example, while
specialized areas of income tax law
involve legal specialists, accounting for
income taxes remains an area of
accounting and auditing. The Board
added a footnote to Appendix A of AS
1105 that references AS 2505.08, as
amended.53 A note to AS 2505.08, as
amended, clarifies the auditor’s
responsibility regarding the use of the
written advice or opinion of a
company’s tax advisor or a company’s
tax legal counsel as audit evidence.54
Also, to the extent that IT is used in
information systems, auditors will still
need to maintain sufficient technical
knowledge to identify and assess risks
and design procedures to respond to
those risks and evaluate the audit
evidence obtained. Accordingly, the
Board does not believe that the need
exists at this time to change the
approach reflected in existing AS 1210
and designate particular areas of either
income taxes or IT as outside the field
of ‘‘accounting and auditing.’’
Comparison With Standards of Other
Standard Setters
ISA 620 uses the terms ‘‘auditor’s
expert’’ and ‘‘management’s expert’’ in a
manner analogous to the term
‘‘specialist’’ in the final amendments.
ISA 620, however, does not address
whether IT is a specialized field outside
of accounting and auditing. The term
‘‘management’s expert’’ is also defined
in ISA 500.
AU–C Section 620 and AU–C Section
500 use the word ‘‘specialist’’ instead of
‘‘expert.’’
Amendments Related to Using the Work
of a Company’s Specialist
The final amendments set forth
requirements for using the work of a
company’s specialist as audit evidence.
The amendments, which supplement
the existing requirements of AS 1105,
include:
• Obtaining an understanding of the
work and report(s), or equivalent
communication, of the company’s
specialist(s) and related company
processes and controls;
• Obtaining an understanding of and
assessing the knowledge, skill, and
ability of the specialist and the entity
that employs the specialist (if other than
the company), and the relationship to
the company of the specialist and the
entity that employs the specialist (if
other than the company); and
• Performing procedures to evaluate
the work of a company’s specialist,
including evaluating: (1) The data,
significant assumptions, and methods
(which may include models) used by
the specialist; and (2) the relevance and
reliability of the specialist’s work and
its relationship to the relevant
assertion.55
54 See
note to AS 2505.08, as amended.
principles from Auditing Interpretation AI
11, Using the Work of a Specialist: Auditing
Interpretations of AS 1210, and Auditing
55 Key
52 See
53 See
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Commenters on the Proposal
generally supported a risk-based
approach for using the work of a
company’s specialist, as set forth in the
proposed amendments. Many
commenters also stated that there was a
need to establish a separate standard for
using the work of a company’s
specialist. However, a number of
commenters questioned various aspects
of the amendments, including the need
for revisions to existing AS 1210
relating to the use of the work of a
company’s specialist. Additionally,
some commenters requested
clarifications or suggested changes to
the proposed requirements. These and
other comments are discussed below. A
number of these comments resulted in
revisions and clarifications to the final
amendments.
Obtaining an Understanding of the
Work of the Company’s Specialist
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See AS 1105.A2, as Adopted, and AS
2110.28A, as Adopted
The proposed amendments to AS
1105 provided that obtaining an
understanding of the company’s
information system relevant to financial
reporting would encompass obtaining
an understanding of the work and
report(s) of the company’s specialist(s)
and related company processes and
controls.56
Some commenters supported the
proposed requirement because, in their
view, an understanding of the
company’s processes for using the work
of company specialists is integral to the
auditor’s understanding of the
information system relevant to financial
reporting. Two commenters asserted
that such controls are important for the
auditor to consider when evaluating the
work of a company’s specialist and
determining the necessary audit
procedures. One commenter expressed
concern that the proposed requirement
was too broad and suggested that the
auditor’s understanding should instead
be part of the evaluation of the
specialist’s objectivity. In addition, two
commenters questioned whether the
Board intended to require the auditor to
evaluate the design of controls over the
use of company specialists, even if the
auditor was not performing an audit of
internal control over financial reporting
or planning to rely on controls for the
related assertions. These commenters
Interpretation AI 28, Evidential Matter Relating to
Income Tax Accruals: Auditing Interpretations,
related to the auditor’s use of the work of a
company’s attorney and the use of written tax
advice or opinions as audit evidence have been
incorporated in AS 1105.A1, as adopted, and a note
added to AS 2505.08, as amended.
56 See proposed AS 1105.B2.
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and others suggested that placing the
proposed requirement for obtaining an
understanding of the specialist’s work
in AS 2110 would better link the
requirement to the auditor’s risk
assessment procedures, thereby
reducing the likelihood that auditors
would consider only the factors in
proposed AS 1105.B2 and fail to
consider other relevant factors set forth
in AS 2110.
The Board considered these
comments and is adopting the
requirement substantially as proposed,
but relocating the requirement to AS
2110 as suggested by certain
commenters.57 The procedure builds
upon a requirement in existing AS 1210
that the auditor obtain an understanding
of the nature of the work performed or
to be performed by a specialist,58 but is
more closely aligned with the required
risk assessment procedures in AS 2110.
The required procedure is important
because it informs the auditor’s
evaluation of the work of the company’s
specialist, and not merely the
assessment of the specialist’s
objectivity.
Placing the requirement for obtaining
an understanding of the specialist’s
work and report(s), or equivalent
communication, in AS 2110, and
framing the required procedure as a risk
assessment procedure, provides better
direction regarding the necessary audit
effort for the procedure. The necessary
audit effort for performing this
procedure is governed primarily by the
general requirements in AS 2110 for
obtaining a sufficient understanding of
the company’s internal control over
financial reporting.59 This includes
consideration of whether the auditor
plans to use the specialist’s work as
audit evidence.
While the requirement, as adopted,
likely will not represent a major change
57 Specifically, the requirements are located in AS
2110.28A, as adopted.
58 See existing AS 1210.09.
59 See AS 2110.18, which provides that the
auditor should obtain a sufficient understanding of
each component of internal control over financial
reporting to: (1) Identify the types of potential
misstatements, (2) assess the factors that affect the
risks of material misstatement, and (3) design
further audit procedures. See also AS 2110.19,
which further provides that the nature, timing, and
extent of procedures that are necessary to obtain an
understanding of internal control depend on the
size and complexity of the company; the auditor’s
existing knowledge of the company’s internal
control over financial reporting; the nature of the
company’s controls, including the company’s use of
IT; the nature and extent of changes in systems and
operations; and the nature of the company’s
documentation of its internal control over financial
reporting. In addition, AS 2110.20 provides that
obtaining an understanding of internal control
includes evaluating the design of controls that are
relevant to the audit and determining whether the
controls have been implemented.
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in practice, particularly for those firms
whose practices already go beyond
existing PCAOB standards, it should
prompt auditors to appropriately
consider the interaction of the
specialist’s work and the company’s
related processes and controls. For
example, under the final amendments,
the auditor should obtain an
understanding of controls for using the
work of specialists that are relevant to
the audit, including evaluating the
design of those controls and
determining whether those controls
have been implemented.60
Comparison With Standards of Other
Standard Setters
The requirements in ISA 500 and AU–
C 500 have some commonality with the
requirements in the final amendments.
Paragraph 8(b) of ISA 500 states that, if
information to be used as audit evidence
has been prepared using the work of a
management’s expert, the auditor shall,
to the extent necessary and having
regard to the significance of that expert’s
work for the auditor’s purposes, obtain
an understanding of the work of that
expert.
AU–C Section 500 contains
requirements that are similar to those in
ISA 500.
Assessing the Knowledge, Skill, and
Ability of the Company’s Specialist and
the Specialist’s Relationship to the
Company
See AS 1105.A3–.A5, as Adopted
The final amendments set forth
requirements similar to existing AS
1210 for evaluating the knowledge, skill,
and ability of the specialist and the
relationship of the specialist to the
company.61
Knowledge, Skill, and Ability
The Proposal set forth a requirement
similar to that in existing AS 1210 for
evaluating the professional
qualifications of the specialist and
generally provided the same factors for
the auditor’s assessment of the
specialist’s knowledge, skill, and
ability.62
60 AS 2110.34 provides additional direction for
determining controls relevant to the audit.
61 Existing AS 1210.08 and AS 1210.10–.11
require the auditor to evaluate the professional
qualifications of a specialist and the relationship of
a specialist to the company.
62 Existing AS 1210.08 provides that the auditor
should consider certain information in evaluating
the professional qualifications of the specialist to
determine that the specialist possesses the
necessary skill or knowledge in the particular field.
The information to be considered in that evaluation
is: (1) The professional certification, license, or
other recognition of the competence of the
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The Proposal differed from existing
AS 1210, however, in certain respects.
First, the Proposal extended the
required understanding to expressly
include the entity that employs the
specialist, if the specialist is not
employed by the company. Second, the
Proposal expressly referred to the
specialist’s ‘‘level’’ of knowledge, skill,
and ability. As with the auditor’s
assessment of competence under AS
2605, Consideration of the Internal
Audit Function, this approach
recognized that specialists may possess
varying degrees of knowledge, skill, and
ability. Third, the Proposal provided
that the necessary evidence to assess the
level of knowledge, skill, and ability of
the company’s specialist would depend
on (1) the significance of the specialist’s
work to the auditor’s conclusion
regarding the relevant assertion and (2)
the risk of material misstatement of the
relevant assertion. Under this approach,
the persuasiveness of the evidence the
auditor would need to obtain increases
as the significance of the specialist’s
work to the auditor’s conclusion or the
risk of material misstatement of the
relevant assertion increases.63
The Board is adopting the
requirement for evaluating the
professional qualifications of the
specialist as proposed. Most
commenters on this aspect of the
Proposal acknowledged the need for the
auditor to obtain an understanding of
and assess the knowledge, skill, and
ability of a company’s specialist. One
commenter asserted that the proposed
requirement was not well-suited to
assessing the qualifications of the entity
that employs the specialist. The Board
considered this comment and notes that
the final requirement retains the
concept in existing AS 1210 that a
specialist may be an individual or an
entity. Accordingly, auditors should be
familiar with assessing the
qualifications of entities that are
specialists or employ specialists.
Furthermore, a strong reputation and
standing of the specialist’s employer in
the specialized field can be a signal that
the employer maintains qualified staff.
On the other hand, an employer with a
poor reputation or little expertise in the
specialized field can indicate that more
specialist in his or her field, as appropriate; (2) the
reputation and standing of the specialist in the
views of peers and others familiar with the
specialist’s capability or performance; and (3) the
specialist’s experience in the type of work under
consideration.
63 Illustrative examples on the application of
these factors when testing and evaluating the work
of a company’s specialist appear in the discussion
on determining the necessary audit effort under AS
1105.A7, as provided below.
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scrutiny of the qualifications of the
individual specialist is warranted.
Some commenters asked for more
direction on how to obtain an
understanding of the professional
qualifications of the company’s
specialist and the entity that employs
the specialist (for example, by including
in the rule text the discussion from the
proposing release of potential sources of
information about a specialist’s
qualifications). One of these
commenters asserted that there are
practical limits on obtaining evidence
related to a company-engaged
specialist’s competence.
The Board considered these
comments, but notes that the final
requirement is similar to a requirement
in existing AS 1210. Outreach to audit
firms suggests that firms have policies
and procedures for evaluating the
qualifications of specialists, whether
individuals or entities. Auditors should
therefore be familiar with the process of
assessing the knowledge, skill, and
ability of entities that employ
specialists.
As with existing AS 1210, the final
amendments do not set forth specific
steps to perform in assessing the
specialist’s knowledge, skill, and ability.
It is not practicable to provide detailed
direction in this area because of the
variety of types of specialists that may
be encountered. Examples of potential
sources of information that, if available,
could be relevant to the auditor’s
evaluation include:
• Information contained within the
audit firm related to the professional
qualifications and reputation of the
specialist or the entity that employs the
specialist (if other than the company) in
the relevant field and experience with
previous work of the specialist;
• Professional or industry
associations and organizations, which
may provide information regarding: (1)
Qualification requirements, technical
performance standards, and continuing
professional education requirements
that govern their members; (2) the
specialist’s education and experience,
certification, and license to practice;
and (3) recognition of, or disciplinary
actions taken against, the specialist;
• Discussions with the specialist,
through the company, about matters
such as the specialist’s understanding of
the financial reporting framework, the
specialist’s experience in performing
similar work, and the methods and
assumptions used in the specialist’s
work the auditor plans to evaluate;
• Information obtained as part of
audit planning, when obtaining an
understanding of the company’s
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processes and identifying controls for
testing;
• Information included in the
specialist’s report about the specialist’s
professional qualifications (e.g., a
biography or resume);
• Responses to questionnaires
provided to the specialist regarding the
specialist’s professional credentials; and
• Published books or papers written
by the specialist.
Requirements applicable to a
specialist pursuant to legislation or
regulation also could help inform the
auditor’s assessment of the specialist’s
knowledge, skill, and ability.
Some of the examples listed above
may provide more persuasive evidence
than others.64 For example, relevant
information from a source not affiliated
with the company or specialist, the
auditor’s experience with previous work
of the specialist, or multiple sources
generally would provide more
persuasive evidence than evidence from
the specialist’s uncorroborated
representations about his or her
professional credentials. Additionally,
the reliability (and thus persuasiveness)
of information about the specialist’s
credentials and experience increases
when the company has effective
controls over that information, e.g., in
conjunction with controls over the
selection of qualified specialists.
Some commenters asked for
clarification as to how the company’s
controls and processes for using the
work of a company’s specialist should
be considered when performing the
assessment of knowledge, skill, and
ability. As discussed earlier, the
interaction of the specialist’s work and
the company’s processes should be
considered by the auditor in assessing
and responding to risk in the related
accounts and disclosures, especially
when the specialist’s work is significant
to the auditor’s conclusion regarding the
relevant assertion and the accounts or
disclosures have higher risk. Therefore,
the company’s controls and processes
are considered in identifying and
appropriately assessing the risks of
material misstatement of the relevant
assertion, which is one of the two
factors that the auditor considers under
AS 1105.A5, as adopted, in determining
the necessary evidence for assessing the
specialist’s level of knowledge, skill,
and ability.
64 As previously discussed, the risk of material
misstatement of the relevant assertion and the
significance of the specialist’s work to the auditor’s
conclusion regarding the relevant assertion affect
the persuasiveness of the evidence needed with
respect to the knowledge, skill, and ability of the
company’s specialist.
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Relationship to the Company
The Proposal provided that the
auditor would assess the relationship to
the company of the specialist and the
entity that employs the specialist (if
other than the company)—specifically,
whether circumstances exist that give
the company the ability to significantly
affect the specialist’s judgments about
the work performed, conclusions, or
findings (e.g., through employment,
financial, ownership, or other business
relationships, contractual rights, family
relationships, or otherwise). The
proposed requirement was similar to
existing AS 1210.10, but expanded the
list of matters that the auditor should
consider to include financial and
business relationships with the
company.
The Board is adopting this
requirement substantially as proposed,
with the addition of a note that sets
forth examples of potential sources of
information that could be relevant to the
auditor’s assessment.
Some commenters supported the
proposed requirement for the auditor to
assess the specialist’s relationship to the
company and stated that it was
appropriate. Two commenters, however,
asserted that there could be practical
challenges to assessing the relationship
to the company of the entity that
employs the specialist (e.g., if the entity
that employs the specialist lacks
systems to track such relationships or
the auditor does not have access to
those systems). The Board considered
these comments, but notes that existing
AS 1210 already requires an evaluation
of the relationship of the specialist,
whether an individual or an entity, to
the client. Outreach to audit firms
suggests that firms have policies and
procedures for evaluating the objectivity
of specialists, whether individuals or
entities. Therefore, auditors should be
familiar with assessing the
qualifications of entities that are
specialists or employ specialists.
Other commenters asked for
additional direction regarding the
necessary effort to obtain information
regarding the specialist’s relationship to
the company. One commenter also
emphasized the importance of
considering ethical and performance
requirements promulgated by a
specialist’s profession or by legislation
or regulation governing the specialist.
The final amendments do not prescribe
specific steps to perform in assessing
the specialist’s relationship to the
company, because additional specificity
would make the requirements
unnecessarily prescriptive. The Board
has added a note to the final
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requirement, however, that includes
non-exclusive examples of potential
sources of information that could be
relevant to the auditor’s assessment of
the relationship to the company of both
the specialist and the specialist’s
employer (if other than the company).65
These examples include disclosures by
the specialist about relationships with
the company in the specialist’s report,
or equivalent communication, pursuant
to requirements promulgated by the
specialist’s profession or by legislation
governing the specialist.66 As with the
auditor’s assessment of a specialist’s
knowledge, skill, and ability, certain
sources of information may provide
more persuasive evidence than others.
In situations where more persuasive
evidence is required under these
requirements, it may be appropriate to
perform procedures to obtain evidence
from multiple sources.
Some commenters also expressed a
preference for retaining the term
‘‘objectivity’’ with respect to a
company’s specialist and further
acknowledging that objectivity may
exist along a spectrum. Similar to the
Proposal, the final amendments reserve
the term ‘‘objectivity’’ for specialists
engaged by the auditor to assist in
obtaining and evaluating audit
evidence. The work of a company’s
specialist is different in nature from the
work of an auditor’s specialist, since a
company’s specialist performs work that
the company frequently uses as source
material for one or more financial
statement accounts or disclosures,
including accounting estimates. With
respect to the existence of objectivity
along a spectrum, the final amendments
recognize that a company’s ability to
significantly affect a specialist’s
judgment may vary and, as discussed
below, provide a spectrum for
evaluating the company’s ability to
significantly affect the specialist’s
judgments.
As was proposed, the final
amendments provide that, if the auditor
identifies relationships between the
company and the specialist (or the
specialist’s employer, if other than the
company), the auditor has a
responsibility to assess whether the
company has the ability to significantly
65 See note to AS 1105.A4, as adopted. These
examples were based on examples set forth in the
Proposal, but have been refined to better reflect
their application in practice.
66 While the Proposal had suggested that
information regarding such requirements could be
relevant to the auditor’s evaluation of the
specialist’s relationships to the company,
disclosures about relationships pursuant to such
requirements are more relevant to the auditor’s
assessment than merely information about the legal
or professional requirements.
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affect the specialist’s judgments about
the work performed, conclusions, or
findings.67 Examples of the types of
circumstances that might give the
company the ability to affect the
specialist’s judgments include, but are
not limited to:
• The reporting relationship of a
company-employed specialist within
the company;
• Compensation of a company’s
specialist based, in part, on the outcome
of the work performed;
• Relationships a company-engaged
specialist has with entities acting as an
agent of the company;
• Personal relationships, including
family relationships, between the
company’s specialist and others within
company management;
• Financial interests, including stock
holdings, company specialists have in
the company; and
• Ownership, business relationships,
or other financial interests the employer
of a company-engaged specialist has
with respect to the company.
The auditor’s assessment that the
company has the ability to influence the
specialist, however, does not preclude
the auditor from using the work of a
company’s specialist, whether
employed or engaged, as audit evidence.
Rather, consistent with existing AS
1210, it is a factor in determining the
necessary audit effort to evaluate that
specialist’s work.68 In general, the
necessary audit effort increases as the
company’s ability to affect the
specialist’s judgments increases.
Determining the Necessary Evidence
The Proposal differed from existing
AS 1210 in that it set forth scalable
requirements for determining the
necessary evidence for evaluating both
the knowledge, skill, and ability of the
specialist and the relationship of the
specialist to the company. The Board is
adopting these requirements as
proposed. Under the final amendments,
the necessary evidence to assess the
level of knowledge, skill, and ability of
the company’s specialist and the
specialist’s relationship to the company
depends on (1) the significance of the
specialist’s work to the auditor’s
conclusion regarding the relevant
assertion and (2) the risk of material
misstatement of the relevant assertion.
As the significance of the specialist’s
67 See
AS 1105.A4, as adopted.
AS 1105.A7–.A10, as adopted. Examples
that illustrate how relationships between the
company and the company’s specialist can affect
the necessary audit effort in evaluating the work of
a company’s specialist under the final amendments
appear in the discussion on determining the
necessary evidence, as provided below.
68 See
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work and risk of material misstatement
increases, the persuasiveness of the
evidence the auditor should obtain for
those assessments also increases.69
No commenters opposed the proposed
framework for determining the
necessary evidence. A number of
commenters, however, asked for
clarification on the application of the
requirement when performing the
relevant evaluations. The Board’s
analysis of these comments is discussed
above in connection with the required
evaluations of the specialist’s
knowledge, skill, and ability, and the
relationship of the specialist to the
company.
Comparison With Standards of Other
Standard Setters
Paragraph 8(a) of ISA 500 provides
that, if information to be used as audit
evidence has been prepared using the
work of a management’s expert, the
auditor shall, to the extent necessary
and having regard to the significance of
that expert’s work for the auditor’s
purposes, evaluate the competence,
capabilities, and objectivity of that
expert.
AU–C Section 500 contains
requirements that are similar to those in
ISA 500.
Evaluating the Work of the Company’s
Specialist
See AS 1105.A6–.A10, as Adopted
In general, a specialist’s work
involves using data, assumptions, and
methods. The auditor’s responsibilities
under existing AS 1210 with respect to
the data, assumptions, and methods
used by the specialist are limited to (a)
obtaining an understanding of the
methods and assumptions used by the
specialist and (b) making appropriate
tests of data provided to the specialist.70
In addition, the auditor should evaluate
whether the specialist’s findings
support the related assertions in the
financial statements.71 Ordinarily, the
auditor would use the work of the
specialist unless the auditor’s
procedures lead the auditor to believe
the findings are unreasonable in the
circumstances.72 If the auditor believes
the specialist’s findings are
unreasonable, he or she is required to
apply additional procedures, which may
include potentially obtaining the
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69 See
AS 1105.A5, as adopted.
fair value measurements, however, another
standard requires the auditor to evaluate the
reasonableness of significant assumptions of the
specialist. See footnote 2 of AS 2502. This standard
is being superseded in the Estimates Release, supra
note 20.
71 See existing AS 1210.12.
72 Id.
70 For
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opinion of another specialist.73 Notably,
before the final amendments, PCAOB
standards have not expressly addressed
how to determine the necessary audit
effort to be applied in performing those
procedures.
The Proposal sought to enhance the
requirements for testing and evaluating
the work of the company’s specialist by:
• Extending the auditor’s
responsibilities for evaluating the
specialist’s assumptions to include all
significant assumptions used by the
specialist (not just those used in fair
value measurements);
• Expanding the auditor’s
responsibilities with respect to data to
include evaluating external data used by
the specialist (not just data provided by
the company to the specialist);
• Adding a requirement for the
auditor to evaluate the appropriateness
of the methods used by the specialist,
including whether the data was
appropriately applied;
• Setting forth a requirement for the
auditor to comply with the Board’s
proposed estimates standard 74 when
the auditor tests management’s process
for developing an estimate and a
company’s specialist was used; and
• Providing direction for determining
the necessary audit effort for testing and
evaluating the specialist’s work, based
on the risk of material misstatement and
other factors set forth in the standard.
Commenters expressed mixed views
on the premise underlying the Proposal
that the auditor should test and evaluate
the work of a company’s specialist.
While a number of commenters
supported that premise, other
commenters opposed expanding the
auditor’s responsibilities with respect to
the specialist’s methods and
assumptions beyond existing AS 1210.
Some of these commenters expressed
concerns that the auditor may not be
qualified to evaluate the work of a
specialist and recommended retaining
the more limited audit approach
reflected in existing AS 1210, including
the statement that ‘‘the auditor is not
expected to have the expertise of a
person trained for or qualified to engage
in practice of another profession or
occupation.’’
A number of commenters also
addressed specific aspects of the
proposed requirements for testing and
evaluating the work of company
specialists. Some commenters
questioned the proposal’s general use of
73 Id.
74 See Proposed Auditing Standard—Auditing
Accounting Estimates, Including Fair Value
Measurements and Proposed Amendments to
PCAOB Auditing Standards, PCAOB Release No.
2017–002 (June 1, 2017).
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the term ‘‘test’’ in describing the
auditor’s responsibilities, as well as the
proposed requirement to also comply
with the proposed estimates standard in
circumstances where the auditor tests
management’s process for developing an
estimate and a company’s specialist was
also used. Those commenters asserted
that the expected audit effort was
unclear. Two commenters stated that
the proposed requirements in this area
could be interpreted as requiring
reperformance of the specialist’s work,
which one of these commenters asserted
would be beyond the expertise of most
auditors and thus require auditors to use
an auditor’s specialist.
In addition, some commenters
requested clarification on the
expectations for evaluating a specialist’s
models, especially in situations where
auditors are unable to gain access to
proprietary models used by companyengaged specialists. Some commenters
also expressed concern about the
proposed requirement to evaluate
whether data was appropriately used by
the specialist. Some of these
commenters asserted that this
requirement appeared to require
auditors to reperform the specialist’s
work and suggested clarifying or
eliminating that requirement.
Additionally, some commenters
suggested allowing auditors to rely on
the issuer’s controls over the use of
specialists in determining the necessary
procedures for evaluating the
specialist’s work.
A number of commenters
acknowledged that the proposed
requirements were intended to be
scalable. However, some commenters
questioned whether they would be
scalable in practice. Other commenters
asked for guidance on tailoring audit
procedures based on risk and the other
factors set forth in the Proposal,
especially procedures under the
proposed requirement to also comply
with the proposed estimates standard.
Also, some commenters asserted that
the requirements did not adequately
distinguish the audit effort based on
whether the specialist was engaged or
employed by the company.
After considering the comments on
the Proposal, the Board is retaining the
fundamental approach in the Proposal—
under which the auditor evaluates the
data, significant assumptions, and
methods used by the specialist. This
approach is intended to increase audit
attention on the work of a company’s
specialist, particularly when that work
is significant in areas of higher risk, to
increase the likelihood that the auditor
would detect material financial
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statement misstatements related to that
work.
Taking into account comments on
specific aspects of the proposed
requirements, however, the final
amendments reflect a number of
clarifying revisions to eliminate or
revise certain proposed requirements
that may have been perceived by
commenters as unnecessarily complex
or prescriptive. The revisions address
concerns expressed by certain
commenters, while preserving the
intended benefits of the final
amendments, and include:
• Removing the word ‘‘test’’ from the
requirements to evaluate the work of the
company’s specialist, except in relation
to company-produced data; and
• Reframing the requirements for
evaluating the data, significant
assumptions, and methods used by the
specialist to describe the key
considerations in making those
evaluations.
In addition, the final amendments
clarify the applicability of the
requirements in circumstances when the
company’s specialist is involved in
developing an accounting estimate, such
as developing assumptions and methods
used in an accounting estimate. In such
circumstances, the requirements in
Appendix A of AS 1105 apply to
evaluating the data, significant
assumptions,75 and methods developed
(or generated) by the specialist, or
sourced by the specialist from outside
the company, as well as to testing
company-produced data. In contrast, for
significant assumptions provided by
management to the specialist, the
auditor is required to look to the
requirements in AS 2501, as adopted.
The final amendments are discussed in
more detail below.
Evaluating the Specialist’s Work: Data,
Significant Assumptions, and Methods
See AS 1105.A6 and .A8, as Adopted
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The revisions reflected in the final
amendments clarify the auditor’s
responsibilities for evaluating the work
of a company’s specialist, and are
intended to avoid potential confusion
that the auditor is required to reperform
the work of the company’s specialist.
Among other things, the revised
requirements reserve the use of the term
‘‘test’’ for procedures applied to
company-produced information used by
75 A footnote to AS 1105.A8, as adopted, refers
the auditor to AS 2501.15, as adopted, for the
procedures to perform when identifying significant
assumptions. For purposes of identifying significant
assumptions, the company’s assumptions include
assumptions developed by the company’s
specialist.
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the specialist, consistent with its usage
in AS 2501, as adopted.76
Notably, instead of requiring the
auditor to comply with AS 2501, as
adopted, the auditor would be required
to apply a set of analogous procedures
for evaluating data, significant
assumptions, and methods that are
tailored to situations in which
specialists are used.77 For example,
under the final amendments, the
auditor’s responsibilities with respect to
data, significant assumptions, and
methods used by the specialist generally
are:
• Company-produced data: Test the
accuracy and completeness of companyproduced data used by the specialist
(see AS 1105.A8a, as adopted); 78
• Data from sources external to the
company: Evaluate the relevance and
reliability of the data from sources
external to the company that are used by
the specialist (see AS 1105.A8a, as
adopted);
• Significant assumptions: Evaluate
whether the significant assumptions
used by the specialist are reasonable:
(1) Assumptions developed by the
specialist: Taking into account the
consistency of those assumptions with
relevant information (see AS
1105.A8b(1), as adopted);
(2) Assumptions provided by
company management and used by the
specialist: Looking to the requirements
set forth in AS 2501.16–.18, as adopted
(see AS 1105.A8b(2), as adopted);
(3) Assumptions based on the
company’s intent and ability to carry
out a particular course of action:
Looking to the requirements set forth in
AS 2501.17, as adopted (see AS
1105.A8b(3), as adopted); and
• Methods: Evaluate whether the
methods used by the specialist are
appropriate under the circumstances,
taking into account the requirements of
the applicable financial reporting
framework (see AS 1105.A8c, as
adopted).
Under the final amendments, the
focus of the auditor’s evaluation of the
work of the company’s specialist does
not require reperforming the specialist’s
work or evaluating whether the work
complies with all technical aspects in
the specialist’s field. Instead, the
auditor’s responsibility is to evaluate
76 See
Estimates Release, supra note 20.
note to AS 1105.A6, as adopted, emphasizes
that paragraphs .16–.17 of AS 2101 describe the
auditor’s responsibilities for determining whether
specialized knowledge or skill is needed. This
includes determining whether an auditor’s
specialist is needed to evaluate the work of a
company’s specialist.
78 See also AS 1105.10 for procedures when the
auditor uses information produced by the company
as audit evidence.
77 A
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whether the specialist’s work provides
sufficient appropriate evidence to
support a conclusion regarding whether
the corresponding accounts or
disclosures in the financial statements
are in conformity with the applicable
financial reporting framework.
With respect to the specialist’s
methods, the auditor’s responsibilities
under PCAOB standards have
historically been to understand the
method used. The final amendments
extend that obligation to encompass
evaluating whether the method is
appropriate under the circumstances,
taking into account the requirements of
the applicable financial reporting
framework.79 In many cases, evaluating
a method’s conformity with the
applicable financial reporting
requirements is the same as evaluating
its appropriateness under the
circumstances (e.g., if the applicable
accounting standard requires a
particular method for determining the
estimate). However, if the applicable
financial reporting framework allows
more than one method, or if the
appropriate method under the
framework depends on the
circumstances, evaluating conformity
with the framework involves
consideration of other relevant factors,
such as, the nature of the estimate and
the auditor’s understanding of the
company and its environment.
A note to the final amendments also
clarifies that evaluating the specialist’s
methods includes assessing whether the
data and significant assumptions are
appropriately applied under the
applicable financial reporting
framework.80 Evaluating the application
of the data encompasses, for example,
whether the data is selected and
adjusted in conformity with the
requirements of the applicable financial
reporting framework. Similarly,
evaluating the application of significant
assumptions encompasses evaluating
whether the assumptions were selected
in conformity with the requirements of
the applicable financial reporting
framework.
The final amendments do not require
the auditor to obtain access to
proprietary models used by the
specialist. Rather, the auditor’s
responsibility is to obtain information to
assess whether the model is in
conformity with the applicable financial
reporting framework. Depending on the
model and the factors set forth in AS
1105.A7, as adopted, this might involve,
for example, obtaining an understanding
of the model, reviewing descriptions of
79 See
80 See
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the model in the specialist’s report or
equivalent communication, testing
controls over the company’s evaluation
of the specialist’s work, or assessing the
inputs to and output from the model (if
necessary, using an alternative model
for comparison).
With respect to the specialist’s
significant assumptions, auditors have
historically had an obligation under
PCAOB standards to understand the
assumptions 81 and, for fair value
measurements, to evaluate the
reasonableness of the assumptions.82
The final amendments extend the
auditor’s obligation to include
evaluating the reasonableness of
significant assumptions used by the
specialist. This involves comparing the
assumptions to relevant information.
The note accompanying AS
1105.A8b(1), as adopted, provides
examples of information that, if
relevant, should be taken into account:
(1) Assumptions generally accepted
within the specialist’s field; (2)
supporting information provided by the
specialist; (3) industry, regulatory, and
other external factors, including
economic conditions; (4) the company’s
objectives, strategies, and related
business risks; (5) existing market
information; (6) historical or recent
experience, along with changes in
conditions and events affecting the
company; and (7) significant
assumptions used in other estimates
tested in the company’s financial
statements. These examples—including
examples (1) and (2), which were
suggested by commenters—point to
information that generally would be
available to the auditor (e.g., through
other procedures performed on the audit
or the auditor’s knowledge or the
company and its industry).
Furthermore, the final amendments
provide that, if a significant assumption
is provided by company management
and used by the specialist, the auditor
should look to the requirements in AS
2501.16–.18, as adopted. The final
amendments also provide that, if a
significant assumption is based on the
company’s intent and ability to carry
out a particular course of action, the
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existing AS 1210.09.
82 See footnote 2 of AS 2502.
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Determining the Necessary Audit Effort
for Evaluating the Specialist’s Work
See AS 1105.A7, as Adopted
Similar to the Proposal, the final
amendments set forth four factors that
affect the necessary evidence from the
auditor’s evaluation of the specialist’s
work to support a conclusion regarding
a relevant assertion. Specifically, under
the final amendments, the necessary
evidence depends on the: (1)
Significance of the specialist’s work to
the auditor’s conclusion regarding the
relevant assertion; (2) risk of material
misstatement of the relevant assertion;
(3) level of knowledge, skill, and ability
of the specialist; 83 and (4) the ability of
the company to significantly affect the
specialist’s judgments about the work
performed, conclusions, or findings.
Some commenters asked for
additional clarification or direction on
how to apply the four factors to
determine the necessary audit effort for
evaluating the specialist’s work. One
commenter requested that the Board
elaborate upon certain terms (e.g., terms
‘‘extensively’’ and ‘‘less extensive
procedures’’) that were used in two of
the three examples that were included
in the Proposal to illustrate how certain
factors could affect the necessary audit
effort in evaluating the work of a
company’s specialist. Another
commenter requested that the Board
provide additional examples of less
complex scenarios.
In addition, some commenters
asserted that the Proposal did not
adequately account for differences
between company-employed and
company-engaged specialists. These
commenters stated that the nature and
extent of an auditor’s procedures with
respect to the work of a companyengaged specialist with the necessary
knowledge, skill, and objectivity should
not necessarily be the same as those for
83 As noted previously, this factor includes
consideration of professional requirements the
specialist is required to follow.
81 See
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auditor should look to the requirements
set forth in AS 2501.17, as adopted. This
applies regardless of whether the
significant assumption was developed
by the company or the company’s
specialist.
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the work of a company-employed
specialist. One commenter suggested
expressly including in the list of factors
performance standards that the
specialist is required to follow.
The requirements regarding
determining the necessary audit effort
for evaluating the specialist’s work were
adopted substantially as proposed. The
changes to the procedural requirements
for evaluating the data, significant
assumptions, and methods used by the
specialist should help address concerns
about the necessary level of effort under
the appendix. Also, the three examples
included in the Proposal have been
revised to align with the final
amendments and expanded to address
factors that lead to more or less audit
attention and illustrate how the
additional attention may be directed
under the circumstances.
With respect to the distinction
between company-employed and
company-engaged specialists, the Board
believes that the final amendments
provide an appropriate framework for
distinguishing the work effort when
using the work of such specialists. In
particular, one of the four factors related
to determining the necessary audit effort
is the ability of the company to
significantly affect the specialist’s
judgments about the work performed,
conclusions, or findings. This factor is
discussed in more detail above.
Specifically, under the four factors set
forth in the final amendments, the
auditor should obtain more persuasive
evidence as the significance of the
specialist’s work, the risk of material
misstatement, or the ability of the
company to affect the specialist’s
judgments increases, or as the level of
knowledge, skill, and ability possessed
by the specialist decreases. In general,
the required audit effort when
evaluating the work of a company’s
specialist would be greatest when the
risk of material misstatement is high;
the specialist’s work is critical to the
auditor’s conclusion; the specialist has
a lower level of knowledge, skill, and
ability in the particular field; and the
company has the ability to significantly
affect the specialist’s judgments. These
factors are also illustrated in Figure 4,
below.
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04APN3
Under the final amendments, the first
two factors, in combination, relate to the
persuasiveness of the evidence needed
from the work of the company’s
specialist, as follows:
• Risk of Material Misstatement.
Consistent with the risk assessment
standards, under the final amendments,
the higher the risk of material
misstatement for an assertion, the more
persuasive the evidence needed to
support a conclusion about that
assertion.84 Pursuant to existing PCAOB
standards, tests of controls are required
if the risk of material misstatement is
based on reliance on controls.85
• Significance of the Specialist’s
Work. The significance of the
specialist’s work refers to the degree to
which the auditor would use the work
of the company’s specialist to support
the auditor’s conclusions about the
assertion. Generally, the greater the
significance of the specialist’s work to
the auditor’s conclusion regarding the
relevant assertion, the more persuasive
the evidence from the specialist’s work
needs to be. The significance of the
specialist’s work stems from:
84 See
paragraph .09a of AS 2301.
AS 2301.16, which addresses testing
controls to modify the nature, timing, and extent of
planned substantive procedures.
85 See
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• The extent to which the specialist’s
work affects significant accounts and
disclosures in the financial statements.
In some situations, the specialist’s work
might be used only as a secondary check
for a significant account or disclosure,
while in other situations that work
might be a primary determinant in one
or more significant accounts and
disclosures in the financial statements.
• The auditor’s approach to testing
the relevant assertion. When a
company’s accounting estimate is
determined principally based on the
work of a company’s specialist, an
auditor testing the company’s process
for developing the accounting estimate
would plan to use the work of the
company’s specialist for evidence
regarding the estimate. On the other
hand, if the auditor tests an assertion by
developing an independent expectation,
the auditor would give less
consideration to the work of the
company’s specialist.86
The other two factors—the specialist’s
level of knowledge, skill, and ability,
86 As another example, the auditor might develop
an independent expectation using certain
assumptions or methods of the company’s
specialist. In those instances, the auditor’s
evaluation would focus on those assumptions or
methods that the auditor used in developing his or
her independent expectation.
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13459
and the ability of the company to
significantly affect the specialist’s
judgments—relate to the degree of
reliability of the specialist’s work as
audit evidence (i.e., the extent to which
the specialist’s work could provide
persuasive evidence, if relevant and
found to be satisfactory after the
auditor’s evaluation).
In some situations, if the auditor has
doubt about the specialist’s knowledge,
skill, and ability or about the company’s
effect on the specialist’s judgments, the
auditor might choose not to use the
work of the company’s specialist,
instead of performing additional
procedures with respect to evaluating
the specialist’s work. The final
amendments do not preclude the
auditor from pursuing other alternatives
to using that specialist’s work. Such
alternatives might include developing
an independent expectation of the
related accounting estimate or seeking
to use the work of another specialist.
The following examples illustrate
various ways in which the factors
discussed above can affect the necessary
audit effort in evaluating the work of a
company’s specialist under the final
amendments. The examples assume that
the auditor will evaluate, as appropriate,
the data, significant assumptions, and
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methods used by the specialist, and
evaluate the relevance and reliability of
the work of the company’s specialist
and its relationship to the relevant
assertion.
Example 1—An oil and gas production
company employs an experienced petroleum
reserve engineer to assist in developing the
estimated proved oil and gas reserves 87 that
are used in multiple financial statement
areas, including: (1) The company’s
impairment analysis; (2) depreciation,
depletion and amortization calculations; and
(3) related financial statement disclosures,
such as reserve disclosures. A substantial
portion of the engineer’s compensation is
based on company earnings, and the engineer
has a reporting line to the company’s chief
financial officer. The auditor concludes that
the risk of material misstatement of the
valuation of oil and gas properties is high,
and the reserve engineer’s work is significant
to the auditor’s conclusion regarding the
assertion. Thus, the auditor would need to
obtain more persuasive audit evidence
commensurate with a high risk of material
misstatement, devoting more audit attention
to the data, significant assumptions, and
methods that are more important to the
specialist’s findings and more susceptible to
error or significant management influence.
On the other hand, relatively less audit
evidence might be needed for the work of an
individual reserve engineer if the company
has several properties of similar risk, and the
reserve studies are performed by different
qualified reserve engineers who are either (1)
engaged by the company, having no
significant ties that give the company
significant influence over the specialists’
judgments or (2) employed specialists for
which the company has implemented
compensation policies, reporting lines, and
other measures to prevent company
management from having significant
influence over the specialists’ judgments.
Example 2—A financial services company
specializes in residential mortgage and
commercial mortgage loans, which are either
sold or held in its portfolio. During the
financial statement audit, the auditor may
inspect appraisals prepared by the company’s
specialists for the real estate collateralizing
loans for a variety of reasons, including in
conjunction with testing the valuation of
loans and the related allowance for loan
losses. Under these circumstances, the
persuasiveness of the evidence needed from
(and the necessary degree of audit attention
devoted to evaluating the methods,
significant assumptions, and data used in) an
individual appraisal would depend, among
other things, on the importance of the
individual appraisal to the auditor’s
conclusion about the related financial
statement assertion. In general, more audit
attention would be needed for appraisals
used in testing the valuation of individually
large loans that are valued principally based
on their collateral than for appraisals
inspected in loan file reviews for a portfolio
of smaller loans with a low risk of default
and a low loan-to-value ratio.
87 See Rule 4–10(a)(22) of Regulation S–X, 17 CFR
210.4–10(a)(22).
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Example 3—A manufacturing company
engages an actuary to calculate the projected
pension benefit obligation (‘‘PBO’’) for its
pension plan, which is used to determine the
related accounts and disclosures in the
financial statements. The auditor has
assessed the risk of material misstatement for
the valuation of the PBO as high and
concluded that the actuary’s work is
significant to the auditor’s conclusion. The
actuary has extensive experience and is
employed by a highly regarded actuarial firm
with many clients. The actuary and actuarial
firm have no relationships with the company
other than performing the actuarial pension
plan calculations for the company’s financial
statements. Under these circumstances, the
necessary level of audit attention is less than
it otherwise would be for a situation where
a specialist has a lower level of knowledge,
skill and ability, or the company has the
ability to significantly affect the specialist’s
judgments about the work performed,
conclusions, or findings. When more audit
attention is needed, the auditor would focus
on those aspects of the specialist’s work that
could be affected by the issues related to the
specialist’s knowledge, skill, and ability or by
the company’s ability to significantly affect
the specialist’s judgments.
The three examples above are
provided only to illustrate the auditor’s
consideration of the four factors set
forth in the final amendments when
determining the necessary audit effort
for evaluating the work of the
company’s specialist. Differences in
circumstances, or additional
information, could lead to different
conclusions. The examples are not
intended to prescribe the specific
procedures to be performed in
evaluating the work of a company’s
specialist in any particular situation,
which should be determined in
accordance with the final amendments.
Evaluating the Specialist’s Work:
Findings
See AS 1105.A9–.A10, as Adopted
The Proposal set forth requirements
for evaluating the relevance and
reliability of the specialist’s findings.
The proposed requirements built upon
the existing requirements to evaluate the
specialist’s findings and were aligned
with the risk assessment standards.88
The Proposal also provided factors that
affect the relevance and reliability of the
specialist’s work. Additionally, the
proposed requirements described
examples of situations in which
additional procedures ordinarily are
necessary. Commenters on this aspect of
88 Existing AS 1210.12 requires the auditor to
evaluate whether the specialist’s findings support
the related assertions in the financial statements. It
does not specify, however, what might lead an
auditor to conclude that he or she should perform
additional procedures or obtain the opinion of
another specialist.
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the Proposal generally supported the
proposed approach. A few commenters
asked for an explanation of the
additional procedures to be performed.
One commenter stated that certain
restrictions, disclaimers, or limitations
are common in specialists’ reports and
that auditors may have no choice but to
accept them.
After considering the comments
received, the Board is adopting the
requirements as proposed with one
modification discussed below. The final
requirements in AS 1105.A10, as
adopted, provide that the auditor should
perform additional procedures, as
necessary, if the specialist’s findings or
conclusions appear to contradict the
relevant assertion or the specialist’s
work does not provide sufficient
appropriate evidence. The final
requirements also provide examples of
situations in which additional
procedures ordinarily are necessary,
such as when the specialist’s report, or
equivalent communication,89 contains
restrictions, disclaimers, or limitations
regarding the auditor’s use of the report
or the auditor has identified that the
specialist has a conflict of interest
relevant to the specialist’s work. The
final requirements do not prescribe
specific procedures to be performed
because the necessary procedures
depend on the circumstances creating
the need for the procedures.
A specialist’s report may contain
restrictions, disclaimers, or limitations
that cast doubt on the relevance and
reliability of the information contained
in the specialist’s report and affect how
the auditor can use the report of the
specialist. For example, a specialist’s
report that states ‘‘the values in this
report are not an indication of the fair
value of the underlying assets’’
generally would not provide sufficient
appropriate evidence related to fair
value measurements. On the other hand,
a specialist’s report that indicates that
the specialist’s calculations were based
on information supplied by
management may still be appropriate for
use by the auditor to support the
relevant assertion, since the auditor
would already be required to test the
company-supplied data used in the
specialist’s calculations.
89 AS 1105.A9–.A10, as adopted, added the
phrase ‘‘or equivalent communication,’’ which was
not part of the proposed amendments, because a
company’s specialist may communicate his or her
findings or conclusions in a memorandum or other
written alternative to a formal report. AS 1201,
Appendix C, as adopted, and AS 1210, as amended,
refer to a specialist’s report ‘‘or equivalent
documentation.’’ The difference in terminology is
intended to distinguish information provided by the
auditor’s specialist from information provided by
the company’s specialist.
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The requirements in AS 1105.A10, as
adopted, do not require the auditor to
perform procedures specifically to
search for potential conflicts of interest
that a company’s specialist might have,
other than those resulting from the
specialist’s relationship with the
company. However, the auditor may
become aware of conflicts of interest
arising from relationships with parties
outside the company (e.g., through
obtaining information about the
specialist’s professional reputation and
standing, reading the specialist’s report,
or performing procedures in other audit
areas). For example, in reviewing an
appraisal of the collateral for a material
loan receivable, the auditor may become
aware that the appraiser has a
substantial financial interest in the
collateral. If the auditor becomes aware
of a conflict of interest that could affect
the specialist’s judgments about the
work performed, conclusions, or
findings, the auditor would need to
consider the effect of that conflict on the
reliability of the specialist’s work, and
perform additional procedures if
necessary to obtain sufficient
appropriate evidence regarding the
relevant financial statement assertion.
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Comparison With Standards of Other
Standard Setters
Paragraph 8(c) of ISA 500 provides
that, if information to be used as audit
evidence has been prepared using the
work of a management’s expert, the
auditor shall, to the extent necessary
and having regard to the significance of
that expert’s work for the auditor’s
purposes, evaluate the appropriateness
of that expert’s work as audit evidence
for the relevant assertion.
AU–C Section 500 contains
requirements that are similar to those in
ISA 500.
Amendments Related to Supervising or
Using the Work of an Auditor’s
Specialist
The final amendments set forth
requirements for supervising or using
the work of an auditor’s specialist,
taking into account differences in the
auditor’s relationship with employed
specialists and engaged specialists. A
new appendix to AS 1201 applies to the
supervision of auditor-employed
specialists, and AS 1210, as amended,
applies when using the work of auditorengaged specialists.
Commenters on the Proposal
generally supported the proposed
approach for overseeing and
coordinating the work of an auditor’s
specialists, which was risk-based and
set forth largely parallel requirements
when using the work of both auditor-
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employed and auditor-engaged
specialists. A few commenters,
however, expressed concerns with the
practicality and clarity of certain aspects
of the proposed requirements. These
comments and others are discussed
below.
Amendments to AS 1201 for
Supervising the Work of an AuditorEmployed Specialist
Appendix C of AS 1201, as adopted,
supplements the existing requirements
in AS 1201.05–.06 by providing more
specific direction on applying the
general supervisory principles in AS
1201 to the supervision of an auditoremployed specialist who assists the
auditor in obtaining or evaluating audit
evidence.
Meaning of ‘‘Auditor-Employed
Specialist’’
See AS 1201.C1, as Adopted
The Proposal used the term ‘‘auditoremployed specialist’’ to mean a
‘‘specialist employed by the auditor’s
firm,’’ consistent with existing
requirements.90 Two commenters asked
for clarification of how to apply the
terms ‘‘auditor-employed’’ and ‘‘auditorengaged’’ specialists when specialists
are employed by entities that are
affiliated with the audit firm and those
specialists are subject to the same
quality control policies and procedures
and independence requirements as
employees of the audit firm.
The final amendments retain the
existing concept that an ‘‘auditoremployed specialist’’ is a ‘‘specialist
employed by the auditor’s firm.’’ Given
that the terms ‘‘auditor-employed
specialist’’ and ‘‘auditor-engaged
specialist’’ in the final amendments are
consistent with existing requirements,
auditors should be familiar with this
distinction. The Board recognizes,
however, that there may be instances
where an auditor uses the work of a
specialist who is a partner, principal,
shareholder or employee of an affiliated
entity that is not an accounting firm and
treats that specialist as if he or she were
employed by the auditor’s firm (i.e., as
an auditor-employed specialist). While
it is not practicable to address all the
legal structures or affiliations between
accounting firms and specialist entities
that may give rise to such situations, the
final amendments are not intended to
change current practice where the
specialist is employed by an affiliated
entity that adheres to the same quality
90 See existing AS 1210.05, which states that AS
1201 applies to situations in which ‘‘a specialist
employed by the auditor’s firm participates in the
audit.’’
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control and independence requirements
as the auditor’s firm. In such
circumstances, the Board understands
that the auditor would assess the
qualifications and independence of that
specialist in the same ways as an
engagement team member employed by
the firm.
Comparison With Standards of Other
Standard Setters
ISA 620 covers the auditor’s use of the
work of both auditor-employed experts
and auditor-engaged experts, but the
requirements in ISA 620 for the
auditor’s evaluation of the objectivity of
an auditor-employed expert differ from
those for evaluating the objectivity of an
auditor-engaged expert.
AU–C Section 620 is similar to ISA
620 in both respects.
Determining the Extent of Supervision
See AS 1201.C2, as Adopted
The Proposal supplemented, in
proposed Appendix C of AS 1201, the
factors set forth in AS 1201.06 for
determining the necessary extent of
supervision of engagement team
members in circumstances involving the
use of the work of an auditor-employed
specialist.91
No commenters opposed the proposed
requirement for determining the extent
of supervision. One commenter stated
that the proposed requirement for
determining the extent of supervision
appeared scalable to the size and
complexity of the audit engagement.
The Board is adopting this requirement
as proposed. The final requirements
provide that the necessary extent of
supervision depends on: (1) The
significance of the specialist’s work to
the auditor’s conclusion regarding the
relevant assertion; (2) the risk of
material misstatement of the relevant
assertion; and (3) the knowledge, skill,
and ability of the auditor-employed
specialist relevant to the work to be
performed by the specialist.
Comparison With Standards of Other
Standard Setters
Paragraph 8 of ISA 620 provides that,
depending on the circumstances, the
nature, timing and extent of the
auditor’s procedures will vary with
respect to: (1) Evaluating the
91 AS 1201.06 provides that, to determine the
extent of supervision necessary for engagement
team members, the engagement partner and other
engagement team members performing supervisory
activities should take into account, among other
things: (1) The nature of the company, including its
size and complexity; (2) the nature of the assigned
work for each engagement team member; (3) the
risks of material misstatement; and (4) the
knowledge, skill, and ability of each engagement
team member.
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competence, capabilities and objectivity
of the auditor’s expert; (2) obtaining an
understanding of the field of expertise
of the auditor’s expert; (3) reaching an
agreement with the auditor’s expert; and
(4) evaluating the adequacy of the
auditor’s expert’s work. In determining
the nature, timing and extent of those
procedures, the auditor shall consider
matters including:
(a) The nature of the matter to which
that expert’s work relates;
(b) The risks of material misstatement
in the matter to which that expert’s
work relates;
(c) The significance of that expert’s
work in the context of the audit;
(d) The auditor’s knowledge of and
experience with previous work
performed by that expert; and
(e) Whether that expert is subject to
the auditor’s firm’s quality control
policies and procedures.
AU–C Section 620 contains
requirements that are similar to those in
ISA 620.
Qualifications and Independence of
Auditor-Employed Specialists
See AS 1015.06, as amended, and
footnote 3A to AS 2101.06b, as amended
PCAOB auditing standards require
that personnel be assigned to
engagement teams based on their
knowledge, skill, and ability.92 This
requirement applies equally to auditoremployed specialists and other
engagement team members. In addition,
auditor-employed specialists must be
independent of the company.93
Accordingly, the requirements in
PCAOB auditing standards for
determining compliance with
independence and ethics requirements
apply to auditor-employed specialists.94
Rather than add specific requirements
for evaluating the qualifications and
independence of auditor-employed
specialists, the Proposal would have
included two paragraphs in Appendix C
92 See
AS 2301.05a and AS 1015.06, as amended.
Rule 3520, Auditor Independence,
requires a registered public accounting firm and its
associated persons to be independent of the firm’s
‘‘audit client’’ throughout the audit and
professional engagement period, meaning that they
must satisfy all independence criteria applicable to
an engagement. In addition, under Rule 2–01 of
Regulation S–X, 17 CFR 210.2–01, any professional
employee of the ‘‘accounting firm’’ (as broadly
defined in Rule 2–01(f)(2) to include associated
entities) who participates in an engagement of an
audit client is a member of the ‘‘audit engagement
team,’’ as that term is defined under Rule
2–01(f)(7)(i). The effect is that an accounting firm
is not independent if it uses the work of a specialist
employed by the accounting firm who does not
meet the independence requirements of Rule 2–01.
94 See AS 2101.06b.
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citing the applicable requirements in
existing standards.95
Most commenters on this topic
advocated for greater acknowledgment
of the auditor’s ability to use
information from the firm’s system of
quality control when assessing the
knowledge, skill, ability, and
independence of an auditor-employed
specialist. Specifically, some of these
commenters recommended the
inclusion of references to QC 20, System
of Quality Control for a CPA Firm’s
Accounting and Auditing Practice (‘‘QC
20’’), in these requirements. In the view
of these commenters, QC 20 more fully
encompasses both the considerations
related to the appropriate assignment of
personnel to an engagement and the
requirements related to independence,
integrity, and objectivity. One
commenter suggested that the standard
provide that a firm’s system of quality
control pursuant to QC 20 would be
sufficient to satisfy the requirements
relating to the qualifications and
independence of auditor-employed
specialists. Another commenter stated
that the necessary guidance was
contained in QC 20 and that the
references in the Proposal to applicable
requirements in existing standards were
duplicative.
The Board considered these
comments in adopting the final
amendments. The intent of the proposed
paragraphs for assigning personnel
based on their knowledge, skill, and
ability, and for determining compliance
with independence and ethics
requirements, was to emphasize that
auditors’ responsibilities for assessing
the qualifications and independence of
the auditor-employed specialists are the
same as for other engagement team
members. To avoid any
misunderstanding that a different
process was expected for assigning
auditor-employed specialists and
determining their compliance with
independence and ethics requirements,
the proposed paragraphs do not appear
in the final amendments. Also, two
related amendments to PCAOB auditing
standards are being adopted. First, AS
1015.06 has been amended to clarify
that engagement team members, which
includes auditor-employed specialists,
should be assigned to tasks and
supervised commensurate with their
level of knowledge, skill, and ability,
and that this requirement is not limited
to the assignment and supervision of
auditors. Second, in another conforming
amendment, a footnote was added to AS
2101.06b to remind auditors of the
95 See proposed AS 1201.C3–.C4; see also AS
2301.05a, AS 1015.06, and AS 2101.06b.
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obligations of registered firms and their
associated persons under PCAOB Rule
3520.
Under the final amendments, auditors
will continue to have the ability to use
information from, and processes in, the
firm’s quality control system when
assessing the knowledge, skill, ability,
and independence of auditor-employed
specialists. The fact that a system of
quality control may have a process for
making assignments of specialists does
not relieve the engagement partner (with
the assistance of appropriate
supervisory personnel on the
engagement team) of his or her
responsibility to determine whether the
assigned specialist has the necessary
qualifications and independence for the
particular audit engagement in
accordance with AS 1015.06, as
amended, and AS 2101.06, as amended.
The relevant facts and circumstances,
including the nature, scope, and
objectives of the specialist’s work,
should be considered when performing
this assessment. For example, a
valuation specialist may have expertise
in valuing oil and gas reserves, but not
in valuing coal reserves. In that case,
failure to consider the specialist’s
expertise when assigning the specialist
work on an audit engagement in an
extractive industry could result in the
inappropriate assignment of significant
engagement responsibilities.
Comparison With Standards of Other
Standard Setters
Paragraph 9 of ISA 620 provides that
the auditor shall evaluate whether the
auditor’s expert has the necessary
competence, capabilities, and
objectivity for the auditor’s purposes.
AU–C Section 620 contains
requirements that are similar to those in
ISA 620.
Informing the Specialist of the Work To
Be Performed
See AS 1201.C3–.C5, as adopted
The Proposal supplemented the
requirements in PCAOB standards for
informing the engagement team
members of their responsibilities to
address situations where auditoremployed specialists are performing
work in an audit.96 Most commenters
96 AS 1201.05a sets forth requirements for the
engagement partner and, as applicable, other
engagement team members performing supervisory
activities to inform engagement team members of
their responsibilities. These matters include: (1)
The objectives of the procedures that engagement
team members are to perform; (2) the nature, timing,
and extent of procedures they are to perform; and
(3) matters that could affect the procedures to be
performed or the evaluation of the results of those
procedures, including relevant aspects of the
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who commented on the supplemental
requirements generally supported the
proposed approach, asserting that it
would foster effective communication
between the auditor and the auditor’s
specialist. Some commenters, however,
asked for clarification of certain aspects
of the proposed requirement to establish
and document an understanding with
the specialist of the work to be
performed. After considering the
comments received, the Board is
adopting the requirements substantially
as proposed.
The final amendments include
requirements for the engagement partner
and, as applicable, other engagement
team members performing supervisory
activities to inform the auditoremployed specialist about the work to
be performed. These requirements
include establishing and documenting
an understanding with the specialist
regarding the responsibilities of the
specialist, the nature of the specialist’s
work, the specialist’s degree of
responsibility for testing data and
evaluating methods and significant
assumptions, and the responsibility of
the specialist to provide a report, or
equivalent documentation.
Some commenters requested
clarification in the final amendments on
the form of documentation of the
auditor’s understanding with the
specialist. In addition, some
commenters suggested removing the
specific reference to the specialist’s
responsibility to provide a ‘‘report, or
equivalent documentation’’ and
allowing for more flexibility when the
specialist’s results are communicated to
the auditor. Some of these commenters
asserted that the proposed requirement
connoted the preparation of a formal,
signed report, which could discourage
effective two-way communication
between the auditor and the specialist.
Another commenter suggested that the
Board consider whether the auditor’s
understanding with the specialist
should also include matters the
specialist should communicate to the
auditor, and the nature, timing, and
extent of those communications. One
commenter also expressed concern that
use of the term ‘‘degree of
responsibility’’ could be seen as a means
for auditors to abdicate responsibility
for audit work to specialists.
The final amendments do not include
specific requirements for how to
document the auditor’s understanding
with the auditor’s specialist. Instead, the
Board contemplates that the
company, its environment, and its internal control
over financial reporting, and possible accounting
and auditing issues.
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understanding with the specialist can be
documented in a variety of ways, such
as in planning memoranda, separate
memoranda, or other related work
papers. This approach should provide
auditors with flexibility, while still
requiring the documentation of the
important aspects of the understanding
reached by the auditor and the auditor’s
specialist. This approach also enables
the specialist to communicate those
matters specific to the work performed
and does not limit the specialist’s ability
to communicate other items to the
auditor.
The final amendments also require
the auditor to establish and document
an understanding with the specialist
regarding the degree of responsibility of
the specialist for: (1) Testing data
produced by the company, or evaluating
the relevance and reliability of data
from sources external to the company;
(2) evaluating the significant
assumptions used by the company or
the company’s specialist, or developing
his or her own assumptions; and (3)
evaluating the methods used by the
company or the company’s specialist, or
using his or her own methods. The
intent of this requirement is to enhance
coordination of the work between the
auditor and the auditor’s specialist and
facilitate supervision of the specialist by
the engagement partner and others with
supervisory responsibilities. For
example, if the auditor’s specialist
assists the auditor in developing an
independent expectation using data,
assumptions, or a model provided by
the auditor or auditor’s specialist, the
auditor would establish an
understanding with the specialist
regarding the specialist’s
responsibilities with respect to the data,
assumptions, or model.97 Regardless of
the specialist’s degree of responsibility,
the engagement partner and, as
applicable, other engagement team
members performing supervisory
activities are responsible for evaluating
the specialist’s work and report, or
equivalent documentation.98
In addition, as proposed, the final
amendments require establishing and
documenting the specialist’s
responsibility to provide ‘‘a report, or
equivalent documentation’’ to the
auditor. This requirement should
provide flexibility for auditors to obtain
97 AS 1201.C5, as adopted, provides that the
auditor should comply with AS 2501.21–.26, as
adopted, when an independent expectation is
developed. For example, the auditor’s
responsibilities with respect to using data or
assumptions obtained from a third party are
presented in AS 2501.23, as adopted. See Estimates
Release, supra note 20.
98 See AS 1201.C6–.C7, as adopted.
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the necessary information about the
specialist’s procedures, findings, and
conclusions through the specialist’s
report, other specialist-provided
documentation, or a combination of the
two. The requirement should also
facilitate the auditor’s compliance with
other PCAOB auditing standards, such
as those on engagement quality review
and audit documentation.99
The final amendments require
establishing and documenting the
auditor’s understanding with the
specialist regarding the ‘‘nature of the
work that the specialist is to perform or
assist in performing.’’ As proposed, this
requirement would have also
encompassed the ‘‘specialist’s approach
to that work.’’ Two commenters
suggested that the Board clarify the
difference between the two terms. The
nature of the specialist’s work would
include, for example, testing data and
evaluating the methods and significant
assumptions used in developing an
estimate when testing the company’s
process used to develop an accounting
estimate or developing an independent
expectation of an estimate. The
specialist’s approach to that work, in
turn, might include the procedures the
specialist performs to test management’s
process or develop an independent
expectation, such as testing data and
evaluating the methods and significant
assumptions used in developing an
estimate. Since the auditor’s obligation
to establish and document the
specialist’s degree of responsibility for
performing similar procedures is
addressed in other provisions of the
final amendments,100 the phrase ‘‘the
specialist’s approach to that work’’ has
been omitted to avoid potential
confusion.
As proposed, the final amendments
also provide that, pursuant to AS
1201.05a(3), the engagement partner
and, as applicable, other engagement
team members performing supervisory
activities should inform the auditoremployed specialist about matters that
could affect the specialist’s work.101
This includes, as applicable,
information about the company and its
environment, the company’s processes
for developing the related accounting
estimate, the company’s use of
specialists in developing the estimate,
relevant requirements of the applicable
financial reporting framework, possible
accounting and auditing issues, and the
need to apply professional skepticism.
Commenters did not offer suggestions
99 See AS 1220, Engagement Quality Review, and
AS 1215, Audit Documentation.
100 See AS 1201.C3c, as adopted.
101 See AS 1201.C4, as adopted.
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on this provision, although one
commenter stated that it concurred with
the proposed requirement.
The final amendments also provide
that the engagement partner and, as
applicable, other engagement team
members performing supervisory
activities should implement measures to
determine that there is a proper
coordination of the work of the
specialist with the work of other
relevant engagement team members to
achieve a proper evaluation of the
evidence obtained in reaching a
conclusion about the relevant
assertion.102 One commenter requested
clarification of the term ‘‘measures,’’ as
used in this context. The final
requirement emphasizes that the auditor
is responsible for complying with
relevant auditing standards, including,
when applicable, AS 2501, as adopted,
and Appendix A of AS 1105, as
adopted.103 This requirement is
intended to prompt the auditor to
coordinate with the specialist to make
sure that the work is performed in
accordance with the applicable
standards, including the requirement to
consider relevant audit evidence,
regardless of whether it supports or
contradicts the relevant financial
statement assertion. For example, in
auditing an accounting estimate under
AS 2501, as adopted, measures taken by
the auditor could include either
performing, or supervising the auditor’s
specialist in performing, the required
procedures with respect to testing and
evaluating the data, and evaluating the
methods and significant assumptions
used in developing that estimate.104
Comparison With Standards of Other
Standard Setters
Paragraph 11 of ISA 620 provides that
the auditor shall agree, in writing when
appropriate, on the following matters
with the auditor’s expert:
(a) The nature, scope and objectives of
that expert’s work;
(b) The respective roles and
responsibilities of the auditor and that
expert;
(c) The nature, timing, and extent of
communication between the auditor and
that expert, including the form of any
report to be provided by that expert; and
102 See
AS 1201.C5, as adopted.
AS 1201.C5, as adopted. In response to
comments, this paragraph was revised in the final
amendments to provide that, if an auditor’s
specialist is used to evaluate the work of a
company’s specialist, measures should be
implemented to comply with Appendix A of AS
1105, as adopted, and, for accounting estimates, AS
2501.19, as adopted.
104 See AS 2501, as adopted, and Estimates
Release, supra note 20.
(d) The need for the auditor’s expert
to observe confidentiality requirements.
AU–C Section 620 contains
requirements that are similar to those in
ISA 620.
Evaluating the Work of the Specialist
See AS 1201.C6–.C7, as Adopted
The Proposal supplemented, in
Appendix C, the requirements in AS
1201.05c for reviewing the work of the
engagement team in circumstances in
which auditor-employed specialists are
used.105 It provided that, if the
specialist’s findings or conclusions
appear to contradict the relevant
assertion or the specialist’s work does
not provide sufficient appropriate
evidence, the engagement partner and,
as applicable, other engagement team
members performing supervisory
activities should perform additional
procedures, or request the specialist to
perform additional procedures, as
necessary to address the issue.
Commenters generally agreed with
these requirements, noting that the
requirements are appropriate and, in the
view of some commenters, would
improve audit quality. Two commenters
asked for additional guidance on how
the auditor should evaluate methods
and assumptions used by an auditoremployed specialist. One commenter
recommended providing additional
guidance on the specific procedures to
be performed by auditors to evaluate a
specialist’s work. After considering the
comments, the Board is adopting the
requirements substantially as proposed.
The final amendments provide a
principles-based framework for
reviewing and evaluating the work of
the specialist. Under the final
amendments, the engagement partner
and, as applicable, other engagement
team members performing supervisory
activities should review the specialist’s
report or equivalent documentation
describing the work performed, the
results of the work, and the findings or
conclusions reached by the specialist, as
provided for under AS 1201.C3d, as
adopted.106
This approach links the scope of the
auditor’s review to the report or
equivalent documentation that the
specialist agreed to furnish to the
auditor under AS 1201.C3, as adopted.
The principles for the necessary extent
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103 See
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105 AS 1201.05c provides that the engagement
partner and, as applicable, other engagement team
members performing supervisory activities should
review the work of engagement team members to
evaluate whether: (1) The work was performed and
documented; (2) the objectives of the procedures
were achieved; and (3) the results of the work
support the conclusions reached.
106 See AS 1201.C6, as adopted.
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of supervision, discussed earlier, also
apply to evaluating the work of the
auditor-employed specialist, including
the report or equivalent documentation
provided by the specialist. Accordingly,
auditors should be familiar with this
approach and how to apply this
requirement in practice.
The necessary extent of review and
evaluation of the auditor-employed
specialist’s work depends on (1) the
significance of the specialist’s work to
the auditor’s conclusion regarding the
relevant assertion; (2) the risk of
material misstatement of the relevant
assertion; and (3) the knowledge, skill,
and ability of the specialist. In
performing the review, the auditor also
should evaluate whether the specialist’s
work provides sufficient appropriate
evidence, specifically whether:
• The specialist’s work and report, or
equivalent documentation, are in
accordance with the auditor’s
understanding with the specialist; and
• The specialist’s findings and
conclusions are consistent with results
of the work performed by the specialist,
other evidence obtained by the auditor,
and the auditor’s understanding of the
company and its environment.
AS 1201.C7, as adopted, provides
that, if the specialist’s findings or
conclusions appear to contradict the
relevant assertion or the specialist’s
work does not provide sufficient
appropriate evidence, the engagement
partner and, as applicable, other
engagement team members performing
supervisory activities should perform
additional procedures, or request the
specialist to perform additional
procedures, as necessary to address the
issue. The final requirement also
provides examples of situations in
which additional procedures ordinarily
would be necessary, including:
• The specialist’s work was not
performed in accordance with the
auditor’s instructions;
• The specialist’s report, or
equivalent documentation, contains
restrictions, disclaimers, or limitations
that affect the auditor’s use of the report
or work; 107
• The specialist’s findings and
conclusions are inconsistent with (1) the
results of the work performed by the
specialist, (2) other evidence obtained
107 The auditor’s consideration of restrictions,
disclaimers, or limitations in a report, or equivalent
documentation, provided by an auditor-employed
specialist is the same as when such language is
contained in a report, or equivalent documentation,
provided by an auditor-engaged specialist. See
below for further discussion of the auditor’s
consideration of the effect of restrictions,
disclaimers, or limitations on the report, or
equivalent documentation, provided by the auditorengaged specialist.
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by the auditor, or (3) the auditor’s
understanding of the company and its
environment;
• The specialist lacks a reasonable
basis for data or significant assumptions
the specialist used; or
• The methods used by the specialist
were not appropriate.
These requirements are consistent
with existing provisions in paragraphs
.06 and .36 of AS 2810, Evaluating
Audit Results, which provide that, if the
auditor concludes that the evidence
gathered is not adequate, he or she
should modify his or her audit
procedures or perform additional
procedures as necessary (e.g., audit
procedures may need to be modified or
additional procedures may need to be
performed as a result of any changes in
the risk assessments). Similarly, if the
evidence gathered by the specialist in
testing or evaluating data, or evaluating
significant assumptions is not adequate,
the engagement partner and, as
applicable, other engagement team
members performing supervisory
activities should perform additional
procedures, or request the specialist to
perform additional procedures, as
necessary to address the issue.
One commenter asserted that auditors
may not have sufficient knowledge of
the specialist’s field of expertise to
evaluate a specialist’s work and
effectively challenge methods,
assumptions, and data, particularly in
relation to highly complex technical
areas. The final amendments recognize
that the engagement partner and, as
applicable, other engagement team
members performing supervisory
responsibilities may not have in-depth
knowledge of the specialist’s field.
However, under existing PCAOB
standards, the auditor is required to
have sufficient knowledge of the subject
matter to evaluate a specialist’s work as
it relates to the nature, timing, and
extent of the auditor’s work and the
effects on the auditor’s report.108
Furthermore, the evaluation of the
specialist’s work under the final
amendments is based on matters that are
within the capabilities of the auditor
(e.g., whether the specialist followed
instructions and whether the results of
the work support the specialist’s
conclusions).
Another commenter asked for
clarification of the term ‘‘reasonable
basis’’ in the context of assessing
whether the specialist lacks a reasonable
basis for data or significant assumptions
the specialist used. In that context,
‘‘reasonable basis’’ refers to whether the
specialist’s selection of data or
108 See
AS 2101.17.
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significant assumptions was determined
arbitrarily or instead based on
consideration of relevant information
available to the specialist.
Comparison With Standards of Other
Standard Setters
Paragraph 12 of ISA 620 provides that
the auditor shall evaluate the adequacy
of the auditor’s expert’s work for the
auditor’s purposes, including:
(a) The relevance and reasonableness
of that expert’s findings or conclusions,
and their consistency with other audit
evidence;
(b) If that expert’s work involves use
of significant assumptions and methods,
the relevance and reasonableness of
those assumptions and methods in the
circumstances; and
(c) If that expert’s work involves the
use of source data that is significant to
that expert’s work, the relevance,
completeness, and accuracy of that
source data.
Paragraph 13 of ISA 620 provides that
if the auditor determines that the work
of the auditor’s expert is not adequate
for the auditor’s purposes, the auditor
shall:
(a) Agree with that expert on the
nature and extent of further work to be
performed by that expert; or
(b) Perform additional audit
procedures appropriate to the
circumstances.
AU–C Section 620 contains
requirements that are similar to those in
ISA 620.
Amendments to Existing AS 1210 for
Using the Work of an Auditor-Engaged
Specialist
This section discusses the final
requirements in AS 1210, as amended,
for audits in which the auditor uses an
auditor-engaged specialist. In such
circumstances, the objective of the
auditor is to determine whether the
work of the auditor-engaged specialist is
suitable for the auditor’s purposes and
supports the auditor’s conclusion
regarding the relevant assertion.
Assessing the Knowledge, Skill, Ability,
and Objectivity of the Engaged
Specialist
As described above, existing AS 1210
requires the auditor to evaluate the
professional qualifications of a
specialist and the relationship of a
specialist to the company.
Similar to the final amendments
related to using a company’s specialist,
the final amendments carry forward the
existing requirements with certain
modifications described below.
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Knowledge, Skill, and Ability
See AS 1210.03–.04, as Amended
Requirements in existing AS 1210
related to the auditor’s evaluation of a
specialist’s qualifications were
described above with regard to a
company’s specialist. These
requirements are the same for a
company’s specialist and an auditorengaged specialist.
The Proposal substantially carried
forward the requirement in existing AS
1210. Unlike the existing standard,
however, the Proposal expressly
provided that the auditor would obtain
an understanding of the professional
qualifications of both the specialist and
the entity that employs the specialist.
The Board is adopting this requirement
as proposed.
Two commenters concurred with the
proposed approach to assessing
knowledge, skill, and ability of the
auditor-engaged specialist. One
commenter suggested allowing auditors
to assess the specialist’s knowledge,
skill, and ability centrally as part of the
firm’s system of quality control. Another
commenter asserted that the proposed
requirement was not well-suited to
assessing the knowledge, skill, and
ability of the entity that employs the
specialist.
Under the final amendments, auditors
will continue to be able to use
information from, and processes in, the
firm’s quality control system when
assessing the knowledge, skill, and
ability of auditor-engaged specialists.
The fact that a system of quality control
may have a firm-level process for
screening engaged specialists does not
relieve the engagement partner (with the
assistance of appropriate supervisory
personnel on the engagement team) of
his or her responsibility to assess
whether the engaged specialist has the
necessary knowledge, skill, and ability
for the particular audit engagement. The
relevant facts and circumstances,
including the nature, scope, and
objectives of the specialist’s work,
should be considered when performing
this assessment.
The final requirement retains the
concept in existing AS 1210 that a
specialist may be an individual or an
entity. Outreach to audit firms suggests
that firms have policies and procedures
for evaluating the qualifications of
specialists, whether individuals or
entities. Accordingly, auditors should
be familiar with assessing the
qualifications of entities that are
specialists or employ specialists.
Therefore, the final requirement is not
expected to result in a significant
change in practice.
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AS 1210, as amended, does not
specify steps to perform or information
sources to use in assessing the
specialist’s knowledge, skill, and ability.
Potential sources of relevant
information, if available, could include
the following:
• Information contained within the
audit firm related to the professional
qualifications and reputation of the
specialist and the entity that employs
the specialist, if applicable, in the
relevant field and experience with
previous work of the specialist;
• Professional or industry
associations and organizations, which
may provide information on: (1)
Qualification requirements, technical
performance standards, and continuing
professional education requirements
that govern their members; (2) the
specialist’s education and experience,
certification, and license to practice;
and (3) recognition of, or disciplinary
actions taken against the specialist;
• Information provided by the
specialist about matters regarding the
specialist’s understanding of the
financial reporting framework,
experience in performing similar work,
and the methods and assumptions used
in the specialist’s work the auditor
plans to evaluate;
• The specialist’s responses to
questionnaires about the specialist’s
professional credentials; and
• Published books or papers written
by the specialist.
Requirements applicable to a
specialist pursuant to legislation or
regulation also could help inform the
auditor’s assessment of the specialist’s
knowledge, skill, and ability.
The purpose of the assessment of the
auditor-engaged specialist’s knowledge,
skill, and ability is two-fold: (1) To
determine whether the specialist
possesses a sufficient level of
knowledge, skill, and ability to perform
his or her assigned work; and (2) to help
determine the necessary extent of the
review and evaluation of the specialist’s
work. AS 1210.04, as amended,
emphasizes the importance of engaging
a sufficiently qualified auditor’s
specialist by expressly providing that
the auditor should not use the work of
an engaged specialist who does not have
a sufficient level of knowledge, skill,
and ability.
The assessment of the specialist’s
knowledge, skill, and ability by the
engagement partner and, as applicable,
other engagement team members
performing supervisory activities is also
a factor when determining the necessary
extent of the review and evaluation of
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the specialist’s work.109 The auditor’s
evaluation of the work of a specialist
may be more extensive if the specialist
generally has sufficient knowledge,
skill, and ability in the relevant field of
expertise, but less experience in the
particular area of specialty within the
field. For example, a valuation specialist
may possess sufficient knowledge, skill,
and ability in business valuation, but
may not be well-versed in the
application of business valuation for
financial reporting purposes.
Objectivity
See AS 1210.05 and .11, as Amended
Requirements in existing AS 1210
related to the auditor’s evaluation of a
specialist’s objectivity are described
above with regard to a company’s
specialist. Those requirements are the
same for a company’s specialist and an
auditor-engaged specialist.
The Proposal built on the
requirements for assessing objectivity in
the existing standard and provided that
the engagement partner and, as
applicable, other engagement team
members performing supervisory
activities would assess whether the
specialist and the entity that employs
the specialist have the necessary
objectivity, which includes evaluating
whether the specialist or the entity that
employs the specialist has a relationship
to the company (e.g., through
employment, financial, ownership, or
other business relationships, contractual
rights, family relationships, or
otherwise), or any other conflicts of
interest relevant to the work to be
performed.
The proposed requirements differed
from the existing requirements in two
primary respects. First, they articulated
the concept of objectivity for purposes
of proposed AS 1210, as referring to the
specialist’s ability ‘‘to exercise impartial
judgment on all issues encompassed by
the specialist’s work related to the
audit.’’ Second, they expanded the list
of matters that the auditor would
consider in assessing objectivity to
include financial and business
relationships with the company and
other conflicts of interest.
Some commenters supported the
proposed approach. Other commenters
expressed concern that the proposed
requirement implied that the assessment
of whether the specialist had the
necessary objectivity was a binary
decision. These commenters expressed a
preference for describing objectivity as
an attribute that exists along a spectrum.
Some of these commenters asserted that
109 See
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an auditor should not be precluded from
using the work of a less objective
specialist, as long as the auditor
performed additional procedures in
those circumstances.
After considering the comments
received, the requirement has been
revised to allow auditors to assess the
specialist’s level of objectivity along a
spectrum and use the work of a less
objective specialist if the auditor
performs additional procedures to
evaluate the specialist’s work. In
revising this requirement, the Board
took into account the need for auditors
to assess the objectivity of auditorengaged specialists, while allowing
auditors, where appropriate, to engage
specialists who have certain
relationships with a company that may
raise questions as to their level of
objectivity.
The final amendments also require
the auditor to perform procedures that
are commensurate with, among other
things, an engaged specialist’s degree of
objectivity.110 Under the final
amendments, if the specialist or the
entity that employs the specialist has a
relationship with the company that
affects the specialist’s objectivity, the
auditor should (1) perform additional
procedures to evaluate the data,
significant assumptions, and methods
that the specialist is responsible for
testing, evaluating, or developing
consistent with the understanding
established with the specialist pursuant
to AS 1210.06, as amended, or (2)
engage another specialist. The necessary
nature and extent of the additional
procedures would depend on the degree
of objectivity of the specialist. As the
degree of objectivity increases, the
evidence needed from additional
procedures decreases.111 If the specialist
has a low degree of objectivity,112 the
auditor should apply the procedures for
evaluating the work of a company’s
specialist.113 For example, if the
specialist’s employer has a significant
ownership interest in the company, the
specialist’s ability to exercise objective
and impartial judgment might be low
and, therefore, the auditor should
evaluate the data, significant
assumptions, and methods used by the
110 See first note to AS 1210.05, as amended. See
also AS 1210.10, as amended, for a description of
other factors affecting the necessary extent of the
auditor’s review.
111 See AS 1210.11, as amended.
112 The concept of a ‘‘low degree of objectivity’’
is used in paragraph .18 of AS 2201, An Audit of
Internal Control Over Financial Reporting That Is
Integrated with An Audit of Financial Statements,
and, therefore, should be familiar to auditors.
113 See AS 1210.11, as amended.
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specialist under the requirements in
Appendix A of AS 1105, as amended.
Some commenters on the Proposal
suggested the Board should provide
additional guidance to specify the steps
to be performed by auditors to assess the
objectivity of an auditor-engaged
specialist, as well as what constitutes
sufficient appropriate evidence to
support this assessment. One
commenter asserted that auditors would
face challenges in assessing the
objectivity of the entity that employs the
specialist, as required under the
Proposal, and suggested that auditors
may be unable to obtain the policies,
procedures, and systems, if any, of the
entity employing the specialist. This
commenter suggested either omitting
the requirement to consider the
objectivity of the specialist’s employer
or limiting the requirement to
performing inquiry of the specialist.
After considering these comments, the
Board has eliminated the assessment of
the objectivity of the entity that employs
the specialist as a separate requirement
under the final requirements. Instead,
the auditor is required to evaluate
relationships between the company and
both the specialist and the specialist’s
employer to determine whether either
has a relationship with the company
that may adversely affect the specialist’s
objectivity.114 This is consistent with
existing AS 1210, under which a
specialist may be either an individual or
an entity. Additionally, outreach to
specialist entities and audit firms
suggests that audit firms have policies
and procedures for evaluating
relationships between a specialist entity
that they engage and the company.
Accordingly, the concept of assessing
relationships between a company and
an entity that employs specialists
should be familiar to auditors.
As under the Proposal, the final
amendments do not prescribe the
procedures the auditor must perform to
obtain information relevant to the
auditor’s assessment. In response to
questions raised by commenters, the
Board added a note to clarify that the
evidence necessary to assess the
specialist’s objectivity depends on the
significance of the specialist’s work and
the related risk of material
misstatement.115 Under this principlesbased approach, as the significance of
the specialist’s work and the risk of
114 See AS 1210.05, as amended. For example, the
specialist’s employer might have an ownership or
other financial interest with respect to the
company, or other business relationships that might
be relevant to the auditor’s assessment of the
specialist’s ability to exercise objective and
impartial judgment.
115 See second note to AS 1210.05, as amended.
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material misstatement increase, the
persuasiveness of the evidence the
auditor should obtain for this
assessment also increases.
In addition, the note includes nonexclusive examples of potential sources
of information that could be relevant to
the auditor’s assessment of the
relationship to the company of both the
specialist and the specialist’s
employer.116 These examples include
responses to questionnaires provided to
the specialist regarding relationships
between the specialist, or the
specialist’s employer, and the company.
As with the auditor’s assessment of a
specialist’s knowledge, skill, and ability,
certain sources of information may
provide more persuasive evidence than
others. In situations where more
persuasive evidence is required, it may
be appropriate to perform procedures to
obtain evidence from multiple sources.
Comparison With Standards of Other
Standard Setters
Paragraph 9 of ISA 620 provides that
in the case of an auditor’s external
expert, the evaluation of objectivity
shall include inquiry regarding interests
and relationships that may create a
threat to that expert’s objectivity.
AU–C Section 620 contains
requirements that are similar to those in
ISA 620.
Informing the Specialist of the Work To
Be Performed, Determining the Extent of
Review, and Evaluating the Work of the
Specialist
See AS 1210.06–.12, as Amended
As is the case with respect to an
auditor-employed specialist, the auditor
uses an auditor-engaged specialist to
assist the auditor in obtaining and
evaluating audit evidence. Given the
similar role of an auditor-employed and
an auditor-engaged specialist in the
audit, the final requirements for the
auditor-engaged specialist are parallel to
the requirements for the auditoremployed specialist when determining
the extent of the auditor’s review,
informing the auditor-engaged specialist
of the work to be performed, and
evaluating the work of the auditorengaged specialist. These final
requirements are discussed in
additional detail above.
Some commenters on the Proposal
commented on the impact of certain
proposed changes solely with respect to
auditor-engaged specialists. These
comments are discussed below.
116 Id. These examples were based on examples
set forth in the Proposal, but have been refined to
better reflect their application in practice.
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One commenter on the Proposal
expressed concern that the auditor may
have limited access to proprietary
models used by auditor-engaged
specialists. This commenter
recommended that the Board include
statements made in the Proposal
regarding the auditor’s access to such
models and the impact on the auditor’s
performance obligations in the final
amendments. Similar to the Proposal,
the final amendments do not require the
auditor to have full access to a
specialist’s proprietary model or to
reperform the work of the specialist, but
instead require the auditor to evaluate
the work of that specialist in accordance
with the final standard. Under AS
1210.10, as amended, the necessary
extent of the evaluation of the
specialist’s work, including a
determination of the necessary access to
a specialist’s model, depends upon (1)
the significance of the specialist’s work
to the auditor’s conclusion regarding the
relevant assertion; (2) the risk of
material misstatement of the relevant
assertion; and (3) the knowledge, skill,
and ability of the specialist. For
example, if the specialist used a
proprietary model to develop an
independent expectation, the auditor
would need to obtain information from
the specialist to assess whether the
specialist’s model was in conformity
with the applicable financial reporting
framework and to evaluate differences
between the independent expectation
and the company’s recorded estimate.
Another commenter recommended
including a requirement to inform
auditor-engaged specialists of the need
to apply professional skepticism, similar
to the requirement for auditor-employed
specialists in proposed AS 1201.C6. A
different commenter recommended that
the requirements for informing the
specialist of the work to be performed
should include communicating the
auditor’s need to exercise professional
skepticism to the auditor-engaged
specialist, so that the specialist is aware
that relevant information should be
passed on to the auditor.
The Board considered these
comments and determined to adopt the
requirement to inform the specialist of
the work to be performed substantially
as proposed. Due professional care in
the performance of audit procedures
requires the auditor to exercise
professional skepticism, including a
questioning mind and a critical
assessment of audit evidence.117 The
Board did not propose extending the
auditing standard on due professional
care to auditor-engaged specialists and,
117 See
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therefore, no change has been made to
AS 1210, as amended. While there is no
requirement for auditors to make the
engaged specialist aware of the auditor’s
responsibility to exercise professional
skepticism, auditors nevertheless may
decide to communicate the auditor’s
responsibility to the auditor-engaged
specialist.
Some commenters asserted that the
discussion of the auditor’s assessment of
disclaimers, limitations, and restrictions
related to the report of a company’s
specialist was equally applicable to the
report of the auditor-engaged specialist
and recommended similar guidance be
provided when using the report of an
auditor-engaged specialist. Under the
final amendments, the auditor’s
evaluation of the specialist’s report or
equivalent documentation includes
considering the effect of any
restrictions, limitations, or disclaimers
in the specialist’s report or equivalent
documentation on both (1) the relevance
and reliability of the audit evidence the
specialist’s work provides and (2) how
the auditor can use the report of the
specialist.118 For example, a specialist’s
report that states ‘‘the values in this
report are not an indication of the fair
value of the underlying assets’’
generally would not provide sufficient
appropriate evidence related to fair
value measurements. On the other hand,
a specialist’s report that indicates that
the specialist’s calculations were based
on information supplied by
management may still be appropriate for
use by the auditor to support the
relevant assertion, since the auditor
would be required to test the data that
was produced by the company and used
in the specialist’s calculations
Comparison With Standards of Other
Standard Setters
The comparative requirements of the
IAASB and the ASB were discussed
above.
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Other Considerations
The Board proposed to rescind two
auditing interpretations.119 The Board
has taken commenters’ views into
account and determined not to rescind
these interpretations at this time. The
Board is incorporating key elements of
each interpretation, however, in the
final amendments. These matters are
discussed below, along with certain
requirements in existing AS 1210 that
118 See
note to AS 1210.12, as amended.
interpretations provide guidance the
auditor should be aware of and consider related to
specific areas of the audit. See paragraph .11 of AS
1001, Responsibilities and Functions of the
Independent Auditor.
119 Auditing
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are not specifically addressed in the
final amendments.
Auditing Interpretation AI 11, Using the
Work of a Specialist: Auditing
Interpretations of AS 1210
The Board proposed to rescind AI 11
in the Proposal. AI 11 provides
guidance for auditing transactions
involving transfers of financial assets,
such as in securitizations that are
accounted for under Statement of
Financial Accounting Standards No.
140.120 The interpretation addresses an
auditor’s use of a legal opinion obtained
from a company’s legal counsel on
matters that may involve the U.S.
Bankruptcy Code, rules of the Federal
Deposit Insurance Corporation
(‘‘FDIC’’),121 and other federal, state, or
foreign law to determine whether
‘‘transferred assets have been isolated
from the transferor—put presumptively
beyond the reach of the transferor and
its creditors, even in bankruptcy or
other receivership,’’ which affects the
accounting for the transaction under
FAS No. 140. AI 11 also reiterates
certain requirements in generally
accepted accounting principles and
PCAOB auditing standards. In addition,
the interpretation includes illustrative
examples of legal isolation letters based
on FAS No. 140 and certain provisions
of the FDIC’s original rule, both of
which have been subsequently
amended.
A few commenters supported the
proposed rescission. A number of other
commenters, however, expressed
concern about the proposed rescission
of AI 11, stating that it continues to
provide useful guidance to auditors
regarding the necessary audit evidence
to support management’s assertion that
a transfer of financial assets has met the
isolation criterion of ASC 860–10–40,
Transfers and Servicing. One
commenter asserted that companies
would struggle to anchor their
accounting conclusions to guidance on
the existing auditing standards if AI 11
was rescinded.
After considering comments and the
continued use of the interpretation in
practice, the Board determined not to
120 See Financial Accounting Standards Board
(‘‘FASB’’), Statement of Financial Accounting
Standards (‘‘FAS’’) No. 140, Accounting for
Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. This standard was
subsequently amended by FAS No. 166, Accounting
for Transfers of Financial Assets—an amendment of
FASB Statement No. 140, and codified into FASB
Accounting Standards Codification (‘‘ASC’’), Topic
860, Transfers and Servicing.
121 Subsequent to the Board’s adoption of AI 11,
the FDIC rule regarding the treatment of financial
assets transferred by an institution in connection
with a securitization or participation was amended
in 2010.
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rescind AI 11 at this time. The final
amendments have been revised to
include conforming changes to AI 11 to
remove outdated references to existing
AS 1210, which has been replaced and
retitled.
The amended standards for using the
work of a company’s specialist also
incorporate certain principles from AI
11. As discussed in AI 11, legal
opinions are sometimes necessary
evidence to support an auditor’s
conclusion about the proper accounting
for transfers of financial assets.
Accordingly, the final amendments
clarify that Appendix A of AS 1105, as
adopted, applies in situations when an
auditor uses the work of a company’s
attorney as audit evidence in other
matters relating to legal expertise, such
as when a legal interpretation of a
contractual provision or a legal opinion
regarding isolation of transferred
financial assets is necessary to
determine appropriate accounting or
disclosure under the applicable
financial reporting framework.122 The
provision emphasizes the importance of
legal opinions as audit evidence in
certain contexts and clarifies the
requirements the auditor should be
applying in such circumstances.
Auditing Interpretation AI 28,
Evidential Matter Relating to Income
Tax Accruals: Auditing Interpretations
The Board also proposed to rescind AI
28 in the Proposal. AI 28 provides
guidance about matters related to
auditing the income tax accounts in a
company’s financial statements. Topics
covered by the interpretation include
restrictions on access to the company’s
books and records related to its income
tax calculation, documentation of
evidence obtained in auditing the
income tax accounts, and use of tax
opinions from company legal counsel
and tax advisors. The interpretation also
reiterates certain requirements from
PCAOB auditing standards.
Most commenters did not express a
view regarding the proposed rescission
of AI 28. A few commenters supported
the proposed rescission. Two
commenters asserted that AI 28
provides useful guidance to auditors
regarding tax specialists and tax
working papers and should be retained.
The Board has considered these
comments and determined not to
rescind AI 28 at this time.
The Board recognizes that written
advice or opinions of a company’s tax
advisor or tax legal counsel on material
tax matters are sometimes necessary
evidence to support the auditor’s
122 See
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conclusions on income tax accounts.
Accordingly, the Board revised the final
amendments to acknowledge such
situations and to clarify that, if an
auditor plans to use an opinion of legal
counsel or the advice of a tax advisor on
specific tax issues as audit evidence, it
is not appropriate for the auditor to rely
solely on that opinion or advice with
respect to those tax issues.123 Instead,
the auditor needs to evaluate the
analysis underlying the tax opinion or
tax advice to determine whether it
provides relevant and reliable evidence,
taking into account the requirements of
the applicable financial reporting
framework.
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Certain Requirements of Existing AS
1210—Discussion of Remaining
Requirements Not Specifically
Addressed in the Final Amendments
Decision to use a specialist. Existing
AS 1210 states that an auditor may
encounter complex or subjective matters
that are potentially material to the
financial statements. It further provides
that such matters, examples of which
are provided, may require special skill
or knowledge and in the auditor’s
judgment require using the work of a
specialist to obtain appropriate
evidential matter.124 The final
amendments do not retain this language,
as this issue is already addressed in AS
2101. Specifically, AS 2101.16 requires
the auditor to determine whether
specialized skill or knowledge is needed
to perform appropriate risk assessments,
plan or perform audit procedures, or
evaluate audit results.
Reporting requirements. Existing AS
1210 prohibits auditors from making
reference to the work or findings of a
specialist in the auditor’s report, unless
such reference will facilitate an
understanding of the reason for an
explanatory paragraph, a departure from
an unqualified opinion, or a critical
audit matter (‘‘CAM’’). A CAM is
defined as any matter arising from the
audit of the financial statements that
was communicated or required to be
communicated to the audit committee
and that relates to accounts or
disclosures that were material to the
financial statements and involved
especially challenging, subjective, or
complex auditor judgment.125
Depending on the circumstances, the
description of such CAMs might include
a discussion of the work or findings of
a specialist.
123 See footnote 1 to AS 1105.A1, as adopted; note
to AS 2505.08, as amended.
124 See existing AS 1210.06.
125 See AS 3101.11–.17.
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No commenters objected to omitting
the prohibition in existing AS 1210 from
the proposed amendments. For the
reasons discussed above, the Board did
not make changes to the final
amendments to incorporate these extant
requirements.
Other Aspects of the Final Amendments
The Board adopted additional
amendments to conform its standards to
the final requirements in AS 1105, AS
1201, and AS 1210, as amended. Those
conforming amendments to AS 1015,
AS 2301, AS 2310, The Confirmation
Process, AS 2401, Consideration of
Fraud in a Financial Statement Audit,
AS 2610, Initial Audits—
Communications Between Predecessor
and Successor Auditors, AT 601,
Compliance Attestation, and AT 701,
Management’s Discussion and Analysis,
do not change the meaning of existing
requirements.
Effective Date
The Board determined that the final
amendments take effect, subject to
approval by the SEC, for audits of
financial statements for fiscal years
ending on or after December 15, 2020.
The Board sought comment on the
amount of time auditors would need
before any amendments would become
effective, if adopted by the Board and
approved by the SEC. A number of
commenters supported an effective date
of two years after SEC approval of final
amendments, asserting that this would
allow firms sufficient time to develop
tools, update methodologies, and
provide training on the new
requirements. A few commenters also
emphasized the importance of having
the same effective date for any new
standards on using the work of
specialists and auditing accounting
estimates.
While recognizing other
implementation efforts, the effective
date determined by the Board is
designed to provide auditors with a
reasonable period of time to implement
the final amendments, without unduly
delaying the intended benefits resulting
from these improvements to PCAOB
standards. The effective date is also
aligned with the effective date of the
related standards and amendments
being adopted in the Estimates Release.
D. Economic Considerations and
Application to Audits of Emerging
Growth Companies
The Board is mindful of the economic
impacts of its standard setting. This
economic analysis describes the
baseline for evaluating the economic
impacts of the final amendments,
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13469
analyzes the need for the final
amendments, and discusses potential
economic impacts of the final
amendments, including the potential
benefits, costs, and unintended
consequences. The analysis also
discusses alternatives considered.
In the Proposal, the Board had
requested input from commenters on
their views pertinent to the economic
considerations, including the potential
benefits and costs, discussed in the
Proposal. One commenter stated that it
believed the Proposal can be effectively
implemented with minimal cost.
Several commenters expressed concern,
however, that the cost of the Proposal
would be relatively greater for smaller
audit firms and certain smaller
companies. Some commenters also
asserted that the Proposal would
adversely affect the ability of smaller
firms to compete in the audit services
market. A number of commenters
suggested that the incremental cost of
certain aspects of the Proposal would
outweigh any increase in audit quality.
Finally, some commenters expressed
concern that the Proposal could result
in a shortage of qualified specialists due
to, for example, a potential increase in
the demand for specialists by some
audit firms under the proposed
requirements.126
The Board has considered all
comments received, and has made
certain changes to the final amendments
to reflect those comments, including
changes that mitigate some of the
concerns expressed above with respect
to the Proposal. The Board has also
sought to develop an economic analysis
that evaluates the potential benefits and
costs of the final amendments, as well
as facilitates comparisons to alternative
Board actions. There are limited data
and research findings available to
estimate quantitatively the economic
impacts of discrete changes to auditing
standards in this area, and furthermore,
no additional data was identified by
commenters that would allow the Board
to generally quantify the expected
economic impacts (including expected
incremental costs related to the
Proposal) on audit firms or
companies.127 Accordingly, the Board’s
discussion of the economic impact is
qualitative in nature.
126 See below for a discussion of revisions to the
proposed requirements in the final amendments to
address this concern.
127 One commenter provided anecdotal data on
certain aspects of the Proposal that was limited to
the commenter’s experience in one specialized area.
The data provided by this commenter, therefore,
could not be used to quantify expected economic
impacts that would generally apply to the use of the
work of specialists.
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Baseline
The conclusion regarding larger audit
firms was based on a PCAOB staff
analysis of the 274 issuer audits 128 by
U.S. audit firms affiliated with global
networks 129 that were selected for
inspection in 2015. This analysis found
that auditors used the work of at least
one auditor-employed specialist in
about 85 percent of those audits. For the
85 percent of those audits that involved
the use of auditor-employed specialists,
an average of four to five individual
specialists performed some work on
each audit. In addition, on each of those
audits, specialists performed work in
one to two fields of expertise on
average.130 The results indicate that
such audits typically had more than one
specialist performing work in the same
area of expertise.
The Proposal further noted that
PCAOB inspections data for issuer
audits suggested that, in contrast to
larger audit firms, smaller U.S. audit
firms generally have fewer audit
engagements in which they use the
work of a company’s specialist or an
auditor’s specialist. Specifically, the
PCAOB staff analyzed data from the 361
audits performed by U.S. audit firms not
affiliated with one of the global
Section C above discusses existing
PCAOB requirements for using the work
of specialists and existing practice in
the application of those requirements.
This section addresses from an
economic perspective: (1) The
prevalence and significance of audits
involving specialists; (2) the existing
audit requirements that apply to the use
of the work of specialists; and (3) the
quality of audits that involve specialists,
based on observations from regulatory
oversight and academic literature.
Prevalence and Significance of Audits
Involving Specialists
Evidence From PCAOB Inspections Data
The Proposal observed that the
PCAOB staff’s analysis of inspections
data for audits of issuers suggests that
larger audit firms extensively use the
work of specialists, in particular
auditor-employed specialists, while
smaller audit firms generally have a
lower percentage of audit engagements
in which they use the work of a
company’s specialist or an auditor’s
specialist.
networks that were selected for
inspection by the PCAOB in 2015. Of
those 361 issuer audits, the PCAOB staff
identified: (1) 36 Audits (i.e., about 10%
of the analyzed audit engagements) in
which the auditor used the work of a
company’s specialist but did not use the
work of an auditor’s specialist; (2) 24
audits (i.e., about 7% of the analyzed
audit engagements) in which the auditor
used the work of an auditor’s specialist
but did not use the work of a company’s
specialist; (3) 30 audits (i.e., about 8%
of the analyzed audit engagements) in
which the auditor used the work of a
company’s specialist and an auditor’s
specialist; and (4) 271 audits (i.e., about
75% of the analyzed audit engagements)
in which the auditor neither used the
work of a company’s specialist nor used
an auditor’s specialist.
A PCAOB staff analysis of the 700
issuer audits by audit firms that were
selected for inspection in 2017 is
broadly consistent with the conclusions
in the Proposal regarding the prevalence
and significance of audits involving
specialists.131 The results of this
analysis are summarized in the table
below:
FIGURE 5—AUDITS PERFORMED BY U.S. AND NON-U.S. AUDIT FIRMS THAT WERE SELECTED FOR INSPECTION BY THE
PCAOB IN 2017, CATEGORIZED BY USE OF THE WORK OF SPECIALISTS
% (number) of
audits by larger
audit firms
(U.S.)
(1) auditor used the work of a company’s specialist but did not
use the work of an auditor’s specialist .........................................
(2) auditor used the work of an auditor’s specialist but did not use
the work of a company’s specialist ..............................................
(3) auditor used the work of both a company’s specialist and an
auditor’s specialist ........................................................................
(4) auditor neither used the work of a company’s specialist nor
used an auditor’s specialist 132 ....................................................
Total 133
.....................................................................................
% (number) of
audits by smaller
audit firms
(U.S.)
% (number) of
audits by larger
audit firms
(non-U.S.)
% (number) of
audits by smaller
audit firms
(non-U.S.)
8% (26)
10% (28)
8% (7)
6% (1)
20% (66)
2% (6)
34% (29)
0% (0)
41% (136)
6% (17)
29% (25)
0% (0)
31% (102)
81% (216)
29% (25)
94% (16)
100% (330)
100% (267)
100% (86)
100% (17)
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Source: PCAOB.
As indicated by Figure 5, auditors
used the work of an auditor’s specialist
in 61% and 63% of the analyzed audit
engagements (the sum of categories (2)
and (3) above) by larger audit firms—
U.S. and non-U.S. firms, respectively—
selected for inspection in 2017.
Auditors used the work of a company’s
specialist without also using the work of
an auditor’s specialist (category (1)
above) in only 8% of the analyzed audit
engagements of larger audit firms—both
128 This analysis was performed on engagementlevel data obtained through PCAOB inspections.
The audits inspected by the PCAOB are most often
selected based on risk rather than selected
randomly, and these numbers may not represent the
use of the work of specialists across a broader
population of companies. On average, the
engagements selected for inspection are more likely
to be complex (and thus more likely to involve the
use of the work of a specialist) than the overall
population of audit engagements.
129 These firms consist of those U.S. audit firms
that are registered with the PCAOB and affiliated
with one of the six largest global networks, based
on information on network affiliations reported by
U.S. audit firms on Form 2 in 2017 and identified
on the ‘‘Global Networks’’ overview page, available
on the Board’s website.
130 The data used in this analysis did not indicate
how frequently the auditor used the work of an
auditor-engaged specialist.
131 The discussion in note 128 that applies to the
2015 analysis—regarding the selection of inspected
audit engagements and how such engagements
likely compare to the overall population of audit
engagements—likewise applies to this 2017
analysis. Unlike the 2015 analysis, the engagementlevel data selected for the analysis of PCAOB
inspections performed in 2017 included data on
issuer audit engagements conducted by non-U.S. as
well as U.S. audit firms. In addition, this
engagement-level data was based on specific focus
areas, such as recurring audit deficiencies and audit
areas that may involve significant management or
auditor judgment, for issuer audit engagements
selected for inspection. For a more detailed
discussion of PCAOB inspection focus areas, see
PCAOB, Staff Inspection Brief: Information about
2017 Inspections, Vol. 2017/3 (Aug. 2017).
132 The audit engagements not included in the
preceding three categories were included in the
fourth category.
133 The total for the values shown in categories (1)
through (4) may not add to 100% due to rounding.
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U.S. and non-U.S. firms, respectively—
selected for inspection in 2017. These
results are also consistent with the
anecdotal evidence discussed in section
C (i.e., that larger audit firms generally
require their engagement teams to
evaluate the work of a company’s
specialist, including the specialist’s
methods and significant assumptions,
and often employ specialists to assist
their audit personnel in evaluating that
work).
The results for smaller audit firms in
Figure 5 are also consistent with the
analysis in the Proposal and suggest that
the work of an auditor’s specialist or a
company’s specialist is used in
relatively few audits. Specifically, in
81% and 94% of the audits by smaller
audit firms—U.S. and non-U.S. firms,
respectively—the auditor neither used
the work of a company’s specialist nor
used an auditor’s specialist (category (4)
above), possibly because those audits
did not involve circumstances that
warranted the use of specialists by
companies or their auditors. Consistent
with the analysis of the issuer audits
selected for inspection in 2015, the
results for smaller audit firms in Figure
5 further suggest that, when smaller
audit firms use the work of a company’s
specialist, they often use that work
without concurrently using the work of
an auditor’s specialist. In 62% of the
audits by smaller U.S. firms that
involved the use of the work of a
company’s specialist, the audit firm did
not concurrently use the work of an
auditor’s specialist.134 An auditor’s
specialist also was not concurrently
involved in the only audit by a smaller
non-U.S. firm that involved the use of
the work of a company’s specialist
(category (1) above).
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Evidence From the Academic Literature
Consistent with the results of the
PCAOB staff analysis, the academic
literature suggests that, when a
company uses a company’s specialist,
some larger audit firms also tend to use
the work of an auditor’s specialist, at
least in the context of audits involving
challenging fair value measurements.135
Furthermore, the academic literature
also suggests that the use of valuation
134 Specifically, out of the 45 audit engagements
of smaller U.S. firms that involved the use of the
work of a company’s specialists (the sum of
categories (1) and (3) in Figure 5), 28 engagements
did not concurrently involve the use of the work
of an auditor’s specialist (category (1) in Figure 5).
135 See, e.g., Nathan H. Cannon and Jean C.
Bedard, Auditing Challenging Fair Value
Measurements: Evidence From the Field, 92 (4) The
Accounting Review 81 (2017) (study using an
experiential questionnaire involving audit partners
and managers of Big 4 firms in audits involving
challenging fair value measurements).
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specialists is prevalent for at least some
audits. One recent study of audits by the
four largest firms that involved
challenging fair value measurements
found that 86% of audit teams used an
auditor’s specialist, including employed
and engaged specialists.136 In addition,
60% of the companies in this study
used a company’s specialist, including
employed and engaged specialists.137
The audits that were included in this
study may not be representative of all
audit engagements, because they were
selected in order to study engagements
that involved material, highly
challenging fair value measurements.
However, the results suggest that the use
of an auditor’s specialist is at least
prevalent among audits performed by
the four largest U.S. firms where a
company’s specialist is used to assist in
the development of highly challenging
and material fair value measurements,
which may also be audit areas with a
high risk of material misstatement and
thus a need for greater audit
attention.138
Furthermore, the academic literature
also corroborates the characterizations
discussed in section C regarding the
current practice of audit firms when
using specialists. Academic studies
suggest that, at least among the audits
that were studied where specialists were
used, larger firms were more likely to
use the work of auditor-employed
specialists than auditor-engaged
specialists in their engagements,139
136 See Cannon and Bedard, Auditing Challenging
Fair Value Measurements: Evidence From the Field
90. In another study of how auditors use valuation
specialists, auditors from seven large U.S. audit
firms who were interviewed stated that, on average,
61% of their engagements in the prior year involved
a valuation specialist, including auditor-employed
and/or auditor-engaged specialists. See Emily E.
Griffith, Auditors, Specialists, and Professional
Jurisdiction in Audits of Fair Values 13 (July 2016)
(working paper, available in Social Science
Research Network (‘‘SSRN’’)).
137 See Cannon and Bedard, Auditing Challenging
Fair Value Measurements: Evidence From the Field
90.
138 Another recent qualitative study conducted
through interviewing audit partners, managers, and
seniors also observed that auditors in the six large
audit firms in Canada consider factors such as the
‘‘client’s regulatory environment and other general
risk factors,’’ ‘‘lack of subject matter expertise
within the audit team,’’ and ‘‘complexity of the
engagement’’ when determining whether to use a
specialist. See J. Efrim Boritz, Natalia KochetovaKozloski, Linda A. Robinson, and Christopher
Wong, Auditors’ and Specialists’ Views About the
Use of Specialists During an Audit 28, 35 (Mar.
2017) (working paper, available in SSRN).
139 See, e.g., Steven M. Glover, Mark H. Taylor,
and Yi-Jing Wu, Current Practices and Challenges
in Auditing Fair Value Measurements and Complex
Estimates: Implications for Auditing Standards and
the Academy, 36 (1) Auditing: A Journal of Practice
& Theory 63, 75 (2017) (‘‘[R]esults indicate that
approximately two-thirds (one-third) of our
participants reported that they use in-house (third-
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while even among the larger firms there
are differences in the extent of their use
of the work of auditor-engaged
specialists.140
A possible explanation for the
tendency of larger firms to use the work
of auditor-employed specialists (instead
of auditor-engaged specialists) is that
larger firms, due to the greater number
of their audit engagements or their
existing non-auditing practices, have
sufficient demand for the services of
specialists to warrant hiring specialists
who work for them full-time. In
contrast, smaller firms may not have
many audit engagements where the
auditor requires the use of an auditor’s
specialist, so that engaging an auditor’s
specialist only as needed may be
economically more advantageous. In
addition, the tendency of smaller firms
to look to the work of a company’s
specialist without using the work of an
auditor’s specialist may reflect the fact
that existing AS 1210 enables the
auditor to use the work of a company’s
specialist in a wide range of situations,
without imposing obligations on the
auditor that might call for the retention
of an auditor’s specialist.141
PCAOB Auditing Standards Regarding
Use of the Work of Specialists
As discussed in more detail in section
C, under existing standards, the
auditor’s primary responsibilities with
respect to a company’s specialist are set
forth in existing AS 1210. That standard
also imposes the same responsibilities
on auditors with respect to an auditorengaged specialist, even though an
auditor-engaged specialist has a
party) valuation specialists to support the audit
work performed for financial FVMs [i.e., fair value
measurements]. Moreover, approximately 87
percent (13 percent) of the audit partners indicated
that they use in-house (third-party) valuation
specialists to support the audit work for
nonfinancial FVMs.’’); see also Emily E. Griffith,
Jacqueline S. Hammersley, and Kathryn Kadous,
Audits of Complex Estimates as Verification of
Management Numbers: How Institutional Pressures
Shape Practice, 32 Contemporary Accounting
Research 833, 836 (2015) (‘‘[A]uditors [from the
U.S. audit firms affiliated with the six largest global
networks] typically enlist audit-firm specialists in
auditing estimates because they do not have
valuation expertise. . .’’).
140 See Griffith, Auditors, Specialists, and
Professional Jurisdiction in Audits of Fair Values
58. In this study, all participating auditors from Big
4 audit firms indicated that they used internal
valuation specialists (i.e., auditor-employed
valuation specialists) and did not use any external
valuation specialists (i.e., auditor-engaged valuation
specialists). In contrast, only 40% of the auditors
from the three other audit firms that participated in
the study indicated that they exclusively used
internal valuation specialists.
141 Similarly, the final amendments enable the
auditor to use the work of a company’s specialist
in a wide range of situations, without necessarily
obligating the auditor to retain an auditor’s
specialist.
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fundamentally different role than a
company’s specialist. While the
auditor’s specialist performs work to
assist the auditor in obtaining and
evaluating audit evidence, the
company’s specialist performs work that
is used by the company in preparing its
financial statements and that the auditor
may use as audit evidence.
The professional relationships
between an auditor and a company’s
specialist, and between an auditor and
an auditor’s specialist, differ, among
other things, in terms of who is
employing or engaging the specialist
(i.e., the company in the case of a
company’s specialist and the auditor in
the case of an auditor’s specialist).
Therefore, the level of control and
oversight an auditor is able to exercise
over the specialist also differs. Given
these differences, which expose a
company’s specialist and an auditorengaged specialist to different
incentives and biases (e.g., pressure to
conform to management bias),142
requirements would ideally differentiate
between the two types of specialists, but
existing requirements do not do so.
In contrast, existing PCAOB
requirements for using the work of an
auditor-employed specialist, who is
subject to supervision under AS 1201,
differ from the requirements that apply
to using the work of an auditor-engaged
specialist. Auditor-employed and
auditor-engaged specialists may differ in
their economic dependency on the
auditor and, by extension, could face
different incentives to acquiesce to
certain auditor decisions, such as a
decision by the auditor to downplay or
suppress unfavorable information in
order to accommodate a conclusion
sought by the auditor.143 While
anecdotal evidence from the academic
142 For a discussion of pressures facing a
company’s specialist, see Divya Anantharaman, The
Role of Specialists in Financial Reporting: Evidence
from Pension Accounting, 22 Review of Accounting
Studies 1261, 1299–300 (2017) (concluding that
‘‘client pressure and opinion shopping’’ affect the
work product of actuaries used by company
management, which ‘‘suggests potentially greater
effects for other specialists not subject to the same
levels of oversight (e.g., experts in valuing complex
financial instruments and other untraded assets)’’
and that ‘‘economically important clients of their
actuaries use more aggressive (obligation-reducing)
discount rates [than] less important clients of the
same actuary’’).
143 See, e.g., Griffith, Auditors, Specialists, and
Professional Jurisdiction in Audits of Fair Values 32
(‘‘[A]udit teams delete extraneous information in
specialists’ memos when that information
contradicts what the audit team has documented in
other audit work papers . . .’’) and 33 (‘‘Auditors
and specialists described several defensive
behaviors by auditors that restrict specialists’ access
to information . . . Restricting specialists’ access to
information can influence how specialists do their
work, what work they do, and what conclusions
they reach.’’).
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literature related to a company’s
specialists suggests that employed
specialists may face stronger incentives
to do so than engaged specialists,144 it
is difficult to generalize as to whether
auditor-employed specialists have a
greater economic dependency on
auditors than auditor-engaged
specialists.145 Any potential bias by
auditor-employed and auditor-engaged
specialists arising from economic
dependency on the auditor may be
mitigated by the responsibility imposed
directly on the engagement partner
under AS 1201 for supervision of the
work of engagement team members and
compliance with PCAOB standards,
including those regarding using the
work of specialists. In addition, AS 1220
requires the engagement quality
reviewer to ‘‘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.’’ Such
significant judgments may include areas
where auditors used the work of an
auditor-employed or auditor-engaged
specialist.
Furthermore, auditor-employed and
auditor-engaged specialists serve similar
roles in helping auditors obtain and
evaluate audit evidence. Given their
similar roles, it seems appropriate that
the auditor would follow similar
requirements when using both types of
specialists, though existing
requirements differ for the two types of
specialists. A notable difference in the
relationship of the auditor with auditoremployed and auditor-engaged
specialists, however, relates to the
integration of auditor-employed
specialists (as compared with auditorengaged specialists) in an audit firm’s or
network’s quality control systems,
which allows the auditor greater
144 See, e.g., J. Richard Dietrich, Mary S. Harris,
and Karl A. Muller III, The Reliability of Investment
Property Fair Value Estimates, 30 Journal of
Accounting and Economics 125, 155 (2001) (‘‘[O]ur
investigation reveals that the reliability of fair value
estimates varies according to the relation between
the appraiser and the [company] (internal versus
external appraiser) . . . We find evidence that
appraisals conducted by external appraisers result
in relatively more reliable fair value accounting
estimates (i.e., lower conservative bias, greater
accuracy and lower managerial manipulation).’’).
145 The extent of economic dependency of an
auditor-employed specialist on the auditor will
depend, for example, on how much of the
specialist’s work and the specialist’s compensation
is related to audits (as opposed to non-audit
services), which may vary for different auditoremployed specialists. Similarly, the extent of
economic dependency of an auditor-engaged
specialist on the auditor will depend on how much
of the specialist’s overall work or income is
connected to the particular audit firm, which may
vary for different auditor-engaged specialists.
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visibility into any relationships that
might affect the auditor-employed
specialist’s independence, as well as
greater visibility into the auditoremployed specialist’s knowledge, skill,
and ability. The final requirements with
respect to evaluating the objectivity, as
well as knowledge, skill, and ability, of
an auditor-engaged specialist, therefore,
sought to reflect that difference by
providing the auditor with specific
requirements to assess whether the
auditor-engaged specialist has both the
necessary objectivity to exercise
impartial judgment on all issues
encompassed by the specialist’s work
related to the audit and the level of
knowledge, skill, and ability to perform
the specialist’s work related to the audit.
As discussed in more detail below,
given the similar role of an auditoremployed and an auditor-engaged
specialist in the audit, the auditor’s
procedures for reaching an
understanding with the specialist and
evaluating the work to be performed by
the specialist should be similar.
However, due to the differences in the
auditor’s ability to assess the specialist’s
independence, as well as the specialist’s
knowledge, skill, and ability, the Board
is adopting separate, but parallel,
requirements for using the work of an
auditor-employed specialist and an
auditor-engaged specialist. It is expected
that there would be few differences in
the procedures undertaken by the
auditor when using an auditor’s
specialist, whether employed or
engaged, with such differences limited
to the auditor’s assessment of the
knowledge, skill, ability, and objectivity
of an auditor-engaged specialist (where
the auditor may not be able to leverage
an audit firm’s or network’s quality
control system to perform these
assessments).
Quality of Audits That Involve
Specialists
As discussed in section C, PCAOB
oversight of audit engagements in which
auditors used the work of a company’s
or an auditor’s specialist and SEC
enforcement actions have identified
instances of noncompliance with
PCAOB standards, e.g., situations where
auditors did not appropriately evaluate
the work of specialists. For issuer audit
engagements, PCAOB staff have more
recently observed a decline in the
number of instances in which auditors
at some audit firms did not perform
sufficient procedures related to the work
of an auditor’s specialist. There are
some preliminary indications that some,
but not all, firms with observed
deficiencies have undertaken remedial
actions in response to such findings,
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which may have contributed, at least in
part, to improvements in audit quality
related to the auditor’s use of an
auditor’s specialist.
Relatively few empirical academic
studies have explicitly examined the
relationship between the use of
specialists and perceptions of audit
quality by investors and auditors.146
This may be because it is difficult,
especially for investors, to assess the
effect of using specialists on audit
quality independently from the effects
of other relevant factors, such as the
quality of the company’s financial
reporting or internal controls.147
However, available studies have
investigated the relationship between
the quality of financial statement
estimates, which often are provided
with the assistance of a company’s
specialist, and the usefulness of such
estimates to investors. These studies
find that less reliable estimates tend to
be less useful to investors.148 Other
studies suggest that some estimates are
also more likely to be discounted by
146 See, e.g., Brant E. Christensen, Steven M.
Glover, Thomas C. Omer, Marjorie K Shelley,
Understanding Audit Quality: Insights from Audit
Professionals and Investors, 33 Contemporary
Accounting Research 1648, 1667 (2016) (‘‘Audit
professionals [that were surveyed as part of the
study] associate the use of both external experts and
internal specialists with higher audit quality.’’).
Relatedly, one recent academic study examined the
relationship between the use of forensic
accountants (described by the authors as
‘‘specialists’’) and the value of their involvement as
perceived by the auditor. While forensic
accountants are not specialists within the scope of
this standard, the authors of the study argued that
the findings ‘‘likely translate into understanding
other specialist domains.’’ The authors suggested
that the involvement of forensic accountants is
accompanied by the ‘‘incremental discovery of . . .
material misstatements,’’ and further stated that
‘‘our results indicate both auditors and forensic
specialists recognize the value and additional
comfort that come from forensic specialist
involvement on audits.’’ See J. Gregory Jenkins, Eric
M. Negangard, and Mitchell J. Oler, Getting
Comfortable on Audits: Understanding Firms’
Usage of Forensic Specialists, Contemporary
Accounting Research, in-press 4 (2017).
147 While not directly assessing the relationship
between the use of specialists and perceptions of
audit quality, academic literature has investigated
factors that influence an auditor’s approach to
auditing accounting estimates, including the
decision whether to use the work of specialists. See,
e.g., Jennifer R. Joe, Scott D. Vandervelde, Yi-Jing
Wu, Use of High Quantification Evidence in Fair
Value Audits: Do Auditors Stay in their Comfort
Zone?, 92 (5) The Accounting Review 89 (2017);
Emily E. Griffith, When Do Auditors Use
Specialists’ Work to Improve Problem
Representations of and Judgments about Complex
Estimates?, 93 (4) The Accounting Review 177
(2018).
148 See, e.g., Scott A. Richardson, Richard G.
Sloan, Mark T. Soliman, and Irem Tuna, Accrual
Reliability, Earnings Persistence and Stock Prices,
39 Journal of Accounting and Economics 437, 437–
438 (2005) (finding that ‘‘less reliable accruals lead
to lower earnings persistence . . . leading to
significant security mispricing’’).
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investors.149 Because investors’
perceptions of the credibility of
financial statements are influenced by
their perceptions of audit quality, the
auditor’s appropriate use of the work of
specialists should increase the
credibility of the accounting estimates
included in the financial statements.
Need for the Rulemaking
From an economic perspective, the
primary cause for market failure 150 that
motivates the need for the final
amendments is the moral hazard 151
affecting the auditor’s decisions on how
to implement audit procedures related
to the use of the work of a specialist,
which increases the risk of lower audit
quality from the investor’s perspective.
As described in the Proposal, the
moral hazard problem related to the use
of the work of a specialist generally
manifests in the auditor not performing
appropriate procedures, even though
such procedures would improve audit
quality by increasing the auditor’s
attention, because the auditor may not
perceive sufficient economic benefit
(compared to the corresponding costs 152
and efforts) from such actions.
149 See, e.g., Chang Joon Song, Wayne B. Thomas,
and Han Yi, Value Relevance of FAS No. 157 Fair
Value Hierarchy Information and the Impact of
Corporate Governance Mechanisms, 85 The
Accounting Review 1375 (2010). Furthermore, the
academic literature notes that auditing estimates
with extreme uncertainty can pose significant
challenges for auditors. See, e.g., Brant E.
Christensen, Steven M. Glover, and David A. Wood,
Extreme Estimation Uncertainty in Fair Value
Estimates: Implications for Audit Assurance, 31 (1)
Auditing: A Journal of Practice & Theory 127
(2012).
150 For a discussion of the concept of market
failure, see, e.g., Francis M. Bator, The Anatomy of
Market Failure, 72 The Quarterly Journal of
Economics 351 (1958); and Steven G. Medema, The
Hesitant Hand: Mill, Sidgwick, and the Evolution of
the Theory of Market Failure, 39 History of Political
Economy 331 (2007).
151 The moral hazard problem is also referred to
as a hidden action, or agency problem, in
economics literature. The term ‘‘moral hazard’’
refers to a situation in which an agent could take
actions (such as not working hard enough) that are
difficult to monitor by the principal and would
benefit the agent at the expense of the principal. To
mitigate moral hazard problems, the agent’s actions
need to be better aligned with the interests of the
principal. Monitoring is one mechanism to mitigate
these problems. See, e.g., Bengt Holmstro¨m, Moral
Hazard and Observability, 10 The Bell Journal of
Economics 74 (1979).
152 For a discussion of the effect of cost pressures
on audit quality, compare James L. Bierstaker and
Arnold Wright, The Effects of Fee Pressure and
Partner Pressure on Audit Planning Decisions, 18
Advances in Accounting 25, 40 (2001) (finding, as
the result of their experiment, that ‘‘auditors
significantly reduced budgeted hours . . . and
planned tests . . . in response to fee pressure’’) with
Bernard Pierce and Breda Sweeney, Cost-Quality
Conflict in Audit Firms: An Empirical Investigation,
13 European Accounting Review 415 (2004)
(finding, in relation to the Irish market, that
‘‘dysfunctional behaviours’’ are related to time
pressure and performance evaluation).
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Specifically, when auditors use the
work of a company’s specialist, moral
hazard may take the form of the auditor
failing to evaluate data, significant
assumptions, and methods used by the
specialist to an extent that would be
commensurate with the risk of material
misstatement inherent in the specialist’s
work. Moral hazard in the context of
auditors using the work of a company’s
specialist might also take the form of the
auditor failing to appropriately assess
relationships between the company’s
specialist and the company.153 In
addition, when auditors use the work of
an auditor’s specialist, moral hazard
may, for example, take the form of not
performing procedures, or performing
insufficient procedures, to communicate
and reach an understanding with the
specialist regarding the specialist’s
responsibilities and the objectives of the
specialist’s work, or insufficiently
evaluating that work.154
In such contexts, moral hazard is
made possible by the information
asymmetry 155 that exists due to the lack
of transparency about the nature of the
auditor’s work (i.e., between the auditor
on the one hand, and investors on the
other hand). Investors typically do not
know whether an auditor used the work
of a specialist and, if so, how the work
of the specialist was used. Because of
this information asymmetry, the auditor
may face little to no scrutiny from
investors or others (e.g., audit
committees) regarding his or her audit
procedures when using the work of
specialists,156 and may perceive limited
153 See Anantharaman, The Role of Specialists in
Financial Reporting: Evidence from Pension
Accounting, at 1265 (describing empirical evidence
that suggests that auditors ‘‘have difficulty in
screening out relationships’’ that might impair the
‘‘objectivity’’ of company specialists).
154 Alternatively, it is conceivable that, in some
situations, moral hazard may take the form of the
auditor either influencing the findings or
conclusions that specialists reach or modifying the
specialist’s work after the fact to support the
conclusions sought by the auditor. See supra note
143.
155 Economists often describe ‘‘information
asymmetry’’ as an imbalance, where one party has
more or better information than another party. For
a discussion of the concept of information
asymmetry, see, e.g., George A. Akerlof, The Market
for ‘‘Lemons’’: Quality Uncertainty and the Market
Mechanism, 84 The Quarterly Journal of Economics
488 (1970).
156 This is true for other aspects of the audit
engagement as well and hence the audit can be
thought of providing investors with a credence
service. Credence services are difficult for users of
the service (such as investors in the context of
company audit services) to value because their
benefits are difficult to observe and measure. See
Monika Causholli and W. Robert Knechel, An
Examination of the Credence Attributes of an Audit,
26 Accounting Horizons 631 (2012). See also Alice
Belcher, Audit Quality and the Market for Audits:
An Analysis of Recent UK Regulatory Policies, 18
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economic benefits (e.g., gains in
revenue, gains in professional
reputation, or a reduction in potential
liability) in incurring costs to perform
additional audit work. Hence, the moral
hazard problem between the auditor and
investors may have a detrimental impact
on audit quality.157
Because market forces (e.g., pressure
and demands from investors) may not
be effective in making the auditor more
responsive to investor interests with
respect to the use of the work of
specialists,158 from an economic
perspective, the situation absent
standards would be characterized as a
form of market failure. While existing
standards regarding the use of the work
of a company’s specialist and an
auditor-engaged specialist are intended
to address and mitigate potential auditor
moral hazard, they could be aligned
more closely with the risk assessment
standards, which could enhance audit
quality. In addition, while auditoremployed specialists are supervised
under a risk-based approach, specifying
requirements for applying that approach
when using an auditor-engaged
specialist could promote an improved,
more uniform approach to supervision.
Additionally, if the work of an auditor’s
specialist is not properly overseen or
evaluated (or the work of a company’s
specialist is not properly evaluated),
there may be a heightened risk that the
auditor’s work will not be sufficient to
detect a material misstatement in
significant accounts and disclosures.
Furthermore, the auditor does not
engage or employ a company’s specialist
Bond Law Review 1, 5 (2006) (An ‘‘audit is a
credence service in that its quality may never be
discovered by the company, the shareholders or
other users of the financial statements. It may only
come into question if a ‘clean’ audit report is
followed by the collapse of the company.’’).
157 Additionally, such situations may occur
because the auditor made an error in judgment
assessing the audit risk involved when using the
work of an auditor’s specialist or a company’s
specialist. In situations in which ‘‘objectives and
the actions needed to achieve them are complex
and multifaceted, it is inevitable that different
people . . . will . . . interpret . . . them in
different ways . . .’’ See John Hendry, The
Principal’s Other Problems: Honest Incompetence
and the Specification of Objectives, 27 Academy of
Management Review 98, 107–108 (2002). When
people are choosing their actions in such situations,
Hendry argues that the predicted actions (and hence
resulting problems) are more or less the same,
whether one assumes that they are unselfish yet
‘‘prone to mak[ing] mistakes,’’ or instead are selfinterested and opportunistic yet unlikely to make
mistakes. Id. at 100.
158 The degree of responsiveness of the auditor to
investor interests, such as increasing audit effort in
some circumstances when using the work of
specialists, may also be related to, among other
things, the auditor’s ability to pass on cost increases
to companies (and, ultimately, to investors) in the
form of higher audit fees. See infra note 175 for a
further discussion of cost pass-through.
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and does not supervise the work of a
company’s specialist. This makes the
auditor’s use of the work of a company’s
specialist different from the auditor’s
use of an auditor’s specialist in several
important ways. First, because of the
different relationships the auditor has
with a company’s specialist and with an
auditor’s specialist, the auditor’s
assessment of the qualifications and
relationships of a company’s specialist
requires greater effort by the auditor
compared to the auditor’s equivalent
procedures with respect to an auditor’s
specialist. Second, the auditor’s
consideration of data, significant
assumptions, and methods used by the
company’s specialist may also be more
challenging (for example, due to the
specialist’s use of proprietary data),
compared to equivalent procedures
performed by the auditor when using a
specialist with whom the auditor has an
employment or contractual relationship.
Third, an auditor is generally more
likely to be familiar with an auditor’s
specialist than with a company’s
specialist (e.g., with the professional
qualifications, reputation, and work),
which reduces the costs associated with
the ongoing monitoring of the
specialist’s work. Given these
differences, the standards would ideally
differentiate between the two types of
specialists, but existing AS 1210
currently does not do so. Accordingly,
the potential for moral hazard relating to
the auditor’s use of the work of a
company’s specialist is a particular
focus of the requirements in the final
amendments to AS 1105.
The need to enhance existing
standards is further heightened by the
fact that it may be particularly
challenging for the auditor to evaluate
the work of either an auditor’s specialist
or a company’s specialist or to supervise
an auditor’s specialist. The work of a
company’s specialist or an auditor’s
specialist often involves professional
judgment, the nature of which the
auditor may not fully appreciate when
evaluating the work of the specialist. In
particular, the specialist’s work is
highly technical in nature and often is
not entirely transparent to the auditor,
who may not have complete access to
the specialist’s work 159 or the same
159 For example, as further discussed in section C,
some commenters on the Proposal expressed
concern that the auditor may have limited access
to proprietary information used by a company’s
specialist or an auditor-engaged specialist (as
compared with information used by an auditoremployed specialist). The final amendments do not
require the auditor to obtain such proprietary
information, but instead to obtain sufficient
information to assess whether the model is in
conformity with the applicable financial reporting
framework.
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level of knowledge and skill in the
specialist’s field.160 Thus, due to the
potential that an auditor would incur
relatively higher cost to supervise an
auditor’s specialist or to evaluate the
work of a company’s or an auditor’s
specialist, the auditor may have
incentives to forego procedures related
to the use of the work of specialists that
could be beneficial to investors.
The potential negative impact on
audit quality of the auditor’s incentives
to forgo procedures is compounded by
the possibility that an auditor’s
specialist may perceive little benefit
(compared to the corresponding costs
and efforts) in fully carrying out their
responsibilities, including the objectives
of the work to be performed.161
Alternatively, the specialist may in
some instances believe that he or she
faces few negative consequences (such
as an increase in potential liability)
when performing low quality work or,
as one commenter on the Proposal
asserted, an auditor’s specialist may not
set forth conclusions anticipated to be
rejected by the auditor. However, any
such concerns are at least partially
alleviated to the extent specialists are
subject to codes of conduct, standards,
and disciplinary processes of their own
profession or could perceive a risk of
reputational damage.162
The Proposal stated that enhanced
performance standards regarding the use
of the work of specialists might improve
audit quality and benefit investors. One
commenter asserted that the Proposal
had not articulated a pervasive problem
that would be solved by a change in
auditing standards. This commenter
further stated that it was not persuaded
160 See, e.g., Griffith, Auditors, Specialists, and
Professional Jurisdiction in Audits of Fair Values 23
(‘‘[Results] show[ ] that many auditors review
specialists’ work for general understanding and
sufficiency of the work performed, rather than
reviewing in detail as they would in other areas of
the audit. They approach the review this way
because they cannot fully understand specialists’
work.’’).
161 To the extent that an auditor’s specialist has
a stronger relationship with the auditor (e.g.,
repeated business interactions between the
specialist and the auditor), the potential for moral
hazard arising in the context of the auditor using
such an auditor’s specialist could be higher.
However, a stronger relationship between the
auditor and the auditor’s specialist may also result
in the specialist’s work being more commensurate
with the risk of material misstatement associated
with the financial statement assertion and,
therefore, improve audit quality.
162 See, e.g., Letter from American Academy of
Actuaries (Aug. 29, 2017), at 1–2, available on the
Board’s website in Docket 044 (stating that the
Academy’s members ‘‘are subject to a code of
professional conduct, standards of qualification and
practice, and a disciplinary process’’ and that ‘‘our
profession has a specific standard that defines
appropriate practice for actuaries during the course
of an audit’’).
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that a change in the audit framework for
the auditor’s use of specialists was
necessary, based on its view that a
significant amount of audit work is
currently being performed. The Board
believes, however, that the changes in
the final amendments described in
section C are needed (and preferable to
other policy-making approaches) 163
because market forces alone cannot
mitigate the moral hazard problem
described above.
Strengthening the requirements for
evaluating the work of a company’s
specialist, as well as applying a riskbased supervisory approach when using
the work of both auditor-employed and
auditor-engaged specialists, will prompt
auditors to plan and perform audit
procedures commensurate with the risk
of material misstatement inherent in the
specialist’s work, and thereby mitigate
the moral hazard problem. The final
amendments direct more audit attention
and effort, when using the work of
specialists, to areas where the
specialist’s work is more significant to
the auditor’s conclusion on a financial
statement assertion and the risk of
material misstatement is higher.
Specifically, as discussed in section
C, the final amendments mitigate the
moral hazard problem by linking the
auditor’s responsibilities for
determining the necessary evidence
when evaluating the work of the
company’s specialist, including the
data, significant assumptions, and
methods used by the specialist, to four
factors: The risk of material
misstatement of the relevant assertion;
the significance of the specialist’s work
to the auditor’s conclusion regarding
that assertion; the level of knowledge,
skill, and ability of the specialist; and
the ability of the company to
significantly affect the specialist’s
judgments about the work performed,
conclusions, or findings.
Further, the final amendments
mitigate the moral hazard problem in
the context of the use of the work of an
auditor’s specialists by clarifying the
auditor’s supervisory responsibilities
over auditor-employed specialists and
establishing parallel requirements when
auditors use the work of auditorengaged specialists, as discussed in
section C. In addition, the necessary
extent of supervision under the final
amendments depends on factors similar
to those that govern the necessary
auditor effort in evaluating the work of
a company’s specialist.
163 See below for a discussion of why the Board
believes that standard setting is preferable to other
policy-making approaches.
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Economic Impacts
The magnitude of the benefits and
costs of the final amendments will be
affected by the nature of and risks
involved in the work performed by
specialists, because more complex work
and work in areas of greater risk will
likely require greater audit effort,
holding all else constant. In addition,
benefits and costs are likely to be
affected by the degree to which auditors
have already adopted audit practices
and methodologies that are similar to
those that the final amendments will
require.164
The remainder of this subsection
discusses the potential benefits, costs,
and unintended consequences that may
result from the final amendments the
Board is adopting.
Benefits
The requirements in the final
amendments are expected to benefit
investors and auditors by directing
auditors to devote more attention to the
work of specialists and enhancing the
coordination between auditors and their
specialists. This should mitigate the
problem of auditor moral hazard
discussed in the preceding section and
contribute to improved audit quality.
The final amendments are intended to
accomplish this, and increase the
likelihood that auditors will detect
material misstatements, through
requirements that take into account
current auditing practices by some
larger audit firms and more strongly
align auditors’ interests with the
interests of investors when auditors use
the work of specialists. At the same
time, by fostering improved audit
quality, the final amendments should
increase investors’ perception of the
credibility of a company’s financial
statements, and help address
uncertainty about audit quality and the
potential risks associated with the use of
the work of company specialists,
auditor-employed specialists, and
auditor-engaged specialists.
The Board believes that investors will
benefit from the final amendments
because the application of the
requirements should result in more
consistently rigorous practices among
auditors when using the work of a
company’s specialist in their audits, as
well as a more consistent approach to
the supervision of auditor-employed
and auditor-engaged specialists. The
164 Additionally, the new standard and related
amendments in the Estimates Release, supra note
20, may affect the future prevalence and
significance of the use of the work of specialists
and, therefore, have an impact on the benefits and
costs of the final amendments discussed in this
section.
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current divergence in practices related
to the auditor’s use of the work of
specialists, combined with a lack of
information about such divergence,
could mean that investors are unable to
distinguish the quality of each audit
separately, which in turn could lead
investors to discount the quality of all
audits. Conversely, greater consistency
in such practices—such as would be
promoted by the final amendments—
could mitigate those concerns by both
enhancing the quality of less rigorous
audits and correcting the inappropriate
discounting of more rigorous audits.
From an investor’s perspective, and as
one commenter concurred, the increase
in audit quality that should result from
the final amendments should contribute
to investor protection. Specifically, an
increase in audit quality may increase
the quality of the information provided
in a company’s financial statements and
decrease the cost of capital for that
company,165 especially if less
information is available about the
company because it has a shorter
financial reporting history.166
From a broader capital markets
perspective, an increase in the
information quality of a company’s
financial statements because of
improved audit quality can increase the
efficiency of capital allocation
decisions. In other words, an increase in
the information quality of companies’
financial statements can reduce the nondiversifiable risk to investors and
generally should result in investment
decisions by investors that more
accurately reflect the financial position
165 See, e.g., Richard A. Lambert, Christian Leuz,
and Robert E. Verrecchia, Accounting Information,
Disclosure, and the Cost of Capital, 45 Journal of
Accounting Research 385, 386–7 (2007)
(‘‘[A]ccounting information influences a
[company’s] cost of capital . . . where higher
quality accounting information . . . affects the
market participants’ assessments of the distribution
of future cash flows’’); see also Randolph P. Beatty,
Auditor Reputation and the Pricing of Initial Public
Offerings, 64 The Accounting Review 693, 696
(1989) (‘‘Since auditing firms that have invested
more in reputation capital have greater incentives
to reduce application errors, the information
disclosed in the accounting reports audited by these
firms will be more precise, ceteris paribus. This
reduction in measurement error will allow
uninformed investors to estimate more precisely the
distribution of firm value.’’).
166 See, e.g., Jeffrey A. Pittman and Steve Fortin,
Auditor Choice and the Cost of Debt Capital for
Newly Public Firms, 37 Journal of Accounting and
Economics 113, 114 (2004) (‘‘[E]ngaging [an audit
firm with] a brand name reputation for supplying
higher-quality audit that enhances the credibility of
financial statements, enables young [companies] to
reduce their borrowing costs . . . [O]ur research
suggests that the economic value of auditor
reputation declines with age as [companies] shift
toward exploiting their own reputations to reduce
information asymmetry.’’).
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and operating results of each
company.167
In addition to the general benefits to
investors and the capital markets
described above, the final amendments
should result in specific benefits to
auditors. In particular, the final
amendments should lead to
improvements in the ability of auditors
to supervise auditor-employed and
auditor-engaged specialists and evaluate
their work, to the extent that auditors
devote more attention to the work of
auditor-employed and auditor-engaged
specialists and enhance the
coordination with those specialists. The
final amendments with regard to the use
of the work of a company’s specialist
should also lead to improvements in the
auditor’s understanding of the data,
significant assumptions, and methods
used by the company’s specialist. As
auditors are better able to identify and
detect potential risks of material
misstatement, this may also spur
companies and their specialists over
time to improve the quality of financial
reporting and their work.
The final amendments may also
contribute to the aggregate benefits of
the auditing standards (i.e., by
enhancing auditors’ understanding of,
and compliance with, other PCAOB
auditing standards), in addition to the
other improvements in audit quality
described above. For example, the final
amendments to evaluate the work of a
company’s specialist should result in
some auditors developing a better
understanding of the company’s
accounting estimates in significant
financial statement accounts and
disclosures. In turn, this may also result
in improved communications with audit
committees.168
The magnitude of the benefits
discussed in this section resulting from
improved audit quality will likely vary
to the extent that current practices are
aligned with the final amendments.
167 See, e.g., Lambert et al., Accounting
Information, Disclosure, and the Cost of Capital 388
(finding that information quality directly influences
a company’s cost of capital and that improvements
in information quality by individual companies
unambiguously affect their non-diversifiable risks.);
Ahsan Habib, Information Risk and the Cost of
Capital: Review of the Empirical Literature, 25
Journal of Accounting Literature 127, 128 (2006)
(‘‘A commitment to increased level [and quality] of
disclosure reduces the possibility of information
asymmetries and hence should lead to a lower cost
of capital effect. . . . In addition, high quality
auditing . . . could provide credible information in
the market regarding the future prospect of the
[company] and hence could reduce the cost of
capital in general, and cost of equity capital in
particular.’’ (footnote omitted)).
168 See paragraphs .12c and .13c of AS 1301,
Communications with Audit Committees, for the
auditor’s communication requirements related to
the company’s critical accounting estimates.
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Based on observations from the Board’s
oversight activities, most firms would
need to enhance their methodologies,
but to varying degrees. In general, both
the greatest changes and the greatest
benefits are likely to occur with auditors
that need to enhance their
methodologies the most.
Costs
The Board recognizes that the benefits
of the final amendments will come at
additional costs to auditors and the
companies they audit. As with any
changes to existing requirements, it is
anticipated that there will be one-time
costs for auditors associated with
updating audit methodologies and tools,
preparing new training materials, and
conducting training.169 The final
amendments could also give rise to
recurring costs in the form of additional
time and effort spent on any individual
audit engagement by specialists and
engagement team members.
The most significant impact of the
final amendments on costs for auditors
is expected to result from the
requirements to evaluate the work of a
company’s specialist. This area of
potential impact was also noted by some
commenters on the proposed
requirements for testing and evaluating
the work of a company’s specialist.
Compared with the existing
requirements,170 the auditor will be
required under the final amendments to
evaluate the significant assumptions
used by the company’s specialist
whenever the specialist’s work is used,
rather than only in certain
circumstances,171 as well as the
methods used by the specialist. In
practice, these requirements may result
in auditors performing more work or
using an auditor’s specialist to assist
them in evaluating the work of a
company’s specialist. This may lead to
significant changes in practice for some
firms, particularly smaller firms that
currently do not employ specialists and
follow methodologies solely based on
existing AS 1210, even though the final
amendments do not require the auditor
169 The PCAOB has observed that larger firms are
likely to update their methodologies using internal
resources, whereas smaller firms are more likely to
purchase updated methodologies from external
vendors.
170 See existing AS 1210.12.
171 In circumstances when an auditor is auditing
fair value measurements and disclosures in
accordance with AS 2502, footnote 2 of that
standard provides that management’s assumptions
include assumptions developed by a specialist
engaged or employed by management. Therefore,
the auditor is currently required to evaluate the
reasonableness of significant assumptions
developed by the company’s specialist when
auditing a fair value measurements and disclosures.
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to use the work of an auditor’s
specialist.
Compared to the Proposal, however,
the final amendments clarify the
auditor’s responsibility when evaluating
the work of the company’s specialist
and, therefore, should further limit any
incremental cost to circumstances
where increases in audit quality can be
reasonably expected. For example, as
detailed in section C, the final
amendments reflect changes to the
Proposal relating to the auditor’s
evaluation of the data, significant
assumptions, and methods used by the
company’s specialist. These revisions
clarify that the focus of the auditor’s
evaluation does not require
reperforming the specialist’s work.
Instead, the auditor’s responsibility is to
evaluate whether the specialist’s work
provides sufficient appropriate evidence
to support a conclusion regarding
whether the corresponding accounts or
disclosures in the financial statements
are in conformity with the applicable
financial reporting framework.
In addition, some of the expected cost
increases for auditors due to the final
amendments are likely to be offset by
the implementation of more risk-based
audit approaches in practice (e.g., more
targeted procedures when using the
work of specialists). More risk-based
audit approaches reduce the risk to the
auditor of failing to detect material
misstatement and thus could lead to a
reduction in costs resulting from
potential liability or reputational loss
faced by auditors.
The final amendments’ impact on
costs for auditors could also vary based
on the size and complexity of an audit
engagement. Holding all else constant,
anticipated costs generally would be
higher for larger, more complex audits
than for smaller, less complex audits.172
As discussed above, a smaller portion of
audits performed by smaller audit firms
tend to involve use of the work of
specialists, compared with audits
performed by larger audit firms.
Accordingly, it is reasonable to infer
that relatively fewer audits of smaller
firms will be impacted by the final
amendments than audits of larger firms.
The impact of the final amendments
would also likely vary, however,
depending on the extent to which
elements of the final amendments have
already been incorporated in an audit
172 See Letter from American Academy of
Actuaries (July 31, 2015), at 18, available on the
Board’s website in Docket 044 (stating that ‘‘smaller
audit firms also tend to have clients that require
fewer special needs’’ and thus implying that audit
engagements of smaller audit firms tend to be less
complex than audit engagements of larger audit
firms).
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firm’s methodologies or applied in
practice by individual engagement
teams. For auditors that have already
implemented elements of the final
amendments, the costs of implementing
the final amendments will be lower than
for firms that currently perform more
limited audit procedures. For example,
some firms employ procedures to reach
and document their understanding with
an auditor’s specialist about, among
other things, the responsibilities of the
auditor’s specialist and the nature of the
work to be performed. Firms that do not
already employ such procedures may
incur additional costs under the final
amendments.
Similarly, the incremental impact of
the final amendments on costs incurred
by auditors would likely vary
depending on, among other things, how
many of an audit firm’s engagements
involve the use of the work of
specialists. Among audit firms that use
the work of specialists on their
engagements, the anticipated costs
would likely be higher for those firms
that use the work of specialists more
frequently or extensively than for firms
that do so less frequently or extensively.
Larger audit firms generally perform a
larger number of audit engagements,
however, and the incremental impact of
the final amendments on their costs per
engagement should be lower than for
smaller firms that generally perform a
smaller number of audit engagements.
This would be the case regardless of
whether the audit engagements of the
larger and smaller firms involve the use
of the work of specialists, since larger
firms, due to their existing economies of
scale 173 and scope,174 would tend to be
able to distribute the overall cost impact
173 See Economies of Scale and Scope, The
Economist, Oct. 20, 2008 (available at https://
www.economist.com/news/2008/10/20/economiesof-scale-and-scope) (‘‘Economies of scale are factors
that cause the average cost of producing something
to fall as the volume of its output [i.e., number of
audit engagements] increases.’’). In this context, the
average cost would likely fall with the number of
audit engagements, because certain costs, such as
the cost of employing specialists, are not directly
related to the number of audit engagements that an
auditor assumes. See also Simon Yu Kit Fung,
Ferdinand A. Gul, and Jagan Krishnan, City-Level
Auditor Industry Specialization, Economies of
Scale, and Audit Pricing 87 The Accounting Review
1281, 1287 (2012) (‘‘For an audit firm, the scale
economies can arise from substantial investment in
general audit technology (e.g., audit software
development or hardware acquisition) and human
capital development (e.g., staff training), which are
likely to be shared among all of their clients. Once
these investments are in place, additional clients
can be serviced at a lower marginal cost than the
cost of servicing the first few clients.’’).
174 See Economies of Scale and Scope, The
Economist (‘‘[E]conomies of scope [are] factors that
make it cheaper to produce a range of products
together than to produce each one of them on its
own. Such economies can come from businesses
sharing centralised functions . . .’’).
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of the final amendments over a larger
number of audit engagements.
Some commenters argued that the
Proposal could lead, in some instances,
to significant (and potentially pervasive)
increases in auditing costs, due to
increased audit effort that would not
necessarily be accompanied by
corresponding increases in audit
quality. In contrast, one commenter
asserted that the requirements could be
implemented effectively with minimal
costs. In adopting the final amendments,
the Board modified certain of the
proposed amendments with the intent
that the final amendments be risk-based
and scalable, and that any cost increases
be accompanied by commensurate
improvements in audit quality. For
example, as discussed earlier in this
subsection, the final amendments reflect
changes to the Proposal relating to the
auditor’s evaluation of the data,
significant assumptions, and methods
used by the company’s specialist. These
changes clarify that the focus of the
auditor’s evaluation does not require
reperforming the specialist’s work and
thus should limit incremental costs to
situations where more auditor
involvement is necessary to address the
identified risk of material misstatement.
The final amendments might result in
additional costs for some companies,
compared to costs incurred under
current requirements, to the extent that
the final amendments lead auditors to
raise their audit fees.175 Such additional
costs could vary for the same reasons as
described above relating to the final
amendments’ potential impact on costs
incurred by auditors. The final
amendments could also give rise to new
recurring costs for management, to the
extent that the final amendments result
in the need for companies to devote
more time and resources to respond to
auditor inquiries and requests. Some
commenters on the Proposal expressed
175 It is not clear to what extent the final
amendments will result in higher audit fees. The
Board is aware of public reports that have analyzed
historical and aggregate data on audit fees and
suggest that audit fees generally have remained
stable in recent years, notwithstanding the fact that
the Board and other auditing standard setters have
issued new standards and amended other standards
during that period. See, e.g., Audit Analytics, Audit
Fees and Non-Audit Fees: A Fifteen Year Trend
(Dec. 2017). For a general discussion of cost passthrough, see, e.g., James Bierstaker, Rich Houston,
Arnold Wright, The Impact of Competition on
Audit Planning, Review, and Performance, 25
Journal of Accounting Literature 1, 12 (2006)
(summarizing research on the market for audit
services and finding ‘‘there is evidence of lower fee
premiums when clients switch auditors, suggesting
that auditors are less able to pass on the increased
costs associated with new audits in a more
competitive environment’’); and RBB Economics,
Brief 48: The Price Effect of Cost Changes: Passing
Through and Here to Stay 1, 3 (Dec. 2014).
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concern about the potential cost to
companies, including smaller
companies. For example, one
commenter suggested that companies
might need to provide more support for
their discount rate assumptions under
the proposed amendments. On the other
hand, another commenter suggested
that, in the context of the size of the
U.S. fixed income market, consistent
use of methodologies compliant with
fair value accounting requirements by
companies would be a small cost to
bear.
For many companies (and, indirectly,
investors), however, the final
amendments should not result in
significant additional costs or
significantly increased audit fees,
particularly recurring costs, as their
auditors, especially if they are larger
audit firms, may have already
incorporated many or all elements of the
final amendments into their audit
methodologies, and individual
engagement teams may already be
applying many or all of the final
amendments in practice. In addition,
the changes from the Proposal reflected
in the final amendments, which clarify
the auditor’s responsibility when
evaluating the work of the company’s
specialist, should mitigate some of the
potential additional costs suggested by
commenters.
Unintended Consequences
In addition to the benefits and costs
discussed above, the final amendments
could have unintended economic
impacts, the possibility of which the
Board has taken into account in
adopting the final amendments. The
discussion below describes the potential
unintended consequences that were
identified in the Proposal or by
commenters, as well as the Board’s
consideration of such consequences in
adopting the final amendments. The
discussion also addresses, where
applicable, factors that mitigate the
potential negative consequences,
including revisions to the proposed
amendments reflected in the final
amendments and the existence of other
countervailing factors.
Potential Adverse Impact on the Ability
of Smaller Firms To Provide Audit
Services
In instances where the final
amendments would increase the need of
some audit firms to use the work of an
auditor’s specialist (rather than only use
the work of a company’s specialist
under existing AS 1210), the final
amendments might result in some
smaller firms accepting fewer audit
engagements that would require the use
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of an auditor’s specialist. Relatedly, in
such instances, some smaller firms
might be inhibited from expanding their
audit services for similar reasons. The
Board had acknowledged the possibility
of such unintended consequences in the
Proposal, and some commenters also
expressed the view that the proposed
amendments might adversely impact the
ability of smaller firms to provide audit
services in certain situations.
In particular, to the extent that
auditors at smaller audit firms have less
experience evaluating the work of a
company’s specialist than auditors at
larger firms, some auditors may have an
increased need to use the work of an
auditor’s specialist for certain
engagements. Potentially, such firms
would be unable to take advantage of
the economies of scale and scope
available to larger firms (for example, if
they did not employ their own
specialists and had to identify and
engage qualified specialists), and find it
economically less attractive to accept
such engagements. In addition, some
commenters on the Proposal suggested
more broadly that the ability of smaller
firms to compete in the audit services
market would be adversely affected. The
Board acknowledges that the final
amendments could have a more
significant impact on smaller firms than
on larger firms. However, the Board
believes that two factors will lessen any
such adverse impact of the final
amendments on smaller firms.
First, as described earlier in this
section, the evidence from PCAOB
inspections data indicates that smaller
audit firms generally have
comparatively few audit engagements in
which they use the work of a company’s
specialist or an auditor’s specialist. For
example, the results for smaller audit
firms in Figure 5 above indicate that the
auditors did not use the work of either
a company’s specialist or an auditor’s
specialist in 81% and 94% of the audits
of smaller audit firms—U.S. and nonU.S. firms, respectively—inspected in
2017, and that the auditors used the
work of a company’s specialist without
also using the work of an auditor’s
specialist 176 in only 10% and 6% of the
audits of smaller audit firms—U.S. and
non-U.S. firms, respectively—inspected
in 2017.177 These results suggest that
176 The fact that the auditor did not use the work
of an auditor’s specialist does not imply that the
auditor should have used the work of an auditor’s
specialist.
177 Furthermore, given that the engagements
selected for inspection are on average more likely
to be complex (and thus more likely to involve the
use of the work of a specialist) than the overall
population of audit engagements of smaller audit
firms, the percentage results shown above for audits
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the number of engagements where
smaller firms might be faced with using
an auditor’s specialist for the first time
to evaluate the work of a company’s
specialist under the final amendments is
a relatively small proportion of audits
subject to the Board’s standards.
Second, there is some evidence that
smaller and larger audit firms do not
directly compete with one another in
some segments of the audit market.178
To the extent smaller audit firms
compete in different segments of the
audit market than larger audit firms, the
competitive impact of the final
amendments on smaller firms would be
lessened.
Taking into consideration the factors
described above, the final amendments
further mitigate the potential adverse
impact on the ability of smaller firms to
provide audit services involving, or
compete for audit engagements that
require, the use of the work of
specialists. For example, the
clarifications in the final amendments
for evaluating the work of a company’s
specialist, such as limiting the use of the
term ‘‘test’’ to procedures applied to
company-produced information used by
the specialist, should alleviate concerns
expressed by certain commenters on the
Proposal that auditors would be
required to reperform the work of a
company’s specialist. In addition, under
the final amendments, auditors are
allowed to assess the objectivity of an
auditor-engaged specialist along a
spectrum, rather than make a binary
determination whether they can use the
work of an auditor-engaged
specialist.179
Potential Diversion of Auditor Attention
From Other Tasks That Warrant
Attention
In some audit engagements involving
specialists, the final amendments might
lead auditors to devote more of their
attention and resources to the work of
a company’s specialists (including the
related training of audit personnel) and
to enhancing the coordination with an
auditor’s specialists, and less time and
resources to other tasks that warrant
greater attention.
involving the use of the work of specialists are
likely greater than the actual percentage of the
overall population of audit engagements of smaller
audit firms.
178 See, e.g., GAO Report No. GAO–03–864,
Public Accounting Firms: Mandated Study on
Consolidation and Competition (July 2003).
179 Similarly, the final amendments recognize that
a company’s ability to significantly affect the
judgments of a company’s specialist may vary and
provide for the auditor to evaluate along a spectrum
the company’s ability to significantly affect those
judgments.
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The potential impact on overall audit
quality might vary as the re-orientation
of attention would occur in different
ways for each audit engagement. Any
potential adverse impact on overall
audit quality is mitigated, however, by
the risk-based approach in the final
amendments to using the work of
specialists. To the extent that the reorientation of the auditor’s attention
leads to more effort in areas with the
greatest risk of material misstatement to
the financial statements, overall audit
quality would be expected to increase.
Furthermore, if auditors devote more
attention to the work of specialists and
enhancing the coordination with their
specialists, the final amendments will
result in some auditors acquiring greater
expertise, which could positively affect
the quality of audit work performed by
such auditors. Such auditor
specialization could lead some audit
firms to seek fewer audit engagements
involving specialists, while other firms
might seek more such engagements. In
such a market, the competitive effects of
increased specialization would likely be
highly dependent on the circumstances.
Potential for Unnecessary Effort by the
Auditor or the Auditor’s Specialist
Under the final amendments, the
potential exists that auditors might
interpret the final requirements to
suggest that they should use the work of
an auditor’s specialist in situations
where the auditor had already obtained
sufficient appropriate evidence with
respect to a relevant assertion of a
significant account or disclosure. The
Proposal also identified this potential
consequence, and some commenters
expressed concern that auditors might
feel compelled to do more work than
was necessary or optimal under the
proposed requirements. This
unintended consequence might also
arise under the final amendments if an
auditor had already evaluated the work
of a company’s specialist, but decided to
employ or engage its own specialist to
perform additional procedures. For
example, the auditor might ask an
auditor’s specialist to develop or assist
in developing an independent
expectation of an estimate in order to
further demonstrate his or her diligence
or err on the side of caution. In some
instances, it is possible that the auditor
might do so even though the auditor
believes the costs of using the work of
an auditor’s specialist will outweigh the
expected benefits in terms of audit
quality.
The final amendments, however,
mitigate this risk in several respects. In
particular, the final amendments do not
require the auditor to use the work of an
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auditor’s specialist. Moreover, the final
amendments regarding the nature,
timing, and extent of the evaluation of
the work of the company’s specialist are
designed to be risk-based and scalable to
companies of varying size and
complexity. In addition, as discussed
above, the final amendments clarify the
requirements for evaluating the work of
a company’s specialist and assessing the
objectivity of an auditor-engaged
specialist, which should avoid
unnecessary effort by the auditor or
auditor’s specialist. Accordingly, any
increases in effort should be
accompanied by improvements in audit
quality.
Potential Shift in the Balance Between
the Work of a Company’s Specialist and
the Work of an Auditor’s Specialist
In audit engagements involving
specialists, the potential exists that the
final amendments could affect the
balance between the work of a
company’s specialist and the work of an
auditor’s specialist. The Proposal also
identified this potential consequence,
and some commenters expressed
concern that companies might, in some
instances, choose not to engage or
involve a company’s specialist if they
expected that the auditor would use an
auditor’s specialist to perform
additional procedures.180
The final amendments do not change
management’s responsibility for the
financial statements or their obligation
to maintain effective internal control
over financial reporting. Anticipating
the use of an auditor’s specialist for the
audit engagement, however, some
issuers may decide to use a company’s
specialist to a lesser extent (or not at all)
when preparing financial statements
and some company specialists may
exhibit a reduced sense of
responsibility. In such instances, the
auditor’s specialist may have to perform
more work in order to adequately
evaluate potential audit evidence
provided by the issuer, including the
work of a company’s specialist if the
issuer continues to use such a specialist.
Alternatively the auditor may decide
not to use the work of a company’s
specialist or use that work to a lesser
extent. If the situations described above
were to occur, audit quality might be
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180 See,
e.g., Letter from Duff & Phelps (Aug. 30,
2017), at 4, available on the Board’s website in
Docket 044 (‘‘situations may arise where
management may feel compelled to invest less time,
costs and effort in supporting certain assertions in
the financial statements by not engaging a specialist
when one would otherwise be called for—
especially given the expectation that the auditor’s
specialist would perform extensive testing and
calculations as part of the audit’’).
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reduced, not enhanced, in some
instances.
The change in the balance between
the work of a company’s specialist and
the work of an auditor’s specialist,
however, would likely be limited, as
companies control the work of a
company’s specialist over information
to be used in the financial statements,
but lack similar control over an
auditor’s specialist. Companies
generally are likely, therefore, to prefer
to continue their use of a company’s
specialist. In addition, the final
amendments do not require auditors to
use an auditor’s specialist when using
the work of a company’s specialist.
Moreover, compared to the Proposal, the
final amendments clarify the
requirements for evaluating the work of
a company’s specialist. For example, the
final amendments clarify the auditor’s
responsibilities for evaluating the
methods and significant assumptions
used by the company’s specialist, and
limit the use of the term ‘‘test’’ to
procedures applied to companyproduced information used by the
specialist. These clarifications should
alleviate concerns expressed by certain
commenters.
Potential Reduction in the Availability
of Specialists
Some commenters on the Proposal
suggested that the proposed
amendments, if adopted, would not
affect the pool of qualified specialists
available to serve as auditors’
specialists. Other commenters, however,
expressed concern that the proposed
amendments might result in a shortage
of, or strains on, the pool of qualified
auditors’ specialists, especially in
situations where an audit firm currently
uses the work of a company’s specialist,
but does not concurrently use an
auditor’s specialist.181 Situations that
involved the auditor’s use of the work
of a company’s specialist, but did not
concurrently involve the use of an
auditor’s specialist, comprised a small
percentage of audit engagements,
ranging from 6% to 10% of the audit
engagements of smaller and larger audit
firms—U.S. and non-U.S.—that were
selected for inspection in 2017 (category
(1) of Figure 5 above).
Similar to the proposed amendments,
the final amendments do not require
auditors to use an auditor’s specialist
when using the work of a company’s
specialist. Moreover, in comparison to
the proposed amendments, auditors are
181 Commenters did not specify whether such
shortages would be permanent, or instead would
reflect a temporary disruption to which the market
would adjust over time.
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13479
allowed under the final amendments to
assess the objectivity of an auditorengaged specialist along a spectrum,
rather than make a binary determination
whether they can use the work of an
auditor-engaged specialist.182 This
change should also reduce the
possibility of a shortage of qualified
auditors’ specialists. Accordingly, the
Board believes that the final
amendments should not result in a
shortage of, or strains on, the pool of
qualified specialists available to serve as
auditors’ specialists.
Alternatives Considered, Including Key
Policy Choices
The development of the final
amendments involved considering a
number of alternative approaches to
address the problems described above.
This subsection explains: (1) Why
standard setting is preferable to other
policy-making approaches, such as
providing interpretive guidance or
enhancing inspection or enforcement
efforts; (2) other standard-setting
approaches that were considered by the
Board; and (3) key policy choices made
in determining the details of the
proposed standard-setting approach.
Why Standard Setting Is Preferable to
Other Policy-Making Approaches
The Board’s policy tools include
alternatives to standard setting, such as
issuing additional interpretive guidance
or an increased focus on inspections or
enforcement of existing standards. One
commenter stated that the Board should
be proactive and supported the Board’s
preference for standard setting over
other policy tools, while other
commenters noted that other policy
tools, such as the issuance of staff
guidance and inspections activity,
should also be considered.
While other policy tools may
complement auditing standards, the
Board has determined that providing
additional guidance or increasing its
inspection or enforcement efforts,
without also amending the existing
requirements regarding the auditor’s
responsibilities for using the work of
specialists, would not be effective
corrective mechanisms to address
concerns with the evaluation of the
work of a company’s specialist, the
182 Additionally, the final amendments provide
for the auditor to evaluate along a spectrum the
company’s ability to significantly affect the
judgments of the company’s specialist.
Furthermore, as discussed above, the final
amendments reflect changes to the Proposal relating
to the evaluation of the data, significant
assumptions, and methods used by the company’s
specialist that clarify that the focus of the auditor’s
evaluation does not require the auditor to reperform
the specialist’s work.
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supervision of an auditor’s specialists,
and the sources of market failure
discussed previously. In addition, while
devoting additional resources to such
activities might focus auditors’ attention
on existing requirements, it would not
provide the benefits associated with
improving the standards discussed
above. Thus, the final approach reflects
the conclusion that standard setting is
needed to fully achieve the benefits
resulting from improvement in audits
involving specialists. The Board will,
however, monitor the implementation of
the final amendments by audit firms
and, if appropriate, consider the need
for additional guidance.
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Other Standard-Setting Alternatives
Considered
Several alternative standard-setting
approaches were also considered,
including: (1) Retaining the existing
framework but requiring the auditor to
disclose when the auditor used the work
of specialists in the audit; or (2) targeted
amendments to existing requirements.
Disclosing When the Work of a
Specialist Is Used
As an alternative to amending AS
1105 and AS 1201 and replacing
existing AS 1210 in its entirety, the
Board considered amending existing AS
1210 to remove the current limitations
in existing AS 1210.15 on disclosing
that a specialist was involved in the
audit. Under this approach, the auditor
would have been required to disclose
this fact. Investors might benefit from
such a requirement, since it would
inform investors, at a minimum, that the
auditor had evaluated the need for
specialized skill or knowledge in order
to perform an audit in accordance with
PCAOB standards. Such disclosures
could, in theory, positively affect audit
practice, as auditors might face more
scrutiny from investors regarding their
decisions whether or not to use
specialists.
Disclosure alone, however, would be
unlikely to achieve the Board’s
objectives, which includes effecting
more consistently rigorous practices
among auditors when using the work of
a company’s specialist in their audits, as
well as effecting a more consistent
approach to the supervision of auditoremployed and auditor-engaged
specialists. For example, with
disclosure alone, some auditors might
not evaluate the significant assumptions
and methods of a company’s specialist,
even in higher risk audit areas.
Moreover, in a separate rulemaking,
the Board has adopted a new auditing
standard that requires the auditor to
communicate CAMs in the auditor’s
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report. A CAM is defined as any matter
arising from the audit of the financial
statements that was communicated or
required to be communicated to the
audit committee and that relates to
accounts or disclosures that were
material to the financial statements and
involved especially challenging,
subjective, or complex auditor
judgment.183 Depending on the
circumstances, the description of such
CAMs might include a discussion of the
work or findings of a specialist. While
it is not yet clear how frequently the use
of the work of specialists will be
disclosed in the auditor’s report as part
of CAMs, these disclosure requirements
are complemented by amending AS
1105 and AS 1201 and replacing
existing AS 1210 to improve
performance requirements over the use
of the work of specialists. As discussed
above, this should directly mitigate
auditor moral hazard and change certain
elements of audit practice observed by
PCAOB oversight activities that have
given rise to concern, such as situations
where auditors did not apply
appropriate professional skepticism
when using the work of specialists.
Targeted Amendments to Existing
Requirements for Using the Work of an
Auditor’s Specialists
The Board considered, but is not
adopting, two alternative approaches for
an auditor’s use of the work of an
auditor’s specialist, as discussed in
further detail in the Proposal. The first
alternative was to develop a separate
standard for using the work of an
auditor’s specialist. This approach
would have created a new auditing
standard for using the work of an
auditor’s specialist, whether employed
or engaged by the auditor, similar to the
approach in ISA 620 and AU–C Section
620 (and thereby separating the
requirements for using the work of an
auditor-engaged specialist from those
for using the work of a company’s
specialist). One commenter on the
Proposal supported this approach. The
second alternative was to extend the
supervisory requirements in AS 1201 to
an auditor-engaged specialist. This
approach would have amended existing
AS 1210 to remove all references to an
auditor-engaged specialist and amended
AS 1201 to include all arrangements
involving auditor-employed and
auditor-engaged specialists.
Given the similar role of an auditoremployed and an auditor-engaged
183 See The Auditor’s Report on an Audit of
Financial Statements When the Auditor Expresses
an Unqualified Opinion and Related Amendments
to PCAOB Standards, PCAOB Release No. 2017–001
(June 1, 2017).
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specialist in the audit, the Board
determined that the auditor’s
procedures for reaching an
understanding with the specialist and
evaluating the work to be performed by
the specialist should be similar.
Accordingly, the Board has adopted
separate, but parallel, requirements for
using the work of an auditor-employed
specialist and an auditor-engaged
specialist related to reaching an
understanding and evaluating the work
to be performed. However, as discussed
above, the auditor’s relationship to an
auditor-employed specialist differs in
certain respects from the auditor’s
relationship to an auditor-engaged
specialist, which may affect the
auditor’s visibility into the specialist’s
knowledge, skill, and ability, as well as
into any relationships that might affect
the specialist’s independence or
objectivity. Accordingly, the final
amendments address these differences
by requiring the auditor to perform
procedures in AS 1210, as amended, to
evaluate the knowledge, skill, ability,
and objectivity of auditor-engaged
specialists, while recognizing that the
auditor evaluates the knowledge, skill,
ability, and independence of auditoremployed specialists in accordance with
the same requirements that apply to
other engagement team members.
Key Policy Choices
Given the preference for creating
separate requirements for using a
company’s specialist, an auditoremployed specialist, and an auditorengaged specialist, the Board considered
different approaches to addressing key
policy issues.
Scope of the Final Amendments
The Board considered a variety of
possible approaches to the scope of the
final amendments, including the
treatment of persons with specialized
skill or knowledge in certain areas of IT
and income taxes. See section C for a
discussion of the Board’s
considerations. In particular, after
considering comments on the Proposal,
the Board has clarified the scope and
application of the final amendments in
the rule text and discussion in its
adopting release. The Board, while
mindful of advances in technology that
could fundamentally impact the audit
process (and hence what is understood
to be skill and knowledge in specialized
areas of accounting and auditing),
believes that the final amendments are
sufficiently principles-based and
flexible to accommodate continued
technological advances that could
impact audit practice in the future.
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Evaluating the Work of a Company’s
Specialist
The Board considered a variety of
possible approaches relating to the
auditor’s evaluation of the work of a
company’s specialist. See section C for
a discussion of the Board’s
considerations. In particular, after
considering the comments on the
Proposal, the Board is retaining the
fundamental approach in the Proposal,
under which the auditor evaluates the
data, significant assumptions, and
methods used by the specialist. The
final amendments, including the
revisions to the proposed requirements
described in section C, retain the
benefits resulting from the use of a riskbased audit approach, while at the same
time directing the auditor to consider
the quality of the source of information
when determining his or her audit
approach.
Evaluating the Qualifications and
Independence of the Auditor-Employed
Specialist
The Board considered a variety of
possible approaches to evaluating the
knowledge, skill, ability, and
independence of auditor-employed
specialists. See section C for a
discussion of the Board’s
considerations. In particular, after
considering the comments on the
Proposal, the Board eliminated from the
final amendments certain paragraphs
that could have been misinterpreted as
suggesting a different process for
evaluating the qualifications and
independence of auditor-employed
specialists than for other engagement
team members. Instead, the final
amendments acknowledge that an
auditor-employed specialist is a member
of the engagement team and that
existing requirements for assessing the
qualifications and independence of
engagement team members apply
equally to auditor-employed specialists.
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Assessing the Qualifications and
Objectivity of the Auditor-Engaged
Specialist
The Board considered a variety of
possible approaches to assessing the
knowledge, skill, ability, and objectivity
of auditor-engaged specialists. See
section C for a discussion of the Board’s
considerations. In particular, after
considering the comments, the Board
made revisions in adopting the
requirements described in section C to
allow auditors to assess the objectivity
of auditor-engaged specialists along a
spectrum, rather than make a binary
determination. The Board believes the
final amendments in this area should
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limit any incremental cost to
circumstances where increases in audit
quality can be reasonably expected and
thereby mitigate any adverse economic
impact from potential unintended
consequences of the final amendments.
For example, requiring the auditor to
perform additional procedures to
evaluate the data, significant
assumptions, and methods used by the
specialist when the specialist has a
relationship with the company that
affects the specialist’s objectivity should
increase audit quality and reduce the
risk that a material misstatement could
go undetected.
Special Considerations for Audits of
Emerging Growth Companies
Pursuant to Section 104 of the
Jumpstart Our Business Startups
(‘‘JOBS’’) Act, rules adopted by the
Board subsequent to April 5, 2012,
generally do not apply to the audits of
EGCs, unless the SEC ‘‘determines that
the application of such additional
requirements is necessary or appropriate
in the public interest, after considering
the protection of investors, and whether
the action will promote efficiency,
competition, and capital formation.’’ 184
As a result of the JOBS Act, the rules
and related amendments to PCAOB
standards the Board adopts are generally
subject to a separate determination by
the SEC regarding their applicability to
audits of EGCs.
The Proposal sought comment on the
applicability of the proposed
requirements to audits of EGCs.
Commenters generally supported
applying the proposed requirements to
audits of EGCs. These commenters
asserted that consistent requirements
should apply for similar situations
encountered in any audit of a company,
whether that company is an EGC or not,
as well as that the benefits described in
the Proposal would be applicable to
EGCs. One commenter suggested
‘‘phasing’’ the implementation of the
requirements for such audits to reduce
the compliance burden.
The Board also notes that any new
PCAOB standards and amendments to
existing standards determined not to
apply to the audits of EGCs would
require auditors to address the differing
184 See Public Law 112–106 (Apr. 5, 2012). See
Section 103(a)(3)(C) of the Sarbanes-Oxley Act, as
added by Section 104 of the JOBS Act. Section 104
of the JOBS Act also provides that any rules of the
Board requiring (1) mandatory audit firm rotation
or (2) a supplement to the auditor’s report in which
the auditor would be required to provide additional
information about the audit and the financial
statements of the issuer (auditor discussion and
analysis) shall not apply to an audit of an EGC. The
final amendments do not fall within either of these
two categories.
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13481
requirements within their
methodologies, which would also create
the potential for confusion.
To inform consideration of the
application of auditing standards to
audits of EGCs, the PCAOB staff has also
published a white paper that provides
general information about
characteristics of EGCs.185 As of the
November 15, 2017 measurement date,
the PCAOB staff identified 1,946
companies that had identified
themselves as EGCs in at least one SEC
filing since 2012 and had filed audited
financial statements with the SEC in the
18 months preceding the measurement
date.
Overall, the discussion of benefits,
costs, and unintended consequences
above is generally applicable to audits
of EGCs. EGCs generally tend to have
shorter financial reporting histories than
other exchange-listed companies. As a
result, there is less information available
to investors regarding such companies
relative to the broader population of
public companies.186
Although the degree of information
asymmetry between investors and
company management for a particular
issuer is unobservable, researchers have
developed a number of proxies that are
thought to be correlated with
information asymmetry, including small
issuer size, lower analyst coverage,
larger insider holdings, and higher
research and development costs.187 To
the extent that EGCs exhibit one or more
of these properties, there may be a
greater degree of information asymmetry
for EGCs than for the broader
population of companies, which
increases the importance to investors of
the external audit to enhance the
credibility of management
disclosures.188 The final amendments
185 See PCAOB white paper, Characteristics of
Emerging Growth Companies as of November 15,
2017 (Oct. 11, 2018) (‘‘EGC White Paper’’), available
on the Board’s website.
186 Id.
187 See, e.g., David Aboody and Baruch Lev,
Information Asymmetry, R&D, and Insider Gains,
55 Journal of Finance 2747 (2002); Michael J.
Brennan and Avanidhar Subrahmanyam,
Investment Analysis and Price Formation in
Securities Markets, 38 Journal of Financial
Economics 361 (1995); Varadarajan V. Chari, Ravi
Jagannathan, and Aharon R. Ofer, Seasonalities in
Security Returns: The Case of Earnings
Announcements, 21 Journal of Financial Economics
101 (1988); and Raymond Chiang, and P. C.
Venkatesh, Insider Holdings and Perceptions of
Information Asymmetry: A Note, 43 Journal of
Finance 1041 (1988).
188 See, e.g., Molly Mercer, How Do Investors
Assess the Credibility of Management Disclosures?,
18 Accounting Horizons 185, 189 (2004)
(‘‘[Academic studies] provide archival evidence that
external assurance from auditors increases
disclosure credibility. . .These archival studies
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relating to the auditor’s use of the work
of specialists, which are intended to
enhance audit quality, could contribute
to an increase in the credibility of
financial statement disclosures by EGCs.
When confronted with information
asymmetry, investors may require a
larger risk premium, and thus increase
the cost of capital to companies.189
Reducing information asymmetry,
therefore, can lower the cost of capital
to companies, including EGCs, by
decreasing the risk premium required by
investors.190
Furthermore, an analysis by PCAOB
staff, the results of which are
summarized in Figure 6 below, suggests
that the prevalence and significance of
the use of the work of specialists in
audits of EGCs is comparable to the
prevalence and significance of the use of
the work of specialists in audits of nonEGCs, for audit engagements by both
smaller audit firms and larger audit
firms.191
FIGURE 6—AUDITS PERFORMED BY U.S. AND NON-U.S. AUDIT FIRMS OF EGCS THAT WERE SELECTED FOR INSPECTION
BY THE PCAOB IN 2017, CATEGORIZED BY USE OF THE WORK OF SPECIALISTS
% (number) of
audits by larger
audit firms
(U.S.)
(1) auditor used the work of a company’s specialist but did not
use the work of an auditor’s specialist .........................................
(2) auditor used the work of an auditor’s specialist but did not use
the work of a company’s specialist ..............................................
(3) auditor used the work of both a company’s specialist and an
auditor’s specialist ........................................................................
(4) auditor neither used the work of a company’s specialist nor
used an auditor’s specialist 192 ....................................................
Total 193 .....................................................................................
% (number) of
audits by smaller
audit firms
(U.S.)
% (number) of
audits by larger
audit firms
(non-U.S.)
% (number) of
audits by smaller
audit firms
(non-U.S.)
0% (0)
9% (3)
11% (1)
13% (1)
8% (2)
0% (0)
22% (2)
0% (0)
29% (7)
12% (4)
22% (2)
0% (0)
63% (15)
79% (26)
44% (4)
88% (7)
100% (24)
100% (33)
100% (9)
100% (8)
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Source: PCAOB
As indicated in Figure 6, the staff
analysis observed that 41 (or about 55%)
of the audit engagements were
performed by U.S. and non-U.S., smaller
audit firms. Among those 41 audit
engagements, only four (or about 10%)
involved the use of the work of a
company’s specialist but did not
concurrently involve the use of the work
of an auditor’s specialist (category (1)
above). In comparison, 33 of the 41
audit engagements (or about 80%) did
not involve the use of the work of either
a company’s specialist or an auditor’s
specialist (category (4) above) and four
of the 41 audit engagements (or about
10%) involved the use of both a
company’s specialist and an auditor’s
specialist (category (3) above). In none
of those 41 audit engagements did the
auditor use the work of an auditor’s
specialist without also concurrently
using the work of a company’s specialist
(category (2) above). Among the 33 audit
engagements of EGCs (or about 45%)
performed by larger firms, both U.S. and
non-U.S. firms, one (or about 3%)
involved the use of the work of a
company’s specialist but did not
concurrently involve the use of the work
of an auditor’s specialist (category (1)
above); 19 (or about 58%) did not
involve the use of the work of either a
company’s specialist or an auditor’s
specialist (category (4) above); nine (or
about 27%) involved the use of both a
company’s specialist and an auditor’s
specialist (category (3) above); and four
(or about 12%) involved the use of the
work of an auditor’s specialist, but did
not concurrently involve the use of
work of a company’s specialist (category
(2) above).
Thus, the Board believes that the need
for the final amendments discussed
earlier and the associated benefits of the
final amendments generally apply also
to audits of EGCs.
While for small companies (including
EGCs), even a small increase in audit
fees could negatively affect their
profitability and competitiveness, many
EGCs are expected to experience
minimal impact from the final
amendments. In particular, some EGCs
do not use a company’s specialist and,
for those EGCs that do use a company’s
specialist, the final amendments relating
to the auditor’s use of the work of such
specialists are risk-based and designed
to be scalable to companies of varying
size and complexity.
In addition, the analysis presented in
the EGC White Paper observed that
about 40% of audits of EGCs are
performed by firms that provided audit
reports for more than 100 issuers and
were required to be inspected on an
annual basis by the PCAOB.194 These
firms tend to already have practices for
using the work of specialists that are
consistent with many or all elements of
the final amendments. For such audit
firms, the costs on a per engagement
basis of adopting the final amendments
should also be low, for the reasons
discussed above.
For the other 60% of audits of EGCs,
the PCAOB staff analysis summarized in
Figure 6 above suggests that the
proportion of EGC audit engagements
that involve the use of the work of
company specialists, but do not involve
the use of the work of an auditor’s
specialist, is small and comparable to
the proportion of similar issuer audit
engagements described previously. As
discussed above, auditors on such audit
engagements may experience the most
significant cost impact of the final
amendments. However, only a small
proportion of audits of EGCs are
expected to be significantly affected by
the final amendments. In addition, the
final amendments clarify the
requirements for evaluating the work of
a company’s specialist and assessing the
objectivity of an auditor-engaged
specialist, which should avoid
suggest that bankers believe audits enhance the
credibility of financial statements . . .’’).
189 See supra notes 165 and 167.
190 For a discussion of how increasing reliable
public information about a company can reduce
risk premium, see David Easley and Maureen
O’Hara, Information and the Cost of Capital, 59 The
Journal of Finance 1553 (2004).
191 The staff analysis was based on engagementlevel data from the subset of 74 audit engagements
of EGCs by U.S. and non-U.S. audit firms that were
selected for inspection in 2017 presented above.
192 The audit engagements not included in the
preceding three categories were included in the
fourth category.
193 The total for the values shown in categories (1)
through (4) may not add to 100% due to rounding.
194 See EGC White Paper, at 3.
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unnecessary effort by the auditor or
auditor’s specialist. Accordingly, any
increase in effort should be
accompanied by improvements in audit
quality.
The Board has provided this analysis
to assist the SEC in its consideration of
whether it is ‘‘necessary or appropriate
in the public interest, after considering
the protection of investors and whether
the action will promote efficiency,
competition, and capital formation,’’ to
apply the final amendments to audits of
EGCs. This information includes data
and analysis of EGCs identified by the
Board’s staff from public sources.
For the reasons explained above, the
Board believes that the final
amendments are in the public interest
and, after considering the protection of
investors and the promotion of
efficiency, competition, and capital
formation, recommends that the final
amendments should apply to audits of
EGCs. Accordingly, the Board
recommends that the Commission
determine that it is necessary or
appropriate in the public interest, after
considering the protection of investors
and whether the action will promote
efficiency, competition, and capital
formation, to apply the final
amendments to audits of EGCs. The
Board stands ready to assist the
Commission in considering any
comments the Commission receives on
these matters during the Commission’s
public comment process.
Applicability to Audits of Brokers and
Dealers
The Proposal indicated that the
proposed amendments would apply to
audits of brokers and dealers, as defined
in Sections 110(3)–(4) of the SarbanesOxley Act. The Board solicited
comment on any factors specifically
related to audits of brokers and dealers
that may affect the application of the
proposed amendments to those audits.
Commenters that addressed the issue
agreed that amendments to the
standards for the auditor’s use of the
work of specialists should apply to
these audits, citing benefits to users of
financial statements of brokers and
dealers and the risk of confusion and
inconsistency if different methodologies
were required under PCAOB standards
for audits of different types of entities.
After considering comments, the
Board determined that the final
amendments, if approved by the SEC,
will be applicable to all audits
performed pursuant to PCAOB
standards, including audits of brokers
and dealers. The Board’s determination
is based on the observation that the
information asymmetry between the
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management of brokers and dealers and
their customers about the brokers’ and
dealers’ financial condition may be
significant and of particular interest to
customers, as a broker or dealer may
have custody of customer assets, which
could become inaccessible to the
customers in the event of the insolvency
of the broker or dealer.
In addition, unlike the owners of
brokers and dealers, who themselves
may be managers and thus be subject to
minimal or no information asymmetry,
customers of brokers and dealers may,
in some instances, be large in number
and may not be expert in the
management or operation of brokers and
dealers. Such information asymmetry
between the management and the
customers of brokers and dealers makes
the role of auditing important to
enhance the reliability of financial
information.
Accordingly, the discussion above of
the need for the final amendments, as
well as the costs, benefits, alternatives
considered and potential unintended
consequences to auditors and the
companies they audit, also applies to
audits of brokers and dealers. In
particular, PCAOB staff analysis of
inspections data for audits of brokers
and dealers indicates that auditors of
brokers and dealers do not frequently
use the work of specialists, whether
company specialists or an auditor’s
specialists.195 Hence, the results suggest
that only a small percentage of audits of
brokers and dealers will be impacted by
the final amendments. In addition, with
respect to the impact of the final
amendments on customers of brokers
and dealers, the expected improvements
in audit quality described previously
would benefit such customers, along
with investors, capital markets and
auditors, while the final requirements
are not expected to result in any direct
costs or unintended consequences to
customers of brokers and dealers.
III. Date of Effectiveness of the
Proposed Rules and Timing for
Commission Action
Pursuant to Section 19(b)(2)(A)(ii) of
the Exchange Act, and based on its
determination that an extension of the
period set forth in Section 19(b)(2)(A)(i)
of the Exchange Act is appropriate in
light of the PCAOB’s request that the
195 The staff analysis is based on 116 audit
engagements of brokers and dealers performed by
audit firms that were selected for inspection in
2017. The results of the analysis found that the
auditor did not use the work of a specialist in about
90% of the broker or dealer audits. This analysis
also found that auditors used the work of at least
one auditor’s specialist in about 8% of the audits
analyzed and used the work of at least one company
specialist in about 2% of those audits.
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13483
Commission, pursuant to Section
103(a)(3)(C) of the Sarbanes-Oxley Act,
determine that the proposed rules apply
to the audits of EGCs, the Commission
has determined to extend to July 3, 2019
the date by which the Commission
should take action on the proposed
rules.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views and
arguments concerning the foregoing,
including whether the proposed rules
are consistent with the requirements of
Title I of the Act. Comments may be
submitted by any of the following
methods:
Electronic Comments
• Use the Commission’s internet
comment form (https://www.sec.gov/
rules/pcaob.shtml); or
• Send an email to rule-comments@
sec.gov. Please include File Number
PCAOB–2019–03 on the subject line.
Paper Comments
• Send paper comments in triplicate
to Secretary, Securities and Exchange
Commission, 100 F Street NE,
Washington, DC 20549–1090.
All submissions should refer to File
Number PCAOB–2019–03. This file
number should be included on the
subject line if email is used. To help the
Commission process and review your
comments more efficiently, please use
only one method. The Commission will
post all comments on the Commission’s
internet website (https://www.sec.gov/
rules/pcaob.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the proposed rules that
are filed with the Commission, and all
written communications relating to the
proposed rules between the Commission
and any person, other than those that
may be withheld from the public in
accordance with the provisions of 5
U.S.C. 552, will be available for website
viewing and printing in the
Commission’s Public Reference Room,
on official business days between the
hours of 10:00 a.m. and 3:00 p.m.
Copies of such filing will also be
available for inspection and copying at
the principal office of the PCAOB. All
comments received will be posted
without charge. Persons submitting
comments are cautioned that we do not
redact or edit personal identifying
information from comment submissions.
You should submit only information
that you wish to make available
publicly. All submissions should refer
to File Number PCAOB–2019–03 and
E:\FR\FM\04APN3.SGM
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Federal Register / Vol. 84, No. 65 / Thursday, April 4, 2019 / Notices
should be submitted on or before April
25, 2019.
For the Commission, by the Office of the
Chief Accountant, by delegated authority.196
Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019–06425 Filed 4–3–19; 8:45 am]
jbell on DSK30RV082PROD with NOTICES3
196 17
CFR 200.30–11(b)(1) and (3).
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Agencies
[Federal Register Volume 84, Number 65 (Thursday, April 4, 2019)]
[Notices]
[Pages 13442-13484]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-06425]
[[Page 13441]]
Vol. 84
Thursday,
No. 65
April 4, 2019
Part III
Securities and Exchange Commission
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Public Company Accounting Oversight Board; Notice of Filing of Proposed
Rules on Amendments to Auditing Standards for Auditor's Use of the Work
of Specialists; Notice
Federal Register / Vol. 84 , No. 65 / Thursday, April 4, 2019 /
Notices
[[Page 13442]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-85435; File No. PCAOB-2019-03]
Public Company Accounting Oversight Board; Notice of Filing of
Proposed Rules on Amendments to Auditing Standards for Auditor's Use of
the Work of Specialists
March 28, 2019.
Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 (the
``Act'' or ``Sarbanes-Oxley Act''), notice is hereby given that on
March 20, 2019, the Public Company Accounting Oversight Board (the
``Board'' or ``PCAOB'') filed with the Securities and Exchange
Commission (the ``Commission'' or ``SEC'') 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 December 20, 2018, the Board adopted amendments to auditing
standards for using the work of specialists (collectively, the
``proposed rules''), including amendments to two existing auditing
standards and the retitling and replacement of a third standard with an
updated standard. The text of the proposed rules appears in Exhibit A
to the SEC Filing Form 19b-4 and is available on the Board's website at
https://pcaobus.org/Rulemaking/Pages/docket-044-auditors-use-work-specialists.aspx and at the Commission's Public Reference Room.
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. In
addition, the Board is requesting that, pursuant to Section
103(a)(3)(C) of the Sarbanes-Oxley Act, the Commission approve the
proposed rules for application to audits of emerging growth companies
(``EGCs'').\1\ The Board's request is set forth in section D.
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\1\ The term ``emerging growth company'' is defined in Section
3(a)(80) of the Securities Exchange Act of 1934 (the ``Exchange
Act'') (15 U.S.C. 78c(a)(80)). See also Inflation Adjustments and
Other Technical Amendments Under Titles I and III of the JOBS Act,
Release No. 33-10332 (Mar. 31, 2017), 82 FR 17545 (Apr. 12, 2017).
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A. Board's Statement of the Purpose of, and Statutory Basis for, the
Proposed Rules
(a) Purpose
Summary
The Board has adopted amendments to its standards for using the
work of specialists (i.e., a person or firm possessing special skill or
knowledge in a particular field other than accounting or auditing),
including amendments to two existing auditing standards and the
retitling and replacement of a third standard with an updated standard.
The amendments are intended to enhance investor protection by
strengthening the requirements for evaluating the work of a company's
specialist, whether employed or engaged by the company, and applying a
supervisory approach to both auditor-employed and auditor-engaged
specialists. The amendments are also designed to be risk-based and
scalable, so that the auditor's work effort to evaluate the
specialist's work is commensurate with the risk of material
misstatement associated with the financial statement assertion to which
the specialist's work relates and the significance of the specialist's
work to that assertion. These amendments should lead to more uniformly
rigorous practices among audit firms of all sizes and enhance audit
quality and the credibility of information provided in financial
statements.
Companies across many industries use specialists to assist in
developing accounting estimates in their financial statements.
Companies may also use specialists to interpret laws, regulations, and
contracts or to evaluate the characteristics of certain physical
assets. Those companies may use a variety of specialists, including
actuaries, appraisers, other valuation specialists, legal specialists,
environmental engineers, and petroleum engineers. Auditors often use
the work of these companies' specialists as audit evidence.
Additionally, auditors frequently use the work of auditors' specialists
to assist in their evaluation of significant accounts and disclosures,
including accounting estimates in those accounts and disclosures.
As financial reporting frameworks continue to evolve and require
greater use of estimates, including those based on fair value
measurements, accounting estimates have become both more prevalent and
significant. As a result, the use of the work of specialists also
continues to increase in both frequency and significance. If a
specialist's work is not properly overseen or evaluated by the auditor,
there may be a heightened risk that the auditor's work will not be
sufficient to detect a material misstatement in accounting estimates.
To address this challenge, the Board has adopted amendments to its
auditing standards that primarily relate to auditors' use of the work
of specialists. First, AS 1105, Audit Evidence, is being amended to add
a new Appendix A that addresses using the work of a company's
specialist as audit evidence, based on the risk-based approach of the
risk assessment standards.
New Appendix A of AS 1105
Supplements the requirements in AS 1105 for circumstances
when the auditor uses the work of the company's specialist as audit
evidence, including requirements related to:
Obtaining an understanding of the work and report(s), or
equivalent communication, of the company's specialist(s) and related
company processes and controls;
Obtaining an understanding of, and assessing, the
knowledge, skill, and ability of a company's specialist and the entity
that employs the specialist (if other than the company) and the
relationship to the company of the specialist and the entity that
employs the specialist (if other than the company); and
Performing procedures to evaluate the work of a company's
specialist, including evaluating: (i) The data, significant
assumptions, and methods (which may include models) used by the
specialist, and (ii) the relevance and reliability of the specialist's
work and its relationship to the relevant assertion.
Aligns the requirements for using the work of a company's
specialist with the risk assessment standards and the standard and
related amendments adopted by the Board on auditing accounting
estimates, including fair value measurements.
Sets forth factors for determining the necessary evidence
to support the auditor's conclusion regarding a relevant assertion when
using the work of a company's specialist.
Second, the Board has also amended AS 1201, Supervision of the
Audit Engagement, by adding a new Appendix C on supervising the work of
auditor-employed specialists, and retitling and replacing AS 1210,
Using the Work of a Specialist (``existing AS 1210''), with new AS
1210, Using the Work of an Auditor-Engaged Specialist (``AS 1210, as
amended''), which sets forth
[[Page 13443]]
requirements for using the work of auditor-engaged specialists.
New Appendix C of AS 1201
Supplements the requirements for applying the supervisory
principles in AS 1201.05-.06 when using the work of an auditor-employed
specialist to assist the auditor in obtaining or evaluating audit
evidence, including requirements related to:
Informing the auditor-employed specialist of the work to
be performed;
Coordinating the work of the auditor-employed specialists
with the work of other engagement team members; and
Reviewing and evaluating whether the work of the auditor-
employed specialist provides sufficient appropriate evidence.
Evaluating the work of the specialist includes evaluating whether the
work is in accordance with the auditor's understanding with the
specialist and whether the specialist's findings and conclusions are
consistent with, among other things, the work performed by the
specialist.
Sets forth factors for determining the necessary extent of
supervision of the work of the auditor-employed specialist.
AS 1210, as Amended
Establishes requirements for using the work of an auditor-
engaged specialist to assist the auditor in obtaining or evaluating
audit evidence;
Includes requirements for reaching an understanding with
an auditor-engaged specialist on the work to be performed and reviewing
and evaluating the specialist's work that parallel the final amendments
to AS 1201 for auditor-employed specialists;
Sets forth factors for determining the necessary extent of
review of the work of the auditor-engaged specialist;
Amends requirements related to assessing the knowledge,
skill, ability, and objectivity of the auditor-engaged specialist; and
Describes objectivity, for these purposes, as the auditor-
engaged specialist's ability to exercise impartial judgment on all
issues encompassed by the specialist's work related to the audit, and
specifies the auditor's obligations when the specialist or the entity
that employs the specialist has a relationship with the company that
affects the specialist's objectivity.
The final amendments strengthen the requirements for evaluating the
work of a company's specialist and for supervising and evaluating the
work of both auditor-employed and auditor-engaged specialists. The
amendments also eliminate certain provisions of existing PCAOB
standards, under which:
The auditor has the same responsibilities under existing
AS 1210 with respect to both a company's specialist and an auditor-
engaged specialist, even though those specialists have fundamentally
different roles (i.e., the company uses the work of its specialist in
the preparation of the financial statements); and
Auditor-employed specialists, but not auditor-engaged
specialists, are subject to risk-based supervision, even though both
serve similar roles in helping auditors obtain and evaluate audit
evidence.
The Board adopted the final amendments after substantial outreach,
including two rounds of public comment. In May 2015, the PCAOB issued a
staff consultation paper to solicit views on various issues, including
the potential need for standard setting. In June 2017, the Board
requested comments on proposed amendments to the standards on using the
work of specialists. The Board received comments on the staff
consultation paper and the proposal. The Board's Standing Advisory
Group (``SAG'') also discussed this issue at several meetings.
Commenters generally supported the Board's objective of improving the
quality of audits involving specialists, and suggested areas to further
improve the amendments, modify proposed requirements that would not
likely improve audit quality, and clarify the application of the
amendments. In adopting these amendments, the Board has taken into
account all of these comments and discussions, as well as observations
from PCAOB oversight activities.
In its consideration of the final amendments, the Board is mindful
of the significant advances in technology that have occurred in recent
years, including increased use of data analysis tools and emerging
technologies. An increased use of technology-based tools, together with
future developments in the use of data and technology, could have a
fundamental impact on the audit process. The Board is actively
exploring these potential impacts through ongoing staff research and
outreach. For example, the PCAOB staff is currently researching the
effects on auditing of data analytics, artificial intelligence,
distributed ledger technology, and other emerging technology, assisted
by a task force of the SAG.\2\
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\2\ See PCAOB, Changes in Use of Data and Technology in the
Conduct of Audits, available at https://pcaobus.org/Standards/research-standard-setting-projects/Pages/data-technology.aspx.
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In the context of this rulemaking, the Board considered how changes
in technology could affect the use of specialists by companies, the use
of the work of companies' specialists by auditors as audit evidence,
and the use of auditor-employed and auditor-engaged specialists by
auditors to obtain and evaluate audit evidence. The Board believes that
the final amendments are sufficiently principles-based and flexible to
accommodate continued advances in the use of data and technology by
both companies and auditors. The Board will continue to monitor
advances in this area and any effect they may have on the application
of the final amendments.
The amendments will apply to all audits conducted under PCAOB
standards. Subject to approval by the Commission, the amendments take
effect for audits for fiscal years ending on or after December 15,
2020.
(b) Statutory Basis
The statutory basis for the proposed rules is Title I of the Act.
B. Board's Statement on Burden on Competition
Not applicable. The Board's consideration of the economic impacts
of the proposed rules is discussed in section D below.
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
Proposed Amendments to Auditing Standards for Auditor's Use of the Work
of Specialists, PCAOB Release No. 2017-003 (June 1, 2017)
(``Proposal''). The PCAOB also issued for public comment Staff
Consultation Paper No. 2015-01, The Auditor's Use of the Work of
Specialists (May 28, 2015) (``SCP''). Copies of Release No. 2017-003,
the SCP, and the comment letters received in response to the PCAOB's
requests for comment are available on the PCAOB's website at https://pcaobus.org/Rulemaking/Pages/docket-044-auditors-use-work-specialists.aspx. The PCAOB received 80 written comment letters. The
Board's response to the comments received and the changes made to the
rules in response to the comments received are discussed below.
Background
Companies across many industries use various types of specialists
to assist in developing accounting estimates in
[[Page 13444]]
their financial statements.\3\ Companies may also use specialists to
interpret laws, regulations, and contracts or to evaluate the
characteristics of certain physical assets. Those companies may use a
variety of specialists, including actuaries, appraisers, other
valuation specialists, legal specialists, environmental engineers, and
petroleum engineers. Auditors often use the work of these companies'
specialists as audit evidence. In addition, auditors frequently use the
work of auditors' specialists to assist in their evaluation of
significant accounts and disclosures, including accounting estimates in
those accounts and disclosures.
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\3\ As used in this notice, a specialist is a person (or firm)
possessing special skill or knowledge in a particular field other
than accounting or auditing.
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The use of fair value measurements and other accounting estimates
continues to grow in financial reporting with, for example, increasing
complexity in business transactions and changes in the financial
reporting frameworks. As a result, the use of the work of specialists
continues to increase in both frequency and significance.\4\ If a
specialist's work is not properly overseen or evaluated, however, there
is heightened risk that the auditor's work will not be sufficient to
detect a material misstatement in accounting estimates.
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\4\ See, e.g., Karin Barac, Elizabeth Gammie, Bryan Howieson,
and Marianne van Staden, The Capability and Competency Requirements
of Auditors in Today's Complex Global Business Environment, at 83
(Mar. 2016) (report commissioned by the Institute of Chartered
Accountants of Scotland and the Financial Reporting Council)
(stating that ``audit teams now include many more experts than in
the past, and for some industries, particularly financial services,
this was a welcome development.'').
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The amendments to the standards for using the work of specialists
are intended to improve audit quality by strengthening the requirements
for evaluating the work of a company's specialist and applying a risk-
based supervisory approach to both auditor-employed and auditor-engaged
specialists. These enhancements should also lead to improvements in
practices, commensurate with the associated risk, among audit firms of
all sizes. The expected increase in audit quality should also enhance
the credibility of information provided to investors.
Rulemaking History
The amendments to the auditing standards adopted by the Board
(``final amendments'' or ``final requirements'') reflect public
comments on both the SCP and the Proposal. In May 2015, the PCAOB
issued the SCP to solicit comments on various issues related to the
auditor's use of the work of a company's specialist and an auditor's
specialist, including possible approaches for changes to PCAOB
standards and the potential economic impacts of those alternatives.
In June 2017, the PCAOB issued the Proposal to solicit comments on
amendments to PCAOB standards to strengthen the requirements for the
auditor's use of the work of specialists. The Proposal was informed by
comments on the SCP. The Board received 35 comment letters on the
Proposal from commenters across a range of affiliations. The final
amendments are informed by comments on the Proposal. Those comments are
discussed throughout this notice.
In addition, the Board's approach has been informed by, among other
things: (1) Observations from PCAOB oversight activities and SEC
enforcement actions; (2) the International Auditing and Assurance
Standards Board's (``IAASB'') and the American Institute of Certified
Public Accountants' Auditing Standards Board's auditing standards and
IAASB's post-implementation review; \5\ (3) substantial outreach,
including discussions with members of the SAG; \6\ and (4) the results
of academic research.
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\5\ See IAASB, Clarified International Standards on Auditing--
Findings from the Post-Implementation Review, at 44-45 (July 2013).
\6\ See SAG meeting briefing papers and webcast archives (Nov.
29-30, 2017, Nov. 30-Dec. 1, 2016, Nov. 12-13, 2015, June 18, 2015,
Oct. 14-15, 2009, and Feb. 9, 2006), available on the Board's
website.
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Overview of Existing Requirements
The primary standard that applies when auditors use the work of
auditor-engaged specialists or company specialists is existing AS 1210.
The primary standard that applies when auditors use the work of
auditor-employed specialists in an audit is AS 1201. Existing AS 1210
was adopted by the Board in 2003 shortly after the PCAOB's
inception.\7\ AS 1201 was one of eight risk assessment standards
adopted by the Board in 2010.\8\
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\7\ See Establishment of Interim Professional Auditing
Standards, PCAOB Release No. 2003-006 (Apr. 18, 2003). AS 1210 was
originally adopted by the PCAOB as AU sec. 336. The PCAOB renumbered
AU sec. 336 as AS 1210 when it reorganized its auditing standards.
See Reorganization of PCAOB Auditing Standards and Related
Amendments to PCAOB Standards and Rules, PCAOB Release No. 2015-002
(Mar. 31, 2015).
\8\ See Auditing Standards Related to the Auditor's Assessment
of and Response to Risk and Related Amendments to PCAOB Standards,
PCAOB Release No. 2010-004 (Aug. 5, 2010). Prior to 2010, auditors
supervised employed specialists under AU sec. 311, Planning and
Supervision. Additionally, paragraph .16 of AS 2101, Audit Planning,
requires the auditor to determine whether specialized skill or
knowledge is needed to perform appropriate risk assessments, plan or
perform audit procedures, or evaluate audit results.
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Existing AS 1210 provides that a specialist is ``a person (or firm)
possessing special skill or knowledge in a particular field other than
accounting or auditing.'' \9\ Existing AS 1210 also states that income
taxes and information technology (``IT'') are specialized areas of
accounting and auditing, and therefore are outside the scope of the
standard.\10\ Existing AS 1210 applies when (1) a company engages or
employs a specialist and the auditor uses that specialist's work as
evidence in performing substantive tests to evaluate material financial
statement assertions or (2) an auditor engages a specialist and uses
that specialist's work as evidence in performing substantive tests to
evaluate material financial statement assertions.\11\
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\9\ See existing AS 1210.01.
\10\ See footnote 1 of existing AS 1210.
\11\ See existing AS 1210.03.
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AS 1201 establishes requirements for the supervision of the audit
engagement, including supervising the work of engagement team
members.\12\ The auditor supervises a specialist employed by the
auditor's firm who participates in the audit under AS 1201.\13\ As
members of the engagement team under PCAOB auditing standards, auditor-
employed specialists are to be assigned based on their knowledge,
skill, and ability.\14\ AS 1201 also applies in situations in which
persons with specialized skill or knowledge in IT or income taxes
participate in the audit, regardless of whether they are employed or
engaged by the auditor's firm.\15\
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\12\ See AS 1201.01.
\13\ See AS 1201.05-.06.
\14\ See paragraph .05a of AS 2301, The Auditor's Responses to
the Risks of Material Misstatement, and paragraph .06 of AS 1015,
Due Professional Care in the Performance of Work. In addition, the
requirements in PCAOB auditing standards for determining compliance
with independence and ethics requirements also include assessing the
independence of auditor-employed specialists. See AS 2101.06b.
\15\ See footnote 1 of existing AS 1210.
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Using the work of a company's specialist and an auditor-engaged
specialist under existing AS 1210. Existing AS 1210 requires that the
auditor perform the following procedures when using the work of a
company's specialist or an auditor-engaged specialist:
Evaluate the professional qualifications of the
specialist; \16\
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\16\ See existing AS 1210.08.
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Obtain an understanding of the nature of the specialist's
work; \17\
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\17\ See existing AS 1210.09.
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Evaluate the relationship of the specialist to the
company, including circumstances that might impair the specialist's
objectivity; \18\ and
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\18\ See existing AS 1210.10-.11.
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[[Page 13445]]
In using the findings of the specialist: \19\
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\19\ See existing AS 1210.12.
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Obtain an understanding of the methods and assumptions
used by the specialist;
Make appropriate tests of data provided to the specialist;
and
Evaluate whether the specialist's findings support the
financial statement assertions.
Using the work of a company's specialist when auditing fair value
measurements under AS 2502.\20\ In circumstances when a company's
specialist develops assumptions used in a fair value measurement and
the auditor tests the company's process, the auditor is required to
evaluate the reasonableness of those assumptions as if the assumptions
were developed by the company,\21\ as well as to comply with the
requirements of existing AS 1210.
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\20\ AS 2502, Auditing Fair Value Measurements and Disclosures,
is being superseded in a separate PCAOB release. See Auditing
Accounting Estimates, Including Fair Value Measurements and
Amendments to PCAOB Auditing Standards, PCAOB Release No. 2018-005
(Dec. 20, 2018) (``Estimates Release'').
\21\ See footnote 2 of AS 2502.
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Supervising the work of auditor-employed specialists under AS 1201.
This standard establishes requirements regarding the auditor's
supervision of an audit engagement, including supervising the work of
auditor-employed specialists and other members of the engagement team.
AS 1201, as it relates to the supervision of auditor-employed
specialists, provides that:
(1) The engagement partner and others who assist the engagement
partner in supervising the audit should:
Inform engagement team members of their responsibilities;
Direct engagement team members to bring significant
accounting and auditing issues arising during the audit to the
attention of the engagement partner or other engagement team members
performing supervisory activities; and
Review the work of engagement team members to evaluate
whether:
The work was performed and documented;
The objectives of the procedures were achieved; and
The results of the work support the conclusions
reached.\22\
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\22\ See AS 1201.05.
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(2) The necessary extent of supervision depends on, for example,
the nature of the work performed, the associated risks of material
misstatement, and the knowledge, skill, and ability of those being
supervised.\23\
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\23\ See AS 1201.06.
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Existing Practice
The PCAOB's understanding of audit practice at both larger audit
firms \24\ and smaller audit firms \25\ under existing PCAOB standards
has been informed by, among other things, the collective experience of
PCAOB staff, observations from oversight activities of the Board,
enforcement actions of the SEC, comments received on the Proposal, and
discussions with the SAG, audit firms, and specialist entities.
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\24\ Unless otherwise indicated, the term ``larger audit firms''
refers to U.S. audit firms that are registered with the PCAOB and
issue audit reports for more than 100 issuers (and are therefore
annually inspected by the PCAOB). This term also refers to non-U.S.
audit firms that are registered with the PCAOB and affiliated with
one of the six largest global networks, based on information on
network affiliations reported by non-US. audit firms on Form 2 in
2017 and identified on the ``Global Network'' overview page,
available on the Board's website.
\25\ Unless otherwise indicated, the term ``smaller audit
firms'' refers to PCAOB-registered audit firms that do not meet the
definition of a ``larger audit firm'' as provided in footnote 24.
These firms generally consist of firms that issued audit reports for
100 or fewer issuers and are not affiliated with any of the six
largest global networks identified on the ``Global Network''
overview page, available on the Board's website.
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These discussions have included outreach by the PCAOB staff to
audit firms and specialist entities to obtain information on: (1) How
auditors evaluate the competence and objectivity of auditor-engaged
specialists and company specialists; (2) how auditors evaluate the work
performed by an auditor-employed specialist, an auditor-engaged
specialist, and a company's specialist; and (3) economic and
demographic considerations relating to the market for services provided
by specialists. The outreach has informed the PCAOB's understanding of
existing practice at both larger and smaller audit firms. Most
commenters who addressed the topic agreed that the Proposal accurately
described existing audit practices regarding the use of the work of
specialists. Commenters also generally supported the PCAOB's assessment
that the use and importance of specialists has increased due to
increasing complexity in business transactions and financial reporting
requirements.
Overview of Existing Practice
When existing AS 1210 was originally issued in the early 1970s, the
use of the work of specialists was largely confined to pension
obligations, insurance reserves, and extractive industry reserves.
Since then, the use of the work of specialists has increased in both
frequency and significance.
Companies across many industries use the work of specialists to:
(1) Assist them in developing accounting estimates, including fair
value measurements presented in the companies' financial statements;
(2) interpret laws, regulations, and contracts; or (3) evaluate
characteristics of physical assets, as shown in Figure 1 below. In
those circumstances, the reliability of a company's financial
statements may depend in part on the quality of the work of a company's
specialist.
[[Page 13446]]
Figure 1: Examples of Activities That Involve the Work of Specialists
------------------------------------------------------------------------
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Valuation:
Assets acquired and liabilities assumed in business combinations
Environmental remediation contingencies
Goodwill impairments
Insurance reserves
Intangible assets
Pension and other post-employment obligations
Impairment of real estate or other long-term assets
Financial instruments
Legal interpretations:
Legal title to property
Laws, regulations, or contracts
Evaluation of physical and other characteristics:
Materials stored in stockpiles
Mineral reserves and condition
Oil and gas reserves
Property, plant, and equipment useful lives and salvage values
------------------------------------------------------------------------
Auditors also increasingly use the work of specialists in their
audits. Auditors may:
Use the work of a company's specialist--employed or
engaged--as audit evidence; or
Use the work of an auditor's specialist--employed or
engaged--to assist the auditor in obtaining and evaluating audit
evidence.
Figure 2 illustrates potential ways that auditors use specialists
in an audit.
[GRAPHIC] [TIFF OMITTED] TN04AP3.002
The company's specialist (A and B above) is employed or engaged by
the company to perform work that the company uses in preparing its
financial statements, which the auditor may use as audit evidence with
respect to auditing significant accounts and disclosures. The auditor's
specialist (C and D above) performs work to assist the auditor in
obtaining and evaluating audit evidence with respect to a relevant
assertion of a significant account or disclosure.
The PCAOB understands that audit practices under existing PCAOB
standards vary among smaller and larger audit firms when auditors use
the work of a specialist in an audit.\26\ For example, smaller audit
firms are more likely to use the work of a company's specialist than to
employ or engage their own specialist. Larger audit firms generally
require their engagement teams to evaluate the work of the company's
specialist, including the specialist's methods and assumptions, and
often employ specialists to assist their audit personnel in evaluating
that work.\27\ The following paragraphs discuss in more detail the
practices of smaller firms and larger firms in audits of issuers,
brokers, and dealers under existing PCAOB standards.
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\26\ As discussed in section D, an analysis of inspection data
by PCAOB staff suggests that larger audit firms generally use the
work of specialists more often than smaller audit firms do.
\27\ An analysis by PCAOB staff indicates that smaller firms
predominantly use the work of an auditor's specialist in valuation
areas, and seldom use the work of an auditor's specialist in other
areas, whereas larger firms tend to use the work of an auditor's
specialist in a wider range of audit areas, even though they also
primarily use the work of specialists in valuation areas.
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Smaller firm practices. Smaller firm practices generally are based
on the required procedures in existing PCAOB standards, primarily
existing AS 1210. Smaller firms typically evaluate the
[[Page 13447]]
competence, relationships to the company, and work of the company's
specialist through inquiries of the company's specialist. For example,
smaller firms may send a company's specialist a questionnaire to obtain
information regarding the specialist's professional qualifications and
the existence of relationships with the company that could impair the
specialist's objectivity. Further, smaller firms typically do not
evaluate the appropriateness of a specialist's methods (it is not
required by existing AS 1210), and any evaluation by smaller firms of
the assumptions of a company's specialist is generally confined to
circumstances when the specialist develops assumptions used in a fair
value measurement covered by AS 2502.
In circumstances when smaller firms engage an auditor's specialist,
some firms perform the procedures specified in existing AS 1210. Other
firms perform procedures similar to those in AS 1201 for supervising
members of the engagement team. For example, some firms evaluate
whether the auditor-engaged specialist's work supports the financial
statement assertions, while other firms go further by also evaluating
whether (1) the specialist's work was performed and documented, (2) the
objectives of the specialist's procedures were achieved, and (3) the
results of the specialist's work support the conclusions reached. One
commenter noted that smaller firms may also use an auditor's specialist
in evaluating the work of a company's specialist.
Larger firm practices. Some larger audit firms evaluate the methods
and assumptions used by company specialists when they test the
company's process for developing accounting estimates, even though this
evaluation is currently required only for significant assumptions
developed by the company's specialist in conjunction with fair value
measurements and disclosures.\28\ Many larger firms employ their own
specialists, who serve on engagement teams and assist with the
evaluation of the work of company specialists.
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\28\ See footnote 2 of AS 2502.
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Auditor-employed specialists at larger firms are generally involved
early in the audit, usually during planning meetings with other members
of the engagement team. Also, in planning the audit, auditors generally
reach an understanding with auditor-employed specialists, documented in
a memorandum, regarding the scope of work to be performed and the
respective responsibilities of the auditor and the specialist. The
items covered in that memorandum typically include: (1) The nature,
scope, and objectives of the specialist's work; \29\ (2) the role and
responsibilities of the auditor and the specialist; \30\ and (3) the
nature, timing, and extent of communication between the auditor and the
specialist.\31\ The auditor communicates with the specialist as the
work progresses to become aware of issues as they arise. When the
specialist completes his or her work, the auditor reviews the
specialist's work, which is typically documented in a separate report
or memorandum.
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\29\ Examples include whether the specialist is testing (or
assisting in testing) the company's process for developing an
accounting estimate or developing (or assisting in developing) an
independent expectation of the estimate.
\30\ For example, the documentation might identify the
respective responsibilities of the auditor and the specialist for
evaluating data, significant assumptions, and methods used by the
company or the company's specialist.
\31\ Examples include administrative matters, such as the
timing, budget, and other staffing-related issues relevant to the
specialist's work, or the protocols for discussing and resolving
findings or issues identified by the specialist.
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In some instances, larger firms may use the work of a company's
specialist without involving an auditor's specialist, particularly when
the risk of material misstatement is low or the firm does not employ a
specialist with expertise in the particular field. Alternatively,
although infrequently, larger firms may engage a specialist with
expertise in the particular field. When larger firms engage
specialists, some firms perform the procedures specified in existing AS
1210 described above. Other firms perform procedures in such situations
that are similar to the procedures for supervising the work of auditor-
employed specialists under AS 1201.
Observations From Audit Inspections and Enforcement Cases
The Board's understanding of audit practice under existing PCAOB
standards has been informed in part by observations from PCAOB
oversight activities and SEC enforcement actions, including (1) audit
deficiencies of both larger and smaller firms, and related remedial
actions to address the deficiencies and (2) enforcement actions where
the work of a specialist was used in the audit.
Inspections observations. Over the past several years, the
observations from PCAOB inspections have included instances in which
the auditor used the work of a company's specialist without performing
the procedures required by existing PCAOB standards.\32\ Recent
findings include instances in which auditors did not: (1) Evaluate the
reasonableness of assumptions used by a company's specialist in
developing fair value measurements; (2) obtain an understanding of
methods or assumptions used by the company's specialist; (3) test the
accuracy and completeness of company-provided data used by the
company's specialist; or (4) evaluate the professional qualifications
of the company's specialist.
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\32\ See existing AS 1210 and AS 2502.
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Over the past several years, the observations from PCAOB
inspections also have indicated that auditors, at times, did not
fulfill their responsibilities under existing standards when using the
work of an auditor's specialist. These findings were more common than
those related to using the work of a company's specialist over the same
period. The observations included instances in which auditors did not:
(1) Reach an understanding with the specialist regarding his or her
responsibilities; (2) adequately evaluate the work performed by the
specialist; or (3) consider contradictory evidence identified by the
specialist or resolve discrepancies or other concerns that the
specialist identified. More recently, PCAOB inspection staff have
observed a decline in the number of instances by some firms in which
auditors did not perform sufficient procedures related to the work of
an auditor's specialist.
There are indications that some firms have undertaken remedial
actions in response to the findings related to the auditor's use of the
work of an auditor's specialist. In most cases, such actions included
enhancements to firm methodologies to improve coordination between the
auditor and the auditor's specialist through earlier and more frequent
communications. These enhancements may have contributed, at least in
part, to the decline in findings described above. Not all firms,
however, have changed their methodologies, resulting in inconsistent
practices in this area. In addition, unlike the findings related to the
auditor's use of the work of an auditor's specialist, PCAOB inspections
staff have not observed a similar change in the frequency of findings
related to the auditor's use of the work of a company's specialist.
[[Page 13448]]
Enforcement actions. Both the SEC \33\ and the PCAOB \34\ have
brought enforcement actions involving situations where auditors
allegedly failed to comply with auditing standards when using the work
of specialists. For example, such proceedings have involved allegations
that auditors failed to (1) perform audit procedures to address the
risks of material misstatements in a company's financial statements
that were prepared in part based on the work of a company's specialist
\35\ or (2) comply with certain requirements of existing AS 1210 when
using the work of a company's specialist (for example, requirements to
evaluate the professional qualifications of the specialist, obtain an
understanding of the methods and assumptions used by the specialist,
evaluate the relationship of the specialist to the company, and apply
additional procedures to address a material difference between the
specialist's findings and the assertions in the financial
statements).\36\ Several of those proceedings were brought in recent
years, suggesting that problems persist in this area.
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\33\ See, e.g., KPMG LLP and John Riordan, CPA, SEC Accounting
and Auditing Enforcement Release (``AAER'') No. 3888 (Aug. 15,
2017); Miller Energy Resources, Inc., Paul W. Boyd, CPA, David M.
Hall, and Carlton W. Vogt, III, CPA, AAER No. 3673 (Aug. 6, 2015);
Troy F. Nilson, CPA, SEC AAER No. 3264 (Apr. 8, 2011); and
Accounting Consultants, Inc., and Carol L. McAtee, CPA, SEC AAER No.
2447 (June 27, 2006).
\34\ See, e.g., Tarvaran Askelson & Company, LLP, Eric Askelson,
and Patrick Tarvaran, PCAOB Release No. 105-2018-001 (Feb. 27,
2018); Grant Thornton LLP, PCAOB Release No. 105-2017-054 (Dec. 19,
2017); KAP Purwantono, Sungkoro & Surja, Roy Iman Wirahardja, and
James Randall Leali, PCAOB Release No. 105-2017-002 (Feb. 9, 2017);
Arturo Vargas Arellano, CPC, PCAOB Release No. 105-2016-045 (Dec. 5,
2016); Gordon Brad Beckstead, CPA, PCAOB Release No. 105-2015-007
(Apr. 1, 2015); and Chisholm, Bierwolf, Nilson & Morrill, LLC, Todd
D. Chisholm, CPA, and Troy F. Nilson, CPA, PCAOB Release No. 105-
2011-003 (Apr. 8, 2011).
\35\ See, e.g., Gordon Brad Beckstead, CPA, PCAOB Release No.
105-2015-007.
\36\ See, e.g., Grant Thornton LLP, PCAOB Release No. 105-2017-
054; KAP Purwantono, Sungkoro & Surja, PCAOB Release No. 105-2017-
002; Arturo Vargas Arellano, CPC, PCAOB Release No. 105-2016-045;
Chisholm, Bierwolf, Nilson & Morrill, LLC, PCAOB Release No. 105-
2011-003; and Miller Energy Resources, Inc., SEC AAER No. 3673.
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Reasons To Improve Auditing Standards
The improvements to PCAOB standards are intended to direct auditors
to devote more attention to the work of a company's specialist and
enhance the coordination between an auditor and the auditor's
specialist--employed or engaged. The final amendments also align with
the Board's risk assessment standards and acknowledge more clearly the
different roles of a company's specialist, an auditor-employed
specialist, and an auditor-engaged specialist. The Board believes that
these improvements will enhance both audit quality and the credibility
of the information provided in a company's financial statements.
Areas of Improvement
The Board has identified two important areas where improvements are
warranted to existing standards, discussed below: (1) Strengthening the
requirements for evaluating the work of a company's specialist and (2)
applying a risk-based supervisory approach to auditor-employed and
auditor-engaged specialists.
Strengthening the Requirements for Evaluating the Work of a Company's
Specialist
Existing AS 1210 is the primary standard that applies when auditors
use the work of an auditor-engaged specialist or a company's
specialist. By its terms, existing AS 1210 applies when (1) a company
engages or employs a specialist and the auditor uses that specialist's
work as evidence in performing substantive tests to evaluate material
financial statement assertions or (2) an auditor engages a specialist
and uses that specialist's work as evidence in performing substantive
tests to evaluate material financial statement assertions.
In practice, however, a company's specialist and an auditor-engaged
specialist have fundamentally different roles: The company uses the
work of a specialist in the preparation of its financial statements,
whereas an auditor's specialist performs work to assist the auditor in
obtaining and evaluating audit evidence. By imposing the same
requirements for using the work of a company's specialist and an
auditor-engaged specialist, existing AS 1210 does not clearly reflect
the different roles of such specialists.
In addition, existing AS 1210 does not expressly require an auditor
to evaluate the appropriateness of a company specialist's methods and
assumptions.\37\ Instead, it requires the auditor to obtain an
understanding of the methods and assumptions used by the specialist, a
less rigorous procedure. Existing AS 1210 also includes certain
provisions that circumscribe the auditor's responsibilities related to
the work of a specialist, including statements that: (1) The
appropriateness and reasonableness of methods and assumptions used, and
their application, are the responsibility of the specialist; (2) the
auditor ordinarily would use the work of the specialist unless the
auditor's procedures lead him or her to believe the findings are
unreasonable in the circumstances; and (3) if the auditor determines
that the specialist's findings support the related assertions in the
financial statements, he or she reasonably may conclude that sufficient
appropriate evidential matter has been obtained.\38\
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\37\ The evaluation of the reasonableness of assumptions
developed by a company's specialist is required only in
circumstances when the specialist develops assumptions used in a
fair value measurement in accordance with AS 2502. AS 2502 is being
superseded in a separate PCAOB release. See Estimates Release, supra
note 20.
\38\ See existing AS 1210.12-.13.
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When an auditor uses the work of a company's specialist, the
requirements in existing AS 1210 allow the auditor to plan and perform
audit procedures that may not be commensurate with the risk of material
misstatement inherent in the work of the specialist, thereby allowing
the auditor to use the work and conclusions of a company's specialist
without performing procedures to evaluate that specialist's work. Some
audit firms, primarily larger firms, go beyond the requirements in
existing AS 1210 and generally require their engagement teams to
evaluate the work of a company's specialist, including the specialist's
methods and assumptions, and often employ specialists to assist their
audit personnel in evaluating that work. Existing audit practices in
this regard, however, vary among firms.
The foregoing factors indicate that improvements to PCAOB standards
for using the work of a company's specialists are needed and that
increasing auditors' attention to the work of a company's specialists
with respect to significant accounts and disclosures will enhance
investor protection. In the Board's view, investor protection will be
enhanced by requiring auditors to do more than merely obtain an
understanding of the methods and significant assumptions used by the
specialist.
Applying a Risk-Based Supervisory Approach to Both Auditor-Employed and
Auditor-Engaged Specialists
The primary standard that applies when auditors use the work of an
auditor-employed specialist in an audit is AS 1201. That standard
establishes requirements regarding the auditor's supervision of the
audit engagement, including supervision of a specialist employed by the
auditor's firm who participates in the audit. While AS 1201 is risk-
based and scalable, it does not specifically address how to apply its
supervisory procedures to promote
[[Page 13449]]
effective coordination between an auditor and a specialist and
evaluation by the auditor of the work of an auditor-employed
specialist.
The primary standard that applies when auditors use the work of an
auditor-engaged specialist in an audit is existing AS 1210. The
requirements in this standard differ from and are less rigorous than
the requirements that apply when using auditor-employed specialists,
even though auditor-employed and auditor-engaged specialists serve
similar roles in helping auditors to obtain and evaluate audit
evidence. For example, existing AS 1210 provides that the auditor
should ``obtain an understanding'' of the nature of the work performed
by an auditor-engaged specialist, including the objectives and scope of
the specialist's work, whereas AS 1201 requires the auditor to review
the work of an auditor-employed specialist to ``evaluate'' whether the
work was performed and documented, the objectives of the procedures
were achieved, and the results of the work support the conclusions
reached.
The PCAOB's observations regarding existing audit practices in this
area also reveal differences in the application of the auditing
standards regarding the use of the work of auditor-employed and
auditor-engaged specialists. For example, in circumstances when audit
firms engage specialists, some firms perform the procedures specified
in existing AS 1210, while other firms perform procedures that are
similar to the procedures for supervising the work of auditor-employed
specialists under AS 1201.
These factors indicate that investor protection can be enhanced by
improving PCAOB standards for applying a risk-based supervisory
approach to auditor-employed specialists, and extending those
requirements to auditor-engaged specialists. This should promote a more
uniform approach to the supervision of an auditor's specialists,
whether employed or engaged, reflecting their similar roles.
Specifically, investor protection can be enhanced by supplementing the
existing supervision requirements under PCAOB standards with more
specific direction on applying those principles when supervising the
work of auditor-employed and auditor-engaged specialists. This
includes, among other things, additional direction on reaching an
understanding with auditor-employed and auditor-engaged specialists on
the work to be performed and on reviewing and evaluating their work.
Comments on the Reasons for Standard Setting
Many commenters on the Proposal broadly expressed support for
revisions to the Board's standards for using the work of specialists or
stated that the Proposal would lead to improvements in audit quality.
For example, some commenters agreed with statements in the Proposal
that the increasing use of specialists, due in part to the increasing
use of fair value measurements in financial reporting frameworks and
increasing complexity of business transactions, warranted strengthening
existing requirements. A number of commenters also indicated that the
requirements for using specialists should be risk-based and more
closely aligned with the Board's risk assessment standards than
existing standards. One of these commenters stated that the Board
should be proactive in addressing issues relating to auditors' use of
the work of specialists through standard setting as an alternative to
devoting additional resources to inspections and enforcement based on
existing standards.
In addition, a number of commenters generally agreed with
developing separate standards for using the work of a company's
specialist, an auditor-employed specialist, and an auditor-engaged
specialist. One commenter noted that separating these requirements
could lead to better application in practice, especially among smaller
CPA firms, while another commenter indicated that providing separate
guidance for using the work of company specialists, auditor-employed
specialists, and auditor-engaged specialists would be an improvement
over existing standards. One commenter stated that inspections of
audits involving the use of specialists had shown a need for
improvement, and that the rationalization and enhancement of existing
requirements would improve the efficiency and quality of audits.
A few commenters on the Proposal questioned the reasons for
revisions to PCAOB auditing standards relating to the use of the work
of specialists.\39\ One commenter stated that the Proposal presented no
clear evidence that audit deficiencies found by the PCAOB relating to
the use of specialists resulted from deficiencies in the auditing
standards. Another commenter stated that inspection findings did not
necessarily warrant revisions to auditing standards and that it
continued to question whether a fundamental change in audit standards
was necessary. A third commenter stated that it did not believe that
the case had been made for having separate standards for the use of
auditor-employed and auditor-engaged specialists. Finally, a fourth
commenter suggested that the Board should develop additional
information on potential costs before proposing or adopting revisions
to existing auditing standards, including through field testing of
potential changes.\40\
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\39\ Some commenters provided comments or expressed concerns
about specific aspects of the proposed revisions to the Board's
existing standards for using the work of specialists. The Board's
consideration of these comments is discussed further below.
\40\ See below for a more detailed discussion of the final
amendments and clarifications of certain aspects of the proposed
amendments, as set forth in the Proposal.
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The SAG has discussed specialist-related issues at a number of
meetings.\41\ Many SAG members expressed support for: (1) Greater
auditor responsibility for evaluating the work performed by a company's
specialists; (2) similar responsibilities when auditors use the work of
auditor-employed specialists and auditor-engaged specialists; and (3)
better communication between auditors and their specialists, whether
employed or engaged. Some SAG members, however, questioned the need for
changes to the existing standards, asserting that auditors may not
always have the necessary level of expertise to evaluate the work of
certain specialists and, as a result, may need to rely on the work of
specialists.
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\41\ See SAG meeting briefing papers and webcast archives (Nov.
29-30, 2017, Nov. 30-Dec. 1, 2016, Nov. 12-13, 2015, June 18, 2015,
Oct. 14-15, 2009, and Feb. 9, 2006), available on the Board's
website.
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In adopting the final amendments, the Board has taken into account
the comments received on the Proposal, as well as its other outreach
activities. The information available to the Board--including the
current regulatory baseline, observations from the Board's oversight
activities, and substantial outreach--suggests that investors would
benefit from strengthened and clarified standards for auditors in this
area. The Board notes that aspects of the required procedures in the
final amendments are similar to current auditing practices by some
larger and smaller audit firms. While the Board does not expect that
the final amendments will eliminate inspection deficiencies observed in
practice, the final amendments are intended to clarify the auditor's
responsibilities and align the requirements for using the work of
specialists more closely with the Board's risk assessment standards.
The final amendments also reflect a number of changes that were made
after the Board's consideration of comments
[[Page 13450]]
received on the Proposal about the potential impact of the proposed
requirements on auditors, issuers, and specialists.\42\
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\42\ See below for a more detailed discussion of changes
reflected in the final amendments and section D for a more detailed
discussion of economic considerations related to the adoption of the
final amendments.
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Overview of Final Rules
The final amendments: (1) Add an appendix to AS 1105 with
supplemental requirements for using the work of a company's specialist
as audit evidence; (2) add an appendix to AS 1201 with supplemental
requirements for supervising an auditor-employed specialist; and (3)
replace existing AS 1210 with an updated standard for using the work of
an auditor-engaged specialist. The key aspects of these amendments,
which are intended to enhance the requirements in existing standards
for using the work of a company's specialist, an auditor-employed
specialist, and an auditor-engaged specialist, are discussed in this
section. The ways in which the final amendments address the need for
change from an economic perspective are discussed in section D.
The final amendments have been informed by the Board's outreach
activities. They are aligned with the Board's risk assessment
standards, so that the necessary audit effort is commensurate with,
among other things, the significance of the specialist's work to the
auditor's conclusion regarding the relevant assertion and the
associated risk. Many commenters on the Proposal supported aligning any
new standards on using the work of specialists with any new standards
related to auditing accounting estimates, including fair value
measurements. The final amendments are aligned with the Estimates
Release.
Figure 3 summarizes the auditor's responsibilities and primary
PCAOB standards for using the work of specialists applicable before and
after the effective date of the final amendments.
[GRAPHIC] [TIFF OMITTED] TN04AP3.003
In brief, the final amendments make the following changes to PCAOB
auditing standards:
Amend AS 1105.
Add a new Appendix A \43\ that supplements the
requirements in AS 1105 for circumstances when the auditor uses the
work of the company's specialist as audit evidence, related to:
---------------------------------------------------------------------------
\43\ As proposed, these requirements would have been set forth
as Appendix B to AS 1105.
---------------------------------------------------------------------------
Obtaining an understanding of the work and report(s), or
equivalent communication, of the company's specialist(s) and related
company processes and controls; \44\
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\44\ See AS 1105.A2, as adopted. Additionally, as amended, AS
2110, Identifying and Assessing Risks of Material Misstatement, sets
forth requirements for understanding company processes and controls
related to the use of specialists.
---------------------------------------------------------------------------
Obtaining an understanding of and assessing the knowledge,
skill, and ability of a company's specialist and the entity that
employs the specialist (if other than the company) and the relationship
to the company of the specialist and the entity that employs the
specialist (if other than the company); and
Performing procedures to evaluate the work of a company's
specialist, including evaluating: (i) The data, significant
assumptions, and methods (which may include models) used by the
specialist,\45\ and (ii) the relevance and reliability of the
specialist's work and its relationship to the relevant assertion;
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\45\ This evaluation is not explicitly required under the
Board's existing standards, other than under AS 2502 with respect to
the significant assumptions of a company's specialist regarding fair
value measurements and disclosures.
---------------------------------------------------------------------------
Align the requirements for using the work of a company's
specialist with the risk assessment standards and the
[[Page 13451]]
standard and related amendments adopted by the Board on auditing
accounting estimates, including fair value measurements; \46\ and
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\46\ Certain provisions of the final amendments include
references to a new auditing standard AS 2501, Auditing Accounting
Estimates, Including Fair Value Measurements (``AS 2501, as
adopted''), which has been adopted by the Board in a separate
release. See Estimates Release, supra note 20.
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Set forth factors for determining the necessary evidence
to support the auditor's conclusion regarding a relevant assertion when
using the work of a company's specialist.
Amend AS 1201.
Add a new Appendix C that supplements the requirements for
applying the supervisory principles in AS 1201.05-.06 when using the
work of an auditor-employed specialist to assist the auditor in
obtaining or evaluating audit evidence, including requirements related
to:
Informing the auditor-employed specialist of the work to
be performed;
Coordinating the work of the auditor-employed specialists
with the work of other engagement team members; and
Reviewing and evaluating whether the work of the auditor-
employed specialist provides sufficient appropriate evidence.
Evaluating the work of the specialist includes evaluating whether the
work is in accordance with the auditor's understanding with the
specialist and whether the specialist's findings and conclusions are
consistent with, among other things, the work performed by the
specialist.
Set forth factors for determining the necessary extent of
supervision of the work of the auditor-employed specialist.
Replace existing AS 1210.
Replace with AS 1210, as amended, Using the Work of an
Auditor-Engaged Specialist, which establishes requirements for using
the work of an auditor-engaged specialist to assist the auditor in
obtaining or evaluating audit evidence;
Include requirements for reaching an understanding with an
auditor-engaged specialist on the work to be performed and reviewing
and evaluating the specialist's work that parallel the final amendments
to AS 1201 for auditor-employed specialists;
Set forth factors for determining the necessary extent of
review of the work of the auditor-engaged specialist;
Amend requirements related to assessing the knowledge,
skill, ability, and objectivity \47\ of the auditor-engaged specialist;
and
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\47\ Under the final amendments, the term ``objectivity'' is
reserved for the auditor-engaged specialist and not used to describe
the relationship to the company of a company's specialist or an
auditor-employed specialist. See below for further discussion of
objectivity.
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Describe objectivity, for purposes of the standard, as the
auditor-engaged specialist's ability to exercise impartial judgment on
all issues encompassed by the specialist's work related to the audit;
and specify the auditor's obligations when the specialist or the entity
that employs the specialist has a relationship with the company that
affects the specialist's objectivity.
The Board has also adopted a single standard to replace its
existing standards on auditing accounting estimates and fair value
measurements and set forth a uniform, risk-based approach designed to
strengthen and enhance the requirements for auditing accounting
estimates.\48\ Certain provisions of the final amendments in this
notice include references to AS 2501, as adopted.
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\48\ As discussed in the Estimates Release, supra note 20, the
Board is retitling and replacing existing AS 2501, Auditing
Accounting Estimates, and superseding AS 2502 and AS 2503, Auditing
Derivative Instruments, Hedging Activities, and Investments in
Securities. AS 2501, as adopted, also includes a special topics
appendix that addresses certain matters relevant to auditing the
fair value of financial instruments, including the use of pricing
information from third parties as audit evidence.
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Most of those who commented on the proposed requirements regarding
the use of the company's specialist expressed support for strengthening
the requirements for evaluating the work of a company's specialist and
aligning them with the Board's risk assessment standards. For example,
one commenter stated that it agreed with statements in the Proposal
that the proposed requirements may result in some auditors gaining a
better understanding of a company's critical accounting estimates
related to relevant financial statements and disclosures. Another
commenter stated that the application of a risk-based approach to the
testing and evaluation of the work of a company's specialist would
reduce the risk of an auditor failing to sufficiently address the risks
of material misstatement.
A few commenters disagreed with the approach, or aspects of the
approach, for evaluating the work of a company's specialist as
described in the Proposal. One commenter asserted that additional
clarification for using the work of a company's specialist was needed
to address practicability issues and avoid unnecessary costs. Another
commenter suggested that the amendments should place greater weight on
the professional requirements and certifications for certain company
specialists.
The Board recognizes that the auditor does not have the same
expertise as a person trained or qualified to engage in the practice of
another profession. At the same time, establishing a uniform, risk-
based approach for using the work of a company's specialist more
clearly acknowledges the different roles of a company's specialist and
an auditor's specialist and builds upon improvements observed in the
practices of certain firms. The final amendments also clarify aspects
of the proposed amendments, including the procedures for evaluating the
work of a company's specialist, so that the required procedures are
both practical and risk-based, and reasonably designed to lead to
improvements in audit quality.\49\
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\49\ See below for a more detailed discussion of the final
amendments and clarifications regarding using the work of a
company's specialist.
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Commenters on the proposed requirements for using an auditor's
specialist generally agreed with a risk-based supervisory approach for
both auditor-employed and auditor-engaged specialists. For example, one
commenter agreed that this approach would promote an improved, more
uniform approach to the supervision of an auditor's specialists.
Consistent with the view of these commenters, the final amendments
apply a risk-based supervisory approach to both auditor-employed and
auditor-engaged specialists, which should enhance investor protection.
The subsections that follow discuss in more detail the final
amendments. The subsections also include a comparison of the final
requirements with the analogous requirements of the following standards
issued by the IAASB and the Auditing Standards Board (``ASB'') of the
American Institute of Certified Public Accountants:
IAASB Standards
International Standard on Auditing 500, Audit Evidence
(``ISA 500''); and
International Standard on Auditing 620, Using the Work of
an Auditor's Expert (``ISA 620'').
ASB Standards
AU-C Section 500, Audit Evidence (``AU-C Section 500'');
and
AU-C Section 620, Using the Work of an Auditor's
Specialist (``AU-C Section 620'').
The comparison included in these subsections may not represent the
views of the IAASB or ASB regarding the interpretation of their
standards. The information presented in the subsections does not cover
the application and explanatory material in
[[Page 13452]]
the IAASB standards or ASB standards.\50\
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\50\ Paragraph A59 of ISA 200, Overall Objectives of the
Independent Auditor and the Conduct of an Audit in Accordance with
International Standards on Auditing, indicates that the application
and other explanatory material section of the ISAs ``does not in
itself impose a requirement'' but ``is relevant to the proper
application of the requirements of an ISA.'' Paragraph .A64 of AU-C
Section 200, Overall Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with Generally Accepted Auditing
Standards, states that, although application and other explanatory
material ``does not in itself impose a requirement, it is relevant
to the proper application of the requirements of an AU-C section.''
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Scope of Final Amendments
The final amendments apply when an auditor uses the work of a
``specialist.'' Thus, the scope of the requirements hinges largely on
the meaning of the term ``specialist.'' As described in the Proposal,
the Board sought to carry forward the meaning of the term
``specialist'' from existing AS 1210, that is, a specialist is a person
(or firm) possessing special skill or knowledge in a particular field
other than accounting or auditing. The Board also sought to carry
forward the concept from existing AS 1210 that income taxes and IT are
specialized areas of accounting and auditing and thus are outside the
scope of the final amendments.\51\ As discussed below, the final
amendments retain, as proposed, the meaning of the term ``specialist,''
including the concept regarding income taxes and IT.
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\51\ See footnote 1 of existing AS 1210.
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Some commenters on the Proposal agreed with retaining the existing
meaning of the term ``specialist.'' Other commenters suggested that the
Board extend the scope of the Proposal to include persons with
specialized skill or knowledge in certain areas of income taxes and IT
(e.g., unusual or complex tax matters, artificial intelligence, and
blockchain). One of these commenters also asserted that income tax and
IT professionals often support both audit and consulting practices and,
as a practical matter, are treated as specialists by auditors. One
commenter requested guidance for applying the proposed requirements
when a legal specialist is involved, while another commenter suggested
that the Board explain in the final amendments that an individual who
specializes in complex taxation law would be a legal specialist.
One commenter suggested eliminating the distinction between
expertise ``inside'' or ``outside'' the field of accounting and
auditing with respect to an auditor's specialist because, in its view,
determining when fields of expertise are outside of accounting and
auditing is becoming more difficult. Another commenter stated that, in
practice, it can be less than straightforward to differentiate between
expertise in auditing and accounting and other areas. Other commenters,
however, asserted that the Board should retain the concept in existing
AS 1210 that an auditor is not expected to have the expertise of a
person trained or qualified to engage in the practice of another
profession or occupation.
As used today, the term ``specialist'' is generally understood by
auditors, and observations from PCAOB oversight activities do not
indicate that there is significant confusion over the meaning of the
terms ``specialist'' and ``specialized area of accounting and
auditing,'' as they have been used in the standards. After considering
the comments received on the Proposal, however, the final amendments
retain the meaning of the term ``specialist'' as proposed, with certain
clarifications discussed below.
Specifically, the Board included a note to clarify when the final
amendments apply to the work of an attorney used by the company.\52\ As
under existing AS 1210, specialists under the final amendments include
attorneys engaged by a company as specialists, such as attorneys
engaged by the company to interpret contractual terms or provide a
legal opinion. The final amendments apply when an auditor uses the work
of a company's attorney as audit evidence in other matters relating to
legal expertise, such as when a legal interpretation of a contractual
provision or a legal opinion regarding isolation of transferred
financial assets is necessary to determine appropriate accounting or
disclosure under the applicable financial reporting framework. The
final amendments also clarify that the scope of these amendments does
not apply to information provided by a company's attorney concerning
litigation, claims, or assessments that is used by the auditor pursuant
to AS 2505, Inquiry of a Client's Lawyer Concerning Litigation, Claims,
and Assessments.
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\52\ See second note to AS 1105.A1, as adopted.
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Consistent with existing AS 1210, income taxes and IT are outside
the scope of the final amendments because they are specialized areas of
accounting and auditing. For example, while specialized areas of income
tax law involve legal specialists, accounting for income taxes remains
an area of accounting and auditing. The Board added a footnote to
Appendix A of AS 1105 that references AS 2505.08, as amended.\53\ A
note to AS 2505.08, as amended, clarifies the auditor's responsibility
regarding the use of the written advice or opinion of a company's tax
advisor or a company's tax legal counsel as audit evidence.\54\ Also,
to the extent that IT is used in information systems, auditors will
still need to maintain sufficient technical knowledge to identify and
assess risks and design procedures to respond to those risks and
evaluate the audit evidence obtained. Accordingly, the Board does not
believe that the need exists at this time to change the approach
reflected in existing AS 1210 and designate particular areas of either
income taxes or IT as outside the field of ``accounting and auditing.''
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\53\ See footnote 1 to AS 1105.A1, as adopted.
\54\ See note to AS 2505.08, as amended.
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Comparison With Standards of Other Standard Setters
ISA 620 uses the terms ``auditor's expert'' and ``management's
expert'' in a manner analogous to the term ``specialist'' in the final
amendments. ISA 620, however, does not address whether IT is a
specialized field outside of accounting and auditing. The term
``management's expert'' is also defined in ISA 500.
AU-C Section 620 and AU-C Section 500 use the word ``specialist''
instead of ``expert.''
Amendments Related to Using the Work of a Company's Specialist
The final amendments set forth requirements for using the work of a
company's specialist as audit evidence. The amendments, which
supplement the existing requirements of AS 1105, include:
Obtaining an understanding of the work and report(s), or
equivalent communication, of the company's specialist(s) and related
company processes and controls;
Obtaining an understanding of and assessing the knowledge,
skill, and ability of the specialist and the entity that employs the
specialist (if other than the company), and the relationship to the
company of the specialist and the entity that employs the specialist
(if other than the company); and
Performing procedures to evaluate the work of a company's
specialist, including evaluating: (1) The data, significant
assumptions, and methods (which may include models) used by the
specialist; and (2) the relevance and reliability of the specialist's
work and its relationship to the relevant assertion.\55\
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\55\ Key principles from Auditing Interpretation AI 11, Using
the Work of a Specialist: Auditing Interpretations of AS 1210, and
Auditing Interpretation AI 28, Evidential Matter Relating to Income
Tax Accruals: Auditing Interpretations, related to the auditor's use
of the work of a company's attorney and the use of written tax
advice or opinions as audit evidence have been incorporated in AS
1105.A1, as adopted, and a note added to AS 2505.08, as amended.
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[[Page 13453]]
Commenters on the Proposal generally supported a risk-based
approach for using the work of a company's specialist, as set forth in
the proposed amendments. Many commenters also stated that there was a
need to establish a separate standard for using the work of a company's
specialist. However, a number of commenters questioned various aspects
of the amendments, including the need for revisions to existing AS 1210
relating to the use of the work of a company's specialist.
Additionally, some commenters requested clarifications or suggested
changes to the proposed requirements. These and other comments are
discussed below. A number of these comments resulted in revisions and
clarifications to the final amendments.
Obtaining an Understanding of the Work of the Company's Specialist
See AS 1105.A2, as Adopted, and AS 2110.28A, as Adopted
The proposed amendments to AS 1105 provided that obtaining an
understanding of the company's information system relevant to financial
reporting would encompass obtaining an understanding of the work and
report(s) of the company's specialist(s) and related company processes
and controls.\56\
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\56\ See proposed AS 1105.B2.
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Some commenters supported the proposed requirement because, in
their view, an understanding of the company's processes for using the
work of company specialists is integral to the auditor's understanding
of the information system relevant to financial reporting. Two
commenters asserted that such controls are important for the auditor to
consider when evaluating the work of a company's specialist and
determining the necessary audit procedures. One commenter expressed
concern that the proposed requirement was too broad and suggested that
the auditor's understanding should instead be part of the evaluation of
the specialist's objectivity. In addition, two commenters questioned
whether the Board intended to require the auditor to evaluate the
design of controls over the use of company specialists, even if the
auditor was not performing an audit of internal control over financial
reporting or planning to rely on controls for the related assertions.
These commenters and others suggested that placing the proposed
requirement for obtaining an understanding of the specialist's work in
AS 2110 would better link the requirement to the auditor's risk
assessment procedures, thereby reducing the likelihood that auditors
would consider only the factors in proposed AS 1105.B2 and fail to
consider other relevant factors set forth in AS 2110.
The Board considered these comments and is adopting the requirement
substantially as proposed, but relocating the requirement to AS 2110 as
suggested by certain commenters.\57\ The procedure builds upon a
requirement in existing AS 1210 that the auditor obtain an
understanding of the nature of the work performed or to be performed by
a specialist,\58\ but is more closely aligned with the required risk
assessment procedures in AS 2110. The required procedure is important
because it informs the auditor's evaluation of the work of the
company's specialist, and not merely the assessment of the specialist's
objectivity.
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\57\ Specifically, the requirements are located in AS 2110.28A,
as adopted.
\58\ See existing AS 1210.09.
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Placing the requirement for obtaining an understanding of the
specialist's work and report(s), or equivalent communication, in AS
2110, and framing the required procedure as a risk assessment
procedure, provides better direction regarding the necessary audit
effort for the procedure. The necessary audit effort for performing
this procedure is governed primarily by the general requirements in AS
2110 for obtaining a sufficient understanding of the company's internal
control over financial reporting.\59\ This includes consideration of
whether the auditor plans to use the specialist's work as audit
evidence.
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\59\ See AS 2110.18, which provides that the auditor should
obtain a sufficient understanding of each component of internal
control over financial reporting to: (1) Identify the types of
potential misstatements, (2) assess the factors that affect the
risks of material misstatement, and (3) design further audit
procedures. See also AS 2110.19, which further provides that the
nature, timing, and extent of procedures that are necessary to
obtain an understanding of internal control depend on the size and
complexity of the company; the auditor's existing knowledge of the
company's internal control over financial reporting; the nature of
the company's controls, including the company's use of IT; the
nature and extent of changes in systems and operations; and the
nature of the company's documentation of its internal control over
financial reporting. In addition, AS 2110.20 provides that obtaining
an understanding of internal control includes evaluating the design
of controls that are relevant to the audit and determining whether
the controls have been implemented.
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While the requirement, as adopted, likely will not represent a
major change in practice, particularly for those firms whose practices
already go beyond existing PCAOB standards, it should prompt auditors
to appropriately consider the interaction of the specialist's work and
the company's related processes and controls. For example, under the
final amendments, the auditor should obtain an understanding of
controls for using the work of specialists that are relevant to the
audit, including evaluating the design of those controls and
determining whether those controls have been implemented.\60\
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\60\ AS 2110.34 provides additional direction for determining
controls relevant to the audit.
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Comparison With Standards of Other Standard Setters
The requirements in ISA 500 and AU-C 500 have some commonality with
the requirements in the final amendments. Paragraph 8(b) of ISA 500
states that, if information to be used as audit evidence has been
prepared using the work of a management's expert, the auditor shall, to
the extent necessary and having regard to the significance of that
expert's work for the auditor's purposes, obtain an understanding of
the work of that expert.
AU-C Section 500 contains requirements that are similar to those in
ISA 500.
Assessing the Knowledge, Skill, and Ability of the Company's Specialist
and the Specialist's Relationship to the Company
See AS 1105.A3-.A5, as Adopted
The final amendments set forth requirements similar to existing AS
1210 for evaluating the knowledge, skill, and ability of the specialist
and the relationship of the specialist to the company.\61\
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\61\ Existing AS 1210.08 and AS 1210.10-.11 require the auditor
to evaluate the professional qualifications of a specialist and the
relationship of a specialist to the company.
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Knowledge, Skill, and Ability
The Proposal set forth a requirement similar to that in existing AS
1210 for evaluating the professional qualifications of the specialist
and generally provided the same factors for the auditor's assessment of
the specialist's knowledge, skill, and ability.\62\
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\62\ Existing AS 1210.08 provides that the auditor should
consider certain information in evaluating the professional
qualifications of the specialist to determine that the specialist
possesses the necessary skill or knowledge in the particular field.
The information to be considered in that evaluation is: (1) The
professional certification, license, or other recognition of the
competence of the specialist in his or her field, as appropriate;
(2) the reputation and standing of the specialist in the views of
peers and others familiar with the specialist's capability or
performance; and (3) the specialist's experience in the type of work
under consideration.
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[[Page 13454]]
The Proposal differed from existing AS 1210, however, in certain
respects. First, the Proposal extended the required understanding to
expressly include the entity that employs the specialist, if the
specialist is not employed by the company. Second, the Proposal
expressly referred to the specialist's ``level'' of knowledge, skill,
and ability. As with the auditor's assessment of competence under AS
2605, Consideration of the Internal Audit Function, this approach
recognized that specialists may possess varying degrees of knowledge,
skill, and ability. Third, the Proposal provided that the necessary
evidence to assess the level of knowledge, skill, and ability of the
company's specialist would depend on (1) the significance of the
specialist's work to the auditor's conclusion regarding the relevant
assertion and (2) the risk of material misstatement of the relevant
assertion. Under this approach, the persuasiveness of the evidence the
auditor would need to obtain increases as the significance of the
specialist's work to the auditor's conclusion or the risk of material
misstatement of the relevant assertion increases.\63\
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\63\ Illustrative examples on the application of these factors
when testing and evaluating the work of a company's specialist
appear in the discussion on determining the necessary audit effort
under AS 1105.A7, as provided below.
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The Board is adopting the requirement for evaluating the
professional qualifications of the specialist as proposed. Most
commenters on this aspect of the Proposal acknowledged the need for the
auditor to obtain an understanding of and assess the knowledge, skill,
and ability of a company's specialist. One commenter asserted that the
proposed requirement was not well-suited to assessing the
qualifications of the entity that employs the specialist. The Board
considered this comment and notes that the final requirement retains
the concept in existing AS 1210 that a specialist may be an individual
or an entity. Accordingly, auditors should be familiar with assessing
the qualifications of entities that are specialists or employ
specialists. Furthermore, a strong reputation and standing of the
specialist's employer in the specialized field can be a signal that the
employer maintains qualified staff. On the other hand, an employer with
a poor reputation or little expertise in the specialized field can
indicate that more scrutiny of the qualifications of the individual
specialist is warranted.
Some commenters asked for more direction on how to obtain an
understanding of the professional qualifications of the company's
specialist and the entity that employs the specialist (for example, by
including in the rule text the discussion from the proposing release of
potential sources of information about a specialist's qualifications).
One of these commenters asserted that there are practical limits on
obtaining evidence related to a company-engaged specialist's
competence.
The Board considered these comments, but notes that the final
requirement is similar to a requirement in existing AS 1210. Outreach
to audit firms suggests that firms have policies and procedures for
evaluating the qualifications of specialists, whether individuals or
entities. Auditors should therefore be familiar with the process of
assessing the knowledge, skill, and ability of entities that employ
specialists.
As with existing AS 1210, the final amendments do not set forth
specific steps to perform in assessing the specialist's knowledge,
skill, and ability. It is not practicable to provide detailed direction
in this area because of the variety of types of specialists that may be
encountered. Examples of potential sources of information that, if
available, could be relevant to the auditor's evaluation include:
Information contained within the audit firm related to the
professional qualifications and reputation of the specialist or the
entity that employs the specialist (if other than the company) in the
relevant field and experience with previous work of the specialist;
Professional or industry associations and organizations,
which may provide information regarding: (1) Qualification
requirements, technical performance standards, and continuing
professional education requirements that govern their members; (2) the
specialist's education and experience, certification, and license to
practice; and (3) recognition of, or disciplinary actions taken
against, the specialist;
Discussions with the specialist, through the company,
about matters such as the specialist's understanding of the financial
reporting framework, the specialist's experience in performing similar
work, and the methods and assumptions used in the specialist's work the
auditor plans to evaluate;
Information obtained as part of audit planning, when
obtaining an understanding of the company's processes and identifying
controls for testing;
Information included in the specialist's report about the
specialist's professional qualifications (e.g., a biography or resume);
Responses to questionnaires provided to the specialist
regarding the specialist's professional credentials; and
Published books or papers written by the specialist.
Requirements applicable to a specialist pursuant to legislation or
regulation also could help inform the auditor's assessment of the
specialist's knowledge, skill, and ability.
Some of the examples listed above may provide more persuasive
evidence than others.\64\ For example, relevant information from a
source not affiliated with the company or specialist, the auditor's
experience with previous work of the specialist, or multiple sources
generally would provide more persuasive evidence than evidence from the
specialist's uncorroborated representations about his or her
professional credentials. Additionally, the reliability (and thus
persuasiveness) of information about the specialist's credentials and
experience increases when the company has effective controls over that
information, e.g., in conjunction with controls over the selection of
qualified specialists.
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\64\ As previously discussed, the risk of material misstatement
of the relevant assertion and the significance of the specialist's
work to the auditor's conclusion regarding the relevant assertion
affect the persuasiveness of the evidence needed with respect to the
knowledge, skill, and ability of the company's specialist.
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Some commenters asked for clarification as to how the company's
controls and processes for using the work of a company's specialist
should be considered when performing the assessment of knowledge,
skill, and ability. As discussed earlier, the interaction of the
specialist's work and the company's processes should be considered by
the auditor in assessing and responding to risk in the related accounts
and disclosures, especially when the specialist's work is significant
to the auditor's conclusion regarding the relevant assertion and the
accounts or disclosures have higher risk. Therefore, the company's
controls and processes are considered in identifying and appropriately
assessing the risks of material misstatement of the relevant assertion,
which is one of the two factors that the auditor considers under AS
1105.A5, as adopted, in determining the necessary evidence for
assessing the specialist's level of knowledge, skill, and ability.
[[Page 13455]]
Relationship to the Company
The Proposal provided that the auditor would assess the
relationship to the company of the specialist and the entity that
employs the specialist (if other than the company)--specifically,
whether circumstances exist that give the company the ability to
significantly affect the specialist's judgments about the work
performed, conclusions, or findings (e.g., through employment,
financial, ownership, or other business relationships, contractual
rights, family relationships, or otherwise). The proposed requirement
was similar to existing AS 1210.10, but expanded the list of matters
that the auditor should consider to include financial and business
relationships with the company.
The Board is adopting this requirement substantially as proposed,
with the addition of a note that sets forth examples of potential
sources of information that could be relevant to the auditor's
assessment.
Some commenters supported the proposed requirement for the auditor
to assess the specialist's relationship to the company and stated that
it was appropriate. Two commenters, however, asserted that there could
be practical challenges to assessing the relationship to the company of
the entity that employs the specialist (e.g., if the entity that
employs the specialist lacks systems to track such relationships or the
auditor does not have access to those systems). The Board considered
these comments, but notes that existing AS 1210 already requires an
evaluation of the relationship of the specialist, whether an individual
or an entity, to the client. Outreach to audit firms suggests that
firms have policies and procedures for evaluating the objectivity of
specialists, whether individuals or entities. Therefore, auditors
should be familiar with assessing the qualifications of entities that
are specialists or employ specialists.
Other commenters asked for additional direction regarding the
necessary effort to obtain information regarding the specialist's
relationship to the company. One commenter also emphasized the
importance of considering ethical and performance requirements
promulgated by a specialist's profession or by legislation or
regulation governing the specialist. The final amendments do not
prescribe specific steps to perform in assessing the specialist's
relationship to the company, because additional specificity would make
the requirements unnecessarily prescriptive. The Board has added a note
to the final requirement, however, that includes non-exclusive examples
of potential sources of information that could be relevant to the
auditor's assessment of the relationship to the company of both the
specialist and the specialist's employer (if other than the
company).\65\ These examples include disclosures by the specialist
about relationships with the company in the specialist's report, or
equivalent communication, pursuant to requirements promulgated by the
specialist's profession or by legislation governing the specialist.\66\
As with the auditor's assessment of a specialist's knowledge, skill,
and ability, certain sources of information may provide more persuasive
evidence than others. In situations where more persuasive evidence is
required under these requirements, it may be appropriate to perform
procedures to obtain evidence from multiple sources.
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\65\ See note to AS 1105.A4, as adopted. These examples were
based on examples set forth in the Proposal, but have been refined
to better reflect their application in practice.
\66\ While the Proposal had suggested that information regarding
such requirements could be relevant to the auditor's evaluation of
the specialist's relationships to the company, disclosures about
relationships pursuant to such requirements are more relevant to the
auditor's assessment than merely information about the legal or
professional requirements.
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Some commenters also expressed a preference for retaining the term
``objectivity'' with respect to a company's specialist and further
acknowledging that objectivity may exist along a spectrum. Similar to
the Proposal, the final amendments reserve the term ``objectivity'' for
specialists engaged by the auditor to assist in obtaining and
evaluating audit evidence. The work of a company's specialist is
different in nature from the work of an auditor's specialist, since a
company's specialist performs work that the company frequently uses as
source material for one or more financial statement accounts or
disclosures, including accounting estimates. With respect to the
existence of objectivity along a spectrum, the final amendments
recognize that a company's ability to significantly affect a
specialist's judgment may vary and, as discussed below, provide a
spectrum for evaluating the company's ability to significantly affect
the specialist's judgments.
As was proposed, the final amendments provide that, if the auditor
identifies relationships between the company and the specialist (or the
specialist's employer, if other than the company), the auditor has a
responsibility to assess whether the company has the ability to
significantly affect the specialist's judgments about the work
performed, conclusions, or findings.\67\ Examples of the types of
circumstances that might give the company the ability to affect the
specialist's judgments include, but are not limited to:
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\67\ See AS 1105.A4, as adopted.
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The reporting relationship of a company-employed
specialist within the company;
Compensation of a company's specialist based, in part, on
the outcome of the work performed;
Relationships a company-engaged specialist has with
entities acting as an agent of the company;
Personal relationships, including family relationships,
between the company's specialist and others within company management;
Financial interests, including stock holdings, company
specialists have in the company; and
Ownership, business relationships, or other financial
interests the employer of a company-engaged specialist has with respect
to the company.
The auditor's assessment that the company has the ability to
influence the specialist, however, does not preclude the auditor from
using the work of a company's specialist, whether employed or engaged,
as audit evidence. Rather, consistent with existing AS 1210, it is a
factor in determining the necessary audit effort to evaluate that
specialist's work.\68\ In general, the necessary audit effort increases
as the company's ability to affect the specialist's judgments
increases.
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\68\ See AS 1105.A7-.A10, as adopted. Examples that illustrate
how relationships between the company and the company's specialist
can affect the necessary audit effort in evaluating the work of a
company's specialist under the final amendments appear in the
discussion on determining the necessary evidence, as provided below.
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Determining the Necessary Evidence
The Proposal differed from existing AS 1210 in that it set forth
scalable requirements for determining the necessary evidence for
evaluating both the knowledge, skill, and ability of the specialist and
the relationship of the specialist to the company. The Board is
adopting these requirements as proposed. Under the final amendments,
the necessary evidence to assess the level of knowledge, skill, and
ability of the company's specialist and the specialist's relationship
to the company depends on (1) the significance of the specialist's work
to the auditor's conclusion regarding the relevant assertion and (2)
the risk of material misstatement of the relevant assertion. As the
significance of the specialist's
[[Page 13456]]
work and risk of material misstatement increases, the persuasiveness of
the evidence the auditor should obtain for those assessments also
increases.\69\
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\69\ See AS 1105.A5, as adopted.
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No commenters opposed the proposed framework for determining the
necessary evidence. A number of commenters, however, asked for
clarification on the application of the requirement when performing the
relevant evaluations. The Board's analysis of these comments is
discussed above in connection with the required evaluations of the
specialist's knowledge, skill, and ability, and the relationship of the
specialist to the company.
Comparison With Standards of Other Standard Setters
Paragraph 8(a) of ISA 500 provides that, if information to be used
as audit evidence has been prepared using the work of a management's
expert, the auditor shall, to the extent necessary and having regard to
the significance of that expert's work for the auditor's purposes,
evaluate the competence, capabilities, and objectivity of that expert.
AU-C Section 500 contains requirements that are similar to those in
ISA 500.
Evaluating the Work of the Company's Specialist
See AS 1105.A6-.A10, as Adopted
In general, a specialist's work involves using data, assumptions,
and methods. The auditor's responsibilities under existing AS 1210 with
respect to the data, assumptions, and methods used by the specialist
are limited to (a) obtaining an understanding of the methods and
assumptions used by the specialist and (b) making appropriate tests of
data provided to the specialist.\70\ In addition, the auditor should
evaluate whether the specialist's findings support the related
assertions in the financial statements.\71\ Ordinarily, the auditor
would use the work of the specialist unless the auditor's procedures
lead the auditor to believe the findings are unreasonable in the
circumstances.\72\ If the auditor believes the specialist's findings
are unreasonable, he or she is required to apply additional procedures,
which may include potentially obtaining the opinion of another
specialist.\73\ Notably, before the final amendments, PCAOB standards
have not expressly addressed how to determine the necessary audit
effort to be applied in performing those procedures.
---------------------------------------------------------------------------
\70\ For fair value measurements, however, another standard
requires the auditor to evaluate the reasonableness of significant
assumptions of the specialist. See footnote 2 of AS 2502. This
standard is being superseded in the Estimates Release, supra note
20.
\71\ See existing AS 1210.12.
\72\ Id.
\73\ Id.
---------------------------------------------------------------------------
The Proposal sought to enhance the requirements for testing and
evaluating the work of the company's specialist by:
Extending the auditor's responsibilities for evaluating
the specialist's assumptions to include all significant assumptions
used by the specialist (not just those used in fair value
measurements);
Expanding the auditor's responsibilities with respect to
data to include evaluating external data used by the specialist (not
just data provided by the company to the specialist);
Adding a requirement for the auditor to evaluate the
appropriateness of the methods used by the specialist, including
whether the data was appropriately applied;
Setting forth a requirement for the auditor to comply with
the Board's proposed estimates standard \74\ when the auditor tests
management's process for developing an estimate and a company's
specialist was used; and
---------------------------------------------------------------------------
\74\ See Proposed Auditing Standard--Auditing Accounting
Estimates, Including Fair Value Measurements and Proposed Amendments
to PCAOB Auditing Standards, PCAOB Release No. 2017-002 (June 1,
2017).
---------------------------------------------------------------------------
Providing direction for determining the necessary audit
effort for testing and evaluating the specialist's work, based on the
risk of material misstatement and other factors set forth in the
standard.
Commenters expressed mixed views on the premise underlying the
Proposal that the auditor should test and evaluate the work of a
company's specialist. While a number of commenters supported that
premise, other commenters opposed expanding the auditor's
responsibilities with respect to the specialist's methods and
assumptions beyond existing AS 1210. Some of these commenters expressed
concerns that the auditor may not be qualified to evaluate the work of
a specialist and recommended retaining the more limited audit approach
reflected in existing AS 1210, including the statement that ``the
auditor is not expected to have the expertise of a person trained for
or qualified to engage in practice of another profession or
occupation.''
A number of commenters also addressed specific aspects of the
proposed requirements for testing and evaluating the work of company
specialists. Some commenters questioned the proposal's general use of
the term ``test'' in describing the auditor's responsibilities, as well
as the proposed requirement to also comply with the proposed estimates
standard in circumstances where the auditor tests management's process
for developing an estimate and a company's specialist was also used.
Those commenters asserted that the expected audit effort was unclear.
Two commenters stated that the proposed requirements in this area could
be interpreted as requiring reperformance of the specialist's work,
which one of these commenters asserted would be beyond the expertise of
most auditors and thus require auditors to use an auditor's specialist.
In addition, some commenters requested clarification on the
expectations for evaluating a specialist's models, especially in
situations where auditors are unable to gain access to proprietary
models used by company-engaged specialists. Some commenters also
expressed concern about the proposed requirement to evaluate whether
data was appropriately used by the specialist. Some of these commenters
asserted that this requirement appeared to require auditors to
reperform the specialist's work and suggested clarifying or eliminating
that requirement. Additionally, some commenters suggested allowing
auditors to rely on the issuer's controls over the use of specialists
in determining the necessary procedures for evaluating the specialist's
work.
A number of commenters acknowledged that the proposed requirements
were intended to be scalable. However, some commenters questioned
whether they would be scalable in practice. Other commenters asked for
guidance on tailoring audit procedures based on risk and the other
factors set forth in the Proposal, especially procedures under the
proposed requirement to also comply with the proposed estimates
standard. Also, some commenters asserted that the requirements did not
adequately distinguish the audit effort based on whether the specialist
was engaged or employed by the company.
After considering the comments on the Proposal, the Board is
retaining the fundamental approach in the Proposal--under which the
auditor evaluates the data, significant assumptions, and methods used
by the specialist. This approach is intended to increase audit
attention on the work of a company's specialist, particularly when that
work is significant in areas of higher risk, to increase the likelihood
that the auditor would detect material financial
[[Page 13457]]
statement misstatements related to that work.
Taking into account comments on specific aspects of the proposed
requirements, however, the final amendments reflect a number of
clarifying revisions to eliminate or revise certain proposed
requirements that may have been perceived by commenters as
unnecessarily complex or prescriptive. The revisions address concerns
expressed by certain commenters, while preserving the intended benefits
of the final amendments, and include:
Removing the word ``test'' from the requirements to
evaluate the work of the company's specialist, except in relation to
company-produced data; and
Reframing the requirements for evaluating the data,
significant assumptions, and methods used by the specialist to describe
the key considerations in making those evaluations.
In addition, the final amendments clarify the applicability of the
requirements in circumstances when the company's specialist is involved
in developing an accounting estimate, such as developing assumptions
and methods used in an accounting estimate. In such circumstances, the
requirements in Appendix A of AS 1105 apply to evaluating the data,
significant assumptions,\75\ and methods developed (or generated) by
the specialist, or sourced by the specialist from outside the company,
as well as to testing company-produced data. In contrast, for
significant assumptions provided by management to the specialist, the
auditor is required to look to the requirements in AS 2501, as adopted.
The final amendments are discussed in more detail below.
---------------------------------------------------------------------------
\75\ A footnote to AS 1105.A8, as adopted, refers the auditor to
AS 2501.15, as adopted, for the procedures to perform when
identifying significant assumptions. For purposes of identifying
significant assumptions, the company's assumptions include
assumptions developed by the company's specialist.
---------------------------------------------------------------------------
Evaluating the Specialist's Work: Data, Significant Assumptions, and
Methods
See AS 1105.A6 and .A8, as Adopted
The revisions reflected in the final amendments clarify the
auditor's responsibilities for evaluating the work of a company's
specialist, and are intended to avoid potential confusion that the
auditor is required to reperform the work of the company's specialist.
Among other things, the revised requirements reserve the use of the
term ``test'' for procedures applied to company-produced information
used by the specialist, consistent with its usage in AS 2501, as
adopted.\76\
---------------------------------------------------------------------------
\76\ See Estimates Release, supra note 20.
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Notably, instead of requiring the auditor to comply with AS 2501,
as adopted, the auditor would be required to apply a set of analogous
procedures for evaluating data, significant assumptions, and methods
that are tailored to situations in which specialists are used.\77\ For
example, under the final amendments, the auditor's responsibilities
with respect to data, significant assumptions, and methods used by the
specialist generally are:
---------------------------------------------------------------------------
\77\ A note to AS 1105.A6, as adopted, emphasizes that
paragraphs .16-.17 of AS 2101 describe the auditor's
responsibilities for determining whether specialized knowledge or
skill is needed. This includes determining whether an auditor's
specialist is needed to evaluate the work of a company's specialist.
---------------------------------------------------------------------------
Company-produced data: Test the accuracy and completeness
of company-produced data used by the specialist (see AS 1105.A8a, as
adopted); \78\
---------------------------------------------------------------------------
\78\ See also AS 1105.10 for procedures when the auditor uses
information produced by the company as audit evidence.
---------------------------------------------------------------------------
Data from sources external to the company: Evaluate the
relevance and reliability of the data from sources external to the
company that are used by the specialist (see AS 1105.A8a, as adopted);
Significant assumptions: Evaluate whether the significant
assumptions used by the specialist are reasonable:
(1) Assumptions developed by the specialist: Taking into account
the consistency of those assumptions with relevant information (see AS
1105.A8b(1), as adopted);
(2) Assumptions provided by company management and used by the
specialist: Looking to the requirements set forth in AS 2501.16-.18, as
adopted (see AS 1105.A8b(2), as adopted);
(3) Assumptions based on the company's intent and ability to carry
out a particular course of action: Looking to the requirements set
forth in AS 2501.17, as adopted (see AS 1105.A8b(3), as adopted); and
Methods: Evaluate whether the methods used by the
specialist are appropriate under the circumstances, taking into account
the requirements of the applicable financial reporting framework (see
AS 1105.A8c, as adopted).
Under the final amendments, the focus of the auditor's evaluation
of the work of the company's specialist does not require reperforming
the specialist's work or evaluating whether the work complies with all
technical aspects in the specialist's field. Instead, the auditor's
responsibility is to evaluate whether the specialist's work provides
sufficient appropriate evidence to support a conclusion regarding
whether the corresponding accounts or disclosures in the financial
statements are in conformity with the applicable financial reporting
framework.
With respect to the specialist's methods, the auditor's
responsibilities under PCAOB standards have historically been to
understand the method used. The final amendments extend that obligation
to encompass evaluating whether the method is appropriate under the
circumstances, taking into account the requirements of the applicable
financial reporting framework.\79\ In many cases, evaluating a method's
conformity with the applicable financial reporting requirements is the
same as evaluating its appropriateness under the circumstances (e.g.,
if the applicable accounting standard requires a particular method for
determining the estimate). However, if the applicable financial
reporting framework allows more than one method, or if the appropriate
method under the framework depends on the circumstances, evaluating
conformity with the framework involves consideration of other relevant
factors, such as, the nature of the estimate and the auditor's
understanding of the company and its environment.
---------------------------------------------------------------------------
\79\ See AS 1105.A8c, as adopted.
---------------------------------------------------------------------------
A note to the final amendments also clarifies that evaluating the
specialist's methods includes assessing whether the data and
significant assumptions are appropriately applied under the applicable
financial reporting framework.\80\ Evaluating the application of the
data encompasses, for example, whether the data is selected and
adjusted in conformity with the requirements of the applicable
financial reporting framework. Similarly, evaluating the application of
significant assumptions encompasses evaluating whether the assumptions
were selected in conformity with the requirements of the applicable
financial reporting framework.
---------------------------------------------------------------------------
\80\ See note to AS 1105.A8c, as adopted.
---------------------------------------------------------------------------
The final amendments do not require the auditor to obtain access to
proprietary models used by the specialist. Rather, the auditor's
responsibility is to obtain information to assess whether the model is
in conformity with the applicable financial reporting framework.
Depending on the model and the factors set forth in AS 1105.A7, as
adopted, this might involve, for example, obtaining an understanding of
the model, reviewing descriptions of
[[Page 13458]]
the model in the specialist's report or equivalent communication,
testing controls over the company's evaluation of the specialist's
work, or assessing the inputs to and output from the model (if
necessary, using an alternative model for comparison).
With respect to the specialist's significant assumptions, auditors
have historically had an obligation under PCAOB standards to understand
the assumptions \81\ and, for fair value measurements, to evaluate the
reasonableness of the assumptions.\82\ The final amendments extend the
auditor's obligation to include evaluating the reasonableness of
significant assumptions used by the specialist. This involves comparing
the assumptions to relevant information. The note accompanying AS
1105.A8b(1), as adopted, provides examples of information that, if
relevant, should be taken into account: (1) Assumptions generally
accepted within the specialist's field; (2) supporting information
provided by the specialist; (3) industry, regulatory, and other
external factors, including economic conditions; (4) the company's
objectives, strategies, and related business risks; (5) existing market
information; (6) historical or recent experience, along with changes in
conditions and events affecting the company; and (7) significant
assumptions used in other estimates tested in the company's financial
statements. These examples--including examples (1) and (2), which were
suggested by commenters--point to information that generally would be
available to the auditor (e.g., through other procedures performed on
the audit or the auditor's knowledge or the company and its industry).
---------------------------------------------------------------------------
\81\ See existing AS 1210.09.
\82\ See footnote 2 of AS 2502.
---------------------------------------------------------------------------
Furthermore, the final amendments provide that, if a significant
assumption is provided by company management and used by the
specialist, the auditor should look to the requirements in AS
2501.16-.18, as adopted. The final amendments also provide that, if a
significant assumption is based on the company's intent and ability to
carry out a particular course of action, the auditor should look to the
requirements set forth in AS 2501.17, as adopted. This applies
regardless of whether the significant assumption was developed by the
company or the company's specialist.
Determining the Necessary Audit Effort for Evaluating the Specialist's
Work
See AS 1105.A7, as Adopted
Similar to the Proposal, the final amendments set forth four
factors that affect the necessary evidence from the auditor's
evaluation of the specialist's work to support a conclusion regarding a
relevant assertion. Specifically, under the final amendments, the
necessary evidence depends on the: (1) Significance of the specialist's
work to the auditor's conclusion regarding the relevant assertion; (2)
risk of material misstatement of the relevant assertion; (3) level of
knowledge, skill, and ability of the specialist; \83\ and (4) the
ability of the company to significantly affect the specialist's
judgments about the work performed, conclusions, or findings.
---------------------------------------------------------------------------
\83\ As noted previously, this factor includes consideration of
professional requirements the specialist is required to follow.
---------------------------------------------------------------------------
Some commenters asked for additional clarification or direction on
how to apply the four factors to determine the necessary audit effort
for evaluating the specialist's work. One commenter requested that the
Board elaborate upon certain terms (e.g., terms ``extensively'' and
``less extensive procedures'') that were used in two of the three
examples that were included in the Proposal to illustrate how certain
factors could affect the necessary audit effort in evaluating the work
of a company's specialist. Another commenter requested that the Board
provide additional examples of less complex scenarios.
In addition, some commenters asserted that the Proposal did not
adequately account for differences between company-employed and
company-engaged specialists. These commenters stated that the nature
and extent of an auditor's procedures with respect to the work of a
company-engaged specialist with the necessary knowledge, skill, and
objectivity should not necessarily be the same as those for the work of
a company-employed specialist. One commenter suggested expressly
including in the list of factors performance standards that the
specialist is required to follow.
The requirements regarding determining the necessary audit effort
for evaluating the specialist's work were adopted substantially as
proposed. The changes to the procedural requirements for evaluating the
data, significant assumptions, and methods used by the specialist
should help address concerns about the necessary level of effort under
the appendix. Also, the three examples included in the Proposal have
been revised to align with the final amendments and expanded to address
factors that lead to more or less audit attention and illustrate how
the additional attention may be directed under the circumstances.
With respect to the distinction between company-employed and
company-engaged specialists, the Board believes that the final
amendments provide an appropriate framework for distinguishing the work
effort when using the work of such specialists. In particular, one of
the four factors related to determining the necessary audit effort is
the ability of the company to significantly affect the specialist's
judgments about the work performed, conclusions, or findings. This
factor is discussed in more detail above.
Specifically, under the four factors set forth in the final
amendments, the auditor should obtain more persuasive evidence as the
significance of the specialist's work, the risk of material
misstatement, or the ability of the company to affect the specialist's
judgments increases, or as the level of knowledge, skill, and ability
possessed by the specialist decreases. In general, the required audit
effort when evaluating the work of a company's specialist would be
greatest when the risk of material misstatement is high; the
specialist's work is critical to the auditor's conclusion; the
specialist has a lower level of knowledge, skill, and ability in the
particular field; and the company has the ability to significantly
affect the specialist's judgments. These factors are also illustrated
in Figure 4, below.
[[Page 13459]]
[GRAPHIC] [TIFF OMITTED] TN04AP3.004
Under the final amendments, the first two factors, in combination,
relate to the persuasiveness of the evidence needed from the work of
the company's specialist, as follows:
Risk of Material Misstatement. Consistent with the risk
assessment standards, under the final amendments, the higher the risk
of material misstatement for an assertion, the more persuasive the
evidence needed to support a conclusion about that assertion.\84\
Pursuant to existing PCAOB standards, tests of controls are required if
the risk of material misstatement is based on reliance on controls.\85\
---------------------------------------------------------------------------
\84\ See paragraph .09a of AS 2301.
\85\ See AS 2301.16, which addresses testing controls to modify
the nature, timing, and extent of planned substantive procedures.
---------------------------------------------------------------------------
Significance of the Specialist's Work. The significance of
the specialist's work refers to the degree to which the auditor would
use the work of the company's specialist to support the auditor's
conclusions about the assertion. Generally, the greater the
significance of the specialist's work to the auditor's conclusion
regarding the relevant assertion, the more persuasive the evidence from
the specialist's work needs to be. The significance of the specialist's
work stems from:
The extent to which the specialist's work affects
significant accounts and disclosures in the financial statements. In
some situations, the specialist's work might be used only as a
secondary check for a significant account or disclosure, while in other
situations that work might be a primary determinant in one or more
significant accounts and disclosures in the financial statements.
The auditor's approach to testing the relevant assertion.
When a company's accounting estimate is determined principally based on
the work of a company's specialist, an auditor testing the company's
process for developing the accounting estimate would plan to use the
work of the company's specialist for evidence regarding the estimate.
On the other hand, if the auditor tests an assertion by developing an
independent expectation, the auditor would give less consideration to
the work of the company's specialist.\86\
---------------------------------------------------------------------------
\86\ As another example, the auditor might develop an
independent expectation using certain assumptions or methods of the
company's specialist. In those instances, the auditor's evaluation
would focus on those assumptions or methods that the auditor used in
developing his or her independent expectation.
---------------------------------------------------------------------------
The other two factors--the specialist's level of knowledge, skill,
and ability, and the ability of the company to significantly affect the
specialist's judgments--relate to the degree of reliability of the
specialist's work as audit evidence (i.e., the extent to which the
specialist's work could provide persuasive evidence, if relevant and
found to be satisfactory after the auditor's evaluation).
In some situations, if the auditor has doubt about the specialist's
knowledge, skill, and ability or about the company's effect on the
specialist's judgments, the auditor might choose not to use the work of
the company's specialist, instead of performing additional procedures
with respect to evaluating the specialist's work. The final amendments
do not preclude the auditor from pursuing other alternatives to using
that specialist's work. Such alternatives might include developing an
independent expectation of the related accounting estimate or seeking
to use the work of another specialist.
The following examples illustrate various ways in which the factors
discussed above can affect the necessary audit effort in evaluating the
work of a company's specialist under the final amendments. The examples
assume that the auditor will evaluate, as appropriate, the data,
significant assumptions, and
[[Page 13460]]
methods used by the specialist, and evaluate the relevance and
reliability of the work of the company's specialist and its
relationship to the relevant assertion.
Example 1--An oil and gas production company employs an
experienced petroleum reserve engineer to assist in developing the
estimated proved oil and gas reserves \87\ that are used in multiple
financial statement areas, including: (1) The company's impairment
analysis; (2) depreciation, depletion and amortization calculations;
and (3) related financial statement disclosures, such as reserve
disclosures. A substantial portion of the engineer's compensation is
based on company earnings, and the engineer has a reporting line to
the company's chief financial officer. The auditor concludes that
the risk of material misstatement of the valuation of oil and gas
properties is high, and the reserve engineer's work is significant
to the auditor's conclusion regarding the assertion. Thus, the
auditor would need to obtain more persuasive audit evidence
commensurate with a high risk of material misstatement, devoting
more audit attention to the data, significant assumptions, and
methods that are more important to the specialist's findings and
more susceptible to error or significant management influence. On
the other hand, relatively less audit evidence might be needed for
the work of an individual reserve engineer if the company has
several properties of similar risk, and the reserve studies are
performed by different qualified reserve engineers who are either
(1) engaged by the company, having no significant ties that give the
company significant influence over the specialists' judgments or (2)
employed specialists for which the company has implemented
compensation policies, reporting lines, and other measures to
prevent company management from having significant influence over
the specialists' judgments.
---------------------------------------------------------------------------
\87\ See Rule 4-10(a)(22) of Regulation S-X, 17 CFR 210.4-
10(a)(22).
---------------------------------------------------------------------------
Example 2--A financial services company specializes in
residential mortgage and commercial mortgage loans, which are either
sold or held in its portfolio. During the financial statement audit,
the auditor may inspect appraisals prepared by the company's
specialists for the real estate collateralizing loans for a variety
of reasons, including in conjunction with testing the valuation of
loans and the related allowance for loan losses. Under these
circumstances, the persuasiveness of the evidence needed from (and
the necessary degree of audit attention devoted to evaluating the
methods, significant assumptions, and data used in) an individual
appraisal would depend, among other things, on the importance of the
individual appraisal to the auditor's conclusion about the related
financial statement assertion. In general, more audit attention
would be needed for appraisals used in testing the valuation of
individually large loans that are valued principally based on their
collateral than for appraisals inspected in loan file reviews for a
portfolio of smaller loans with a low risk of default and a low
loan-to-value ratio.
Example 3--A manufacturing company engages an actuary to
calculate the projected pension benefit obligation (``PBO'') for its
pension plan, which is used to determine the related accounts and
disclosures in the financial statements. The auditor has assessed
the risk of material misstatement for the valuation of the PBO as
high and concluded that the actuary's work is significant to the
auditor's conclusion. The actuary has extensive experience and is
employed by a highly regarded actuarial firm with many clients. The
actuary and actuarial firm have no relationships with the company
other than performing the actuarial pension plan calculations for
the company's financial statements. Under these circumstances, the
necessary level of audit attention is less than it otherwise would
be for a situation where a specialist has a lower level of
knowledge, skill and ability, or the company has the ability to
significantly affect the specialist's judgments about the work
performed, conclusions, or findings. When more audit attention is
needed, the auditor would focus on those aspects of the specialist's
work that could be affected by the issues related to the
specialist's knowledge, skill, and ability or by the company's
ability to significantly affect the specialist's judgments.
The three examples above are provided only to illustrate the
auditor's consideration of the four factors set forth in the final
amendments when determining the necessary audit effort for evaluating
the work of the company's specialist. Differences in circumstances, or
additional information, could lead to different conclusions. The
examples are not intended to prescribe the specific procedures to be
performed in evaluating the work of a company's specialist in any
particular situation, which should be determined in accordance with the
final amendments.
Evaluating the Specialist's Work: Findings
See AS 1105.A9-.A10, as Adopted
The Proposal set forth requirements for evaluating the relevance
and reliability of the specialist's findings. The proposed requirements
built upon the existing requirements to evaluate the specialist's
findings and were aligned with the risk assessment standards.\88\ The
Proposal also provided factors that affect the relevance and
reliability of the specialist's work. Additionally, the proposed
requirements described examples of situations in which additional
procedures ordinarily are necessary. Commenters on this aspect of the
Proposal generally supported the proposed approach. A few commenters
asked for an explanation of the additional procedures to be performed.
One commenter stated that certain restrictions, disclaimers, or
limitations are common in specialists' reports and that auditors may
have no choice but to accept them.
---------------------------------------------------------------------------
\88\ Existing AS 1210.12 requires the auditor to evaluate
whether the specialist's findings support the related assertions in
the financial statements. It does not specify, however, what might
lead an auditor to conclude that he or she should perform additional
procedures or obtain the opinion of another specialist.
---------------------------------------------------------------------------
After considering the comments received, the Board is adopting the
requirements as proposed with one modification discussed below. The
final requirements in AS 1105.A10, as adopted, provide that the auditor
should perform additional procedures, as necessary, if the specialist's
findings or conclusions appear to contradict the relevant assertion or
the specialist's work does not provide sufficient appropriate evidence.
The final requirements also provide examples of situations in which
additional procedures ordinarily are necessary, such as when the
specialist's report, or equivalent communication,\89\ contains
restrictions, disclaimers, or limitations regarding the auditor's use
of the report or the auditor has identified that the specialist has a
conflict of interest relevant to the specialist's work. The final
requirements do not prescribe specific procedures to be performed
because the necessary procedures depend on the circumstances creating
the need for the procedures.
---------------------------------------------------------------------------
\89\ AS 1105.A9-.A10, as adopted, added the phrase ``or
equivalent communication,'' which was not part of the proposed
amendments, because a company's specialist may communicate his or
her findings or conclusions in a memorandum or other written
alternative to a formal report. AS 1201, Appendix C, as adopted, and
AS 1210, as amended, refer to a specialist's report ``or equivalent
documentation.'' The difference in terminology is intended to
distinguish information provided by the auditor's specialist from
information provided by the company's specialist.
---------------------------------------------------------------------------
A specialist's report may contain restrictions, disclaimers, or
limitations that cast doubt on the relevance and reliability of the
information contained in the specialist's report and affect how the
auditor can use the report of the specialist. For example, a
specialist's report that states ``the values in this report are not an
indication of the fair value of the underlying assets'' generally would
not provide sufficient appropriate evidence related to fair value
measurements. On the other hand, a specialist's report that indicates
that the specialist's calculations were based on information supplied
by management may still be appropriate for use by the auditor to
support the relevant assertion, since the auditor would already be
required to test the company-supplied data used in the specialist's
calculations.
[[Page 13461]]
The requirements in AS 1105.A10, as adopted, do not require the
auditor to perform procedures specifically to search for potential
conflicts of interest that a company's specialist might have, other
than those resulting from the specialist's relationship with the
company. However, the auditor may become aware of conflicts of interest
arising from relationships with parties outside the company (e.g.,
through obtaining information about the specialist's professional
reputation and standing, reading the specialist's report, or performing
procedures in other audit areas). For example, in reviewing an
appraisal of the collateral for a material loan receivable, the auditor
may become aware that the appraiser has a substantial financial
interest in the collateral. If the auditor becomes aware of a conflict
of interest that could affect the specialist's judgments about the work
performed, conclusions, or findings, the auditor would need to consider
the effect of that conflict on the reliability of the specialist's
work, and perform additional procedures if necessary to obtain
sufficient appropriate evidence regarding the relevant financial
statement assertion.
Comparison With Standards of Other Standard Setters
Paragraph 8(c) of ISA 500 provides that, if information to be used
as audit evidence has been prepared using the work of a management's
expert, the auditor shall, to the extent necessary and having regard to
the significance of that expert's work for the auditor's purposes,
evaluate the appropriateness of that expert's work as audit evidence
for the relevant assertion.
AU-C Section 500 contains requirements that are similar to those in
ISA 500.
Amendments Related to Supervising or Using the Work of an Auditor's
Specialist
The final amendments set forth requirements for supervising or
using the work of an auditor's specialist, taking into account
differences in the auditor's relationship with employed specialists and
engaged specialists. A new appendix to AS 1201 applies to the
supervision of auditor-employed specialists, and AS 1210, as amended,
applies when using the work of auditor-engaged specialists.
Commenters on the Proposal generally supported the proposed
approach for overseeing and coordinating the work of an auditor's
specialists, which was risk-based and set forth largely parallel
requirements when using the work of both auditor-employed and auditor-
engaged specialists. A few commenters, however, expressed concerns with
the practicality and clarity of certain aspects of the proposed
requirements. These comments and others are discussed below.
Amendments to AS 1201 for Supervising the Work of an Auditor-Employed
Specialist
Appendix C of AS 1201, as adopted, supplements the existing
requirements in AS 1201.05-.06 by providing more specific direction on
applying the general supervisory principles in AS 1201 to the
supervision of an auditor-employed specialist who assists the auditor
in obtaining or evaluating audit evidence.
Meaning of ``Auditor-Employed Specialist''
See AS 1201.C1, as Adopted
The Proposal used the term ``auditor-employed specialist'' to mean
a ``specialist employed by the auditor's firm,'' consistent with
existing requirements.\90\ Two commenters asked for clarification of
how to apply the terms ``auditor-employed'' and ``auditor-engaged''
specialists when specialists are employed by entities that are
affiliated with the audit firm and those specialists are subject to the
same quality control policies and procedures and independence
requirements as employees of the audit firm.
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\90\ See existing AS 1210.05, which states that AS 1201 applies
to situations in which ``a specialist employed by the auditor's firm
participates in the audit.''
---------------------------------------------------------------------------
The final amendments retain the existing concept that an ``auditor-
employed specialist'' is a ``specialist employed by the auditor's
firm.'' Given that the terms ``auditor-employed specialist'' and
``auditor-engaged specialist'' in the final amendments are consistent
with existing requirements, auditors should be familiar with this
distinction. The Board recognizes, however, that there may be instances
where an auditor uses the work of a specialist who is a partner,
principal, shareholder or employee of an affiliated entity that is not
an accounting firm and treats that specialist as if he or she were
employed by the auditor's firm (i.e., as an auditor-employed
specialist). While it is not practicable to address all the legal
structures or affiliations between accounting firms and specialist
entities that may give rise to such situations, the final amendments
are not intended to change current practice where the specialist is
employed by an affiliated entity that adheres to the same quality
control and independence requirements as the auditor's firm. In such
circumstances, the Board understands that the auditor would assess the
qualifications and independence of that specialist in the same ways as
an engagement team member employed by the firm.
Comparison With Standards of Other Standard Setters
ISA 620 covers the auditor's use of the work of both auditor-
employed experts and auditor-engaged experts, but the requirements in
ISA 620 for the auditor's evaluation of the objectivity of an auditor-
employed expert differ from those for evaluating the objectivity of an
auditor-engaged expert.
AU-C Section 620 is similar to ISA 620 in both respects.
Determining the Extent of Supervision
See AS 1201.C2, as Adopted
The Proposal supplemented, in proposed Appendix C of AS 1201, the
factors set forth in AS 1201.06 for determining the necessary extent of
supervision of engagement team members in circumstances involving the
use of the work of an auditor-employed specialist.\91\
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\91\ AS 1201.06 provides that, to determine the extent of
supervision necessary for engagement team members, the engagement
partner and other engagement team members performing supervisory
activities should take into account, among other things: (1) The
nature of the company, including its size and complexity; (2) the
nature of the assigned work for each engagement team member; (3) the
risks of material misstatement; and (4) the knowledge, skill, and
ability of each engagement team member.
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No commenters opposed the proposed requirement for determining the
extent of supervision. One commenter stated that the proposed
requirement for determining the extent of supervision appeared scalable
to the size and complexity of the audit engagement. The Board is
adopting this requirement as proposed. The final requirements provide
that the necessary extent of supervision depends on: (1) The
significance of the specialist's work to the auditor's conclusion
regarding the relevant assertion; (2) the risk of material misstatement
of the relevant assertion; and (3) the knowledge, skill, and ability of
the auditor-employed specialist relevant to the work to be performed by
the specialist.
Comparison With Standards of Other Standard Setters
Paragraph 8 of ISA 620 provides that, depending on the
circumstances, the nature, timing and extent of the auditor's
procedures will vary with respect to: (1) Evaluating the
[[Page 13462]]
competence, capabilities and objectivity of the auditor's expert; (2)
obtaining an understanding of the field of expertise of the auditor's
expert; (3) reaching an agreement with the auditor's expert; and (4)
evaluating the adequacy of the auditor's expert's work. In determining
the nature, timing and extent of those procedures, the auditor shall
consider matters including:
(a) The nature of the matter to which that expert's work relates;
(b) The risks of material misstatement in the matter to which that
expert's work relates;
(c) The significance of that expert's work in the context of the
audit;
(d) The auditor's knowledge of and experience with previous work
performed by that expert; and
(e) Whether that expert is subject to the auditor's firm's quality
control policies and procedures.
AU-C Section 620 contains requirements that are similar to those in
ISA 620.
Qualifications and Independence of Auditor-Employed Specialists
See AS 1015.06, as amended, and footnote 3A to AS 2101.06b, as amended
PCAOB auditing standards require that personnel be assigned to
engagement teams based on their knowledge, skill, and ability.\92\ This
requirement applies equally to auditor-employed specialists and other
engagement team members. In addition, auditor-employed specialists must
be independent of the company.\93\ Accordingly, the requirements in
PCAOB auditing standards for determining compliance with independence
and ethics requirements apply to auditor-employed specialists.\94\
Rather than add specific requirements for evaluating the qualifications
and independence of auditor-employed specialists, the Proposal would
have included two paragraphs in Appendix C citing the applicable
requirements in existing standards.\95\
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\92\ See AS 2301.05a and AS 1015.06, as amended.
\93\ PCAOB Rule 3520, Auditor Independence, requires a
registered public accounting firm and its associated persons to be
independent of the firm's ``audit client'' throughout the audit and
professional engagement period, meaning that they must satisfy all
independence criteria applicable to an engagement. In addition,
under Rule 2-01 of Regulation S-X, 17 CFR 210.2-01, any professional
employee of the ``accounting firm'' (as broadly defined in Rule 2-
01(f)(2) to include associated entities) who participates in an
engagement of an audit client is a member of the ``audit engagement
team,'' as that term is defined under Rule 2-01(f)(7)(i). The effect
is that an accounting firm is not independent if it uses the work of
a specialist employed by the accounting firm who does not meet the
independence requirements of Rule 2-01.
\94\ See AS 2101.06b.
\95\ See proposed AS 1201.C3-.C4; see also AS 2301.05a, AS
1015.06, and AS 2101.06b.
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Most commenters on this topic advocated for greater acknowledgment
of the auditor's ability to use information from the firm's system of
quality control when assessing the knowledge, skill, ability, and
independence of an auditor-employed specialist. Specifically, some of
these commenters recommended the inclusion of references to QC 20,
System of Quality Control for a CPA Firm's Accounting and Auditing
Practice (``QC 20''), in these requirements. In the view of these
commenters, QC 20 more fully encompasses both the considerations
related to the appropriate assignment of personnel to an engagement and
the requirements related to independence, integrity, and objectivity.
One commenter suggested that the standard provide that a firm's system
of quality control pursuant to QC 20 would be sufficient to satisfy the
requirements relating to the qualifications and independence of
auditor-employed specialists. Another commenter stated that the
necessary guidance was contained in QC 20 and that the references in
the Proposal to applicable requirements in existing standards were
duplicative.
The Board considered these comments in adopting the final
amendments. The intent of the proposed paragraphs for assigning
personnel based on their knowledge, skill, and ability, and for
determining compliance with independence and ethics requirements, was
to emphasize that auditors' responsibilities for assessing the
qualifications and independence of the auditor-employed specialists are
the same as for other engagement team members. To avoid any
misunderstanding that a different process was expected for assigning
auditor-employed specialists and determining their compliance with
independence and ethics requirements, the proposed paragraphs do not
appear in the final amendments. Also, two related amendments to PCAOB
auditing standards are being adopted. First, AS 1015.06 has been
amended to clarify that engagement team members, which includes
auditor-employed specialists, should be assigned to tasks and
supervised commensurate with their level of knowledge, skill, and
ability, and that this requirement is not limited to the assignment and
supervision of auditors. Second, in another conforming amendment, a
footnote was added to AS 2101.06b to remind auditors of the obligations
of registered firms and their associated persons under PCAOB Rule 3520.
Under the final amendments, auditors will continue to have the
ability to use information from, and processes in, the firm's quality
control system when assessing the knowledge, skill, ability, and
independence of auditor-employed specialists. The fact that a system of
quality control may have a process for making assignments of
specialists does not relieve the engagement partner (with the
assistance of appropriate supervisory personnel on the engagement team)
of his or her responsibility to determine whether the assigned
specialist has the necessary qualifications and independence for the
particular audit engagement in accordance with AS 1015.06, as amended,
and AS 2101.06, as amended. The relevant facts and circumstances,
including the nature, scope, and objectives of the specialist's work,
should be considered when performing this assessment. For example, a
valuation specialist may have expertise in valuing oil and gas
reserves, but not in valuing coal reserves. In that case, failure to
consider the specialist's expertise when assigning the specialist work
on an audit engagement in an extractive industry could result in the
inappropriate assignment of significant engagement responsibilities.
Comparison With Standards of Other Standard Setters
Paragraph 9 of ISA 620 provides that the auditor shall evaluate
whether the auditor's expert has the necessary competence,
capabilities, and objectivity for the auditor's purposes.
AU-C Section 620 contains requirements that are similar to those in
ISA 620.
Informing the Specialist of the Work To Be Performed
See AS 1201.C3-.C5, as adopted
The Proposal supplemented the requirements in PCAOB standards for
informing the engagement team members of their responsibilities to
address situations where auditor-employed specialists are performing
work in an audit.\96\ Most commenters
[[Page 13463]]
who commented on the supplemental requirements generally supported the
proposed approach, asserting that it would foster effective
communication between the auditor and the auditor's specialist. Some
commenters, however, asked for clarification of certain aspects of the
proposed requirement to establish and document an understanding with
the specialist of the work to be performed. After considering the
comments received, the Board is adopting the requirements substantially
as proposed.
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\96\ AS 1201.05a sets forth requirements for the engagement
partner and, as applicable, other engagement team members performing
supervisory activities to inform engagement team members of their
responsibilities. These matters include: (1) The objectives of the
procedures that engagement team members are to perform; (2) the
nature, timing, and extent of procedures they are to perform; and
(3) matters that could affect the procedures to be performed or the
evaluation of the results of those procedures, including relevant
aspects of the company, its environment, and its internal control
over financial reporting, and possible accounting and auditing
issues.
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The final amendments include requirements for the engagement
partner and, as applicable, other engagement team members performing
supervisory activities to inform the auditor-employed specialist about
the work to be performed. These requirements include establishing and
documenting an understanding with the specialist regarding the
responsibilities of the specialist, the nature of the specialist's
work, the specialist's degree of responsibility for testing data and
evaluating methods and significant assumptions, and the responsibility
of the specialist to provide a report, or equivalent documentation.
Some commenters requested clarification in the final amendments on
the form of documentation of the auditor's understanding with the
specialist. In addition, some commenters suggested removing the
specific reference to the specialist's responsibility to provide a
``report, or equivalent documentation'' and allowing for more
flexibility when the specialist's results are communicated to the
auditor. Some of these commenters asserted that the proposed
requirement connoted the preparation of a formal, signed report, which
could discourage effective two-way communication between the auditor
and the specialist. Another commenter suggested that the Board consider
whether the auditor's understanding with the specialist should also
include matters the specialist should communicate to the auditor, and
the nature, timing, and extent of those communications. One commenter
also expressed concern that use of the term ``degree of
responsibility'' could be seen as a means for auditors to abdicate
responsibility for audit work to specialists.
The final amendments do not include specific requirements for how
to document the auditor's understanding with the auditor's specialist.
Instead, the Board contemplates that the understanding with the
specialist can be documented in a variety of ways, such as in planning
memoranda, separate memoranda, or other related work papers. This
approach should provide auditors with flexibility, while still
requiring the documentation of the important aspects of the
understanding reached by the auditor and the auditor's specialist. This
approach also enables the specialist to communicate those matters
specific to the work performed and does not limit the specialist's
ability to communicate other items to the auditor.
The final amendments also require the auditor to establish and
document an understanding with the specialist regarding the degree of
responsibility of the specialist for: (1) Testing data produced by the
company, or evaluating the relevance and reliability of data from
sources external to the company; (2) evaluating the significant
assumptions used by the company or the company's specialist, or
developing his or her own assumptions; and (3) evaluating the methods
used by the company or the company's specialist, or using his or her
own methods. The intent of this requirement is to enhance coordination
of the work between the auditor and the auditor's specialist and
facilitate supervision of the specialist by the engagement partner and
others with supervisory responsibilities. For example, if the auditor's
specialist assists the auditor in developing an independent expectation
using data, assumptions, or a model provided by the auditor or
auditor's specialist, the auditor would establish an understanding with
the specialist regarding the specialist's responsibilities with respect
to the data, assumptions, or model.\97\ Regardless of the specialist's
degree of responsibility, the engagement partner and, as applicable,
other engagement team members performing supervisory activities are
responsible for evaluating the specialist's work and report, or
equivalent documentation.\98\
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\97\ AS 1201.C5, as adopted, provides that the auditor should
comply with AS 2501.21-.26, as adopted, when an independent
expectation is developed. For example, the auditor's
responsibilities with respect to using data or assumptions obtained
from a third party are presented in AS 2501.23, as adopted. See
Estimates Release, supra note 20.
\98\ See AS 1201.C6-.C7, as adopted.
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In addition, as proposed, the final amendments require establishing
and documenting the specialist's responsibility to provide ``a report,
or equivalent documentation'' to the auditor. This requirement should
provide flexibility for auditors to obtain the necessary information
about the specialist's procedures, findings, and conclusions through
the specialist's report, other specialist-provided documentation, or a
combination of the two. The requirement should also facilitate the
auditor's compliance with other PCAOB auditing standards, such as those
on engagement quality review and audit documentation.\99\
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\99\ See AS 1220, Engagement Quality Review, and AS 1215, Audit
Documentation.
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The final amendments require establishing and documenting the
auditor's understanding with the specialist regarding the ``nature of
the work that the specialist is to perform or assist in performing.''
As proposed, this requirement would have also encompassed the
``specialist's approach to that work.'' Two commenters suggested that
the Board clarify the difference between the two terms. The nature of
the specialist's work would include, for example, testing data and
evaluating the methods and significant assumptions used in developing
an estimate when testing the company's process used to develop an
accounting estimate or developing an independent expectation of an
estimate. The specialist's approach to that work, in turn, might
include the procedures the specialist performs to test management's
process or develop an independent expectation, such as testing data and
evaluating the methods and significant assumptions used in developing
an estimate. Since the auditor's obligation to establish and document
the specialist's degree of responsibility for performing similar
procedures is addressed in other provisions of the final
amendments,\100\ the phrase ``the specialist's approach to that work''
has been omitted to avoid potential confusion.
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\100\ See AS 1201.C3c, as adopted.
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As proposed, the final amendments also provide that, pursuant to AS
1201.05a(3), the engagement partner and, as applicable, other
engagement team members performing supervisory activities should inform
the auditor-employed specialist about matters that could affect the
specialist's work.\101\ This includes, as applicable, information about
the company and its environment, the company's processes for developing
the related accounting estimate, the company's use of specialists in
developing the estimate, relevant requirements of the applicable
financial reporting framework, possible accounting and auditing issues,
and the need to apply professional skepticism. Commenters did not offer
suggestions
[[Page 13464]]
on this provision, although one commenter stated that it concurred with
the proposed requirement.
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\101\ See AS 1201.C4, as adopted.
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The final amendments also provide that the engagement partner and,
as applicable, other engagement team members performing supervisory
activities should implement measures to determine that there is a
proper coordination of the work of the specialist with the work of
other relevant engagement team members to achieve a proper evaluation
of the evidence obtained in reaching a conclusion about the relevant
assertion.\102\ One commenter requested clarification of the term
``measures,'' as used in this context. The final requirement emphasizes
that the auditor is responsible for complying with relevant auditing
standards, including, when applicable, AS 2501, as adopted, and
Appendix A of AS 1105, as adopted.\103\ This requirement is intended to
prompt the auditor to coordinate with the specialist to make sure that
the work is performed in accordance with the applicable standards,
including the requirement to consider relevant audit evidence,
regardless of whether it supports or contradicts the relevant financial
statement assertion. For example, in auditing an accounting estimate
under AS 2501, as adopted, measures taken by the auditor could include
either performing, or supervising the auditor's specialist in
performing, the required procedures with respect to testing and
evaluating the data, and evaluating the methods and significant
assumptions used in developing that estimate.\104\
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\102\ See AS 1201.C5, as adopted.
\103\ See AS 1201.C5, as adopted. In response to comments, this
paragraph was revised in the final amendments to provide that, if an
auditor's specialist is used to evaluate the work of a company's
specialist, measures should be implemented to comply with Appendix A
of AS 1105, as adopted, and, for accounting estimates, AS 2501.19,
as adopted.
\104\ See AS 2501, as adopted, and Estimates Release, supra note
20.
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Comparison With Standards of Other Standard Setters
Paragraph 11 of ISA 620 provides that the auditor shall agree, in
writing when appropriate, on the following matters with the auditor's
expert:
(a) The nature, scope and objectives of that expert's work;
(b) The respective roles and responsibilities of the auditor and
that expert;
(c) The nature, timing, and extent of communication between the
auditor and that expert, including the form of any report to be
provided by that expert; and
(d) The need for the auditor's expert to observe confidentiality
requirements.
AU-C Section 620 contains requirements that are similar to those in
ISA 620.
Evaluating the Work of the Specialist
See AS 1201.C6-.C7, as Adopted
The Proposal supplemented, in Appendix C, the requirements in AS
1201.05c for reviewing the work of the engagement team in circumstances
in which auditor-employed specialists are used.\105\ It provided that,
if the specialist's findings or conclusions appear to contradict the
relevant assertion or the specialist's work does not provide sufficient
appropriate evidence, the engagement partner and, as applicable, other
engagement team members performing supervisory activities should
perform additional procedures, or request the specialist to perform
additional procedures, as necessary to address the issue.
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\105\ AS 1201.05c provides that the engagement partner and, as
applicable, other engagement team members performing supervisory
activities should review the work of engagement team members to
evaluate whether: (1) The work was performed and documented; (2) the
objectives of the procedures were achieved; and (3) the results of
the work support the conclusions reached.
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Commenters generally agreed with these requirements, noting that
the requirements are appropriate and, in the view of some commenters,
would improve audit quality. Two commenters asked for additional
guidance on how the auditor should evaluate methods and assumptions
used by an auditor-employed specialist. One commenter recommended
providing additional guidance on the specific procedures to be
performed by auditors to evaluate a specialist's work. After
considering the comments, the Board is adopting the requirements
substantially as proposed.
The final amendments provide a principles-based framework for
reviewing and evaluating the work of the specialist. Under the final
amendments, the engagement partner and, as applicable, other engagement
team members performing supervisory activities should review the
specialist's report or equivalent documentation describing the work
performed, the results of the work, and the findings or conclusions
reached by the specialist, as provided for under AS 1201.C3d, as
adopted.\106\
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\106\ See AS 1201.C6, as adopted.
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This approach links the scope of the auditor's review to the report
or equivalent documentation that the specialist agreed to furnish to
the auditor under AS 1201.C3, as adopted. The principles for the
necessary extent of supervision, discussed earlier, also apply to
evaluating the work of the auditor-employed specialist, including the
report or equivalent documentation provided by the specialist.
Accordingly, auditors should be familiar with this approach and how to
apply this requirement in practice.
The necessary extent of review and evaluation of the auditor-
employed specialist's work depends on (1) the significance of the
specialist's work to the auditor's conclusion regarding the relevant
assertion; (2) the risk of material misstatement of the relevant
assertion; and (3) the knowledge, skill, and ability of the specialist.
In performing the review, the auditor also should evaluate whether the
specialist's work provides sufficient appropriate evidence,
specifically whether:
The specialist's work and report, or equivalent
documentation, are in accordance with the auditor's understanding with
the specialist; and
The specialist's findings and conclusions are consistent
with results of the work performed by the specialist, other evidence
obtained by the auditor, and the auditor's understanding of the company
and its environment.
AS 1201.C7, as adopted, provides that, if the specialist's findings
or conclusions appear to contradict the relevant assertion or the
specialist's work does not provide sufficient appropriate evidence, the
engagement partner and, as applicable, other engagement team members
performing supervisory activities should perform additional procedures,
or request the specialist to perform additional procedures, as
necessary to address the issue. The final requirement also provides
examples of situations in which additional procedures ordinarily would
be necessary, including:
The specialist's work was not performed in accordance with
the auditor's instructions;
The specialist's report, or equivalent documentation,
contains restrictions, disclaimers, or limitations that affect the
auditor's use of the report or work; \107\
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\107\ The auditor's consideration of restrictions, disclaimers,
or limitations in a report, or equivalent documentation, provided by
an auditor-employed specialist is the same as when such language is
contained in a report, or equivalent documentation, provided by an
auditor-engaged specialist. See below for further discussion of the
auditor's consideration of the effect of restrictions, disclaimers,
or limitations on the report, or equivalent documentation, provided
by the auditor-engaged specialist.
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The specialist's findings and conclusions are inconsistent
with (1) the results of the work performed by the specialist, (2) other
evidence obtained
[[Page 13465]]
by the auditor, or (3) the auditor's understanding of the company and
its environment;
The specialist lacks a reasonable basis for data or
significant assumptions the specialist used; or
The methods used by the specialist were not appropriate.
These requirements are consistent with existing provisions in
paragraphs .06 and .36 of AS 2810, Evaluating Audit Results, which
provide that, if the auditor concludes that the evidence gathered is
not adequate, he or she should modify his or her audit procedures or
perform additional procedures as necessary (e.g., audit procedures may
need to be modified or additional procedures may need to be performed
as a result of any changes in the risk assessments). Similarly, if the
evidence gathered by the specialist in testing or evaluating data, or
evaluating significant assumptions is not adequate, the engagement
partner and, as applicable, other engagement team members performing
supervisory activities should perform additional procedures, or request
the specialist to perform additional procedures, as necessary to
address the issue.
One commenter asserted that auditors may not have sufficient
knowledge of the specialist's field of expertise to evaluate a
specialist's work and effectively challenge methods, assumptions, and
data, particularly in relation to highly complex technical areas. The
final amendments recognize that the engagement partner and, as
applicable, other engagement team members performing supervisory
responsibilities may not have in-depth knowledge of the specialist's
field. However, under existing PCAOB standards, the auditor is required
to have sufficient knowledge of the subject matter to evaluate a
specialist's work as it relates to the nature, timing, and extent of
the auditor's work and the effects on the auditor's report.\108\
Furthermore, the evaluation of the specialist's work under the final
amendments is based on matters that are within the capabilities of the
auditor (e.g., whether the specialist followed instructions and whether
the results of the work support the specialist's conclusions).
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\108\ See AS 2101.17.
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Another commenter asked for clarification of the term ``reasonable
basis'' in the context of assessing whether the specialist lacks a
reasonable basis for data or significant assumptions the specialist
used. In that context, ``reasonable basis'' refers to whether the
specialist's selection of data or significant assumptions was
determined arbitrarily or instead based on consideration of relevant
information available to the specialist.
Comparison With Standards of Other Standard Setters
Paragraph 12 of ISA 620 provides that the auditor shall evaluate
the adequacy of the auditor's expert's work for the auditor's purposes,
including:
(a) The relevance and reasonableness of that expert's findings or
conclusions, and their consistency with other audit evidence;
(b) If that expert's work involves use of significant assumptions
and methods, the relevance and reasonableness of those assumptions and
methods in the circumstances; and
(c) If that expert's work involves the use of source data that is
significant to that expert's work, the relevance, completeness, and
accuracy of that source data.
Paragraph 13 of ISA 620 provides that if the auditor determines
that the work of the auditor's expert is not adequate for the auditor's
purposes, the auditor shall:
(a) Agree with that expert on the nature and extent of further work
to be performed by that expert; or
(b) Perform additional audit procedures appropriate to the
circumstances.
AU-C Section 620 contains requirements that are similar to those in
ISA 620.
Amendments to Existing AS 1210 for Using the Work of an Auditor-Engaged
Specialist
This section discusses the final requirements in AS 1210, as
amended, for audits in which the auditor uses an auditor-engaged
specialist. In such circumstances, the objective of the auditor is to
determine whether the work of the auditor-engaged specialist is
suitable for the auditor's purposes and supports the auditor's
conclusion regarding the relevant assertion.
Assessing the Knowledge, Skill, Ability, and Objectivity of the Engaged
Specialist
As described above, existing AS 1210 requires the auditor to
evaluate the professional qualifications of a specialist and the
relationship of a specialist to the company.
Similar to the final amendments related to using a company's
specialist, the final amendments carry forward the existing
requirements with certain modifications described below.
Knowledge, Skill, and Ability
See AS 1210.03-.04, as Amended
Requirements in existing AS 1210 related to the auditor's
evaluation of a specialist's qualifications were described above with
regard to a company's specialist. These requirements are the same for a
company's specialist and an auditor-engaged specialist.
The Proposal substantially carried forward the requirement in
existing AS 1210. Unlike the existing standard, however, the Proposal
expressly provided that the auditor would obtain an understanding of
the professional qualifications of both the specialist and the entity
that employs the specialist. The Board is adopting this requirement as
proposed.
Two commenters concurred with the proposed approach to assessing
knowledge, skill, and ability of the auditor-engaged specialist. One
commenter suggested allowing auditors to assess the specialist's
knowledge, skill, and ability centrally as part of the firm's system of
quality control. Another commenter asserted that the proposed
requirement was not well-suited to assessing the knowledge, skill, and
ability of the entity that employs the specialist.
Under the final amendments, auditors will continue to be able to
use information from, and processes in, the firm's quality control
system when assessing the knowledge, skill, and ability of auditor-
engaged specialists. The fact that a system of quality control may have
a firm-level process for screening engaged specialists does not relieve
the engagement partner (with the assistance of appropriate supervisory
personnel on the engagement team) of his or her responsibility to
assess whether the engaged specialist has the necessary knowledge,
skill, and ability for the particular audit engagement. The relevant
facts and circumstances, including the nature, scope, and objectives of
the specialist's work, should be considered when performing this
assessment.
The final requirement retains the concept in existing AS 1210 that
a specialist may be an individual or an entity. Outreach to audit firms
suggests that firms have policies and procedures for evaluating the
qualifications of specialists, whether individuals or entities.
Accordingly, auditors should be familiar with assessing the
qualifications of entities that are specialists or employ specialists.
Therefore, the final requirement is not expected to result in a
significant change in practice.
[[Page 13466]]
AS 1210, as amended, does not specify steps to perform or
information sources to use in assessing the specialist's knowledge,
skill, and ability. Potential sources of relevant information, if
available, could include the following:
Information contained within the audit firm related to the
professional qualifications and reputation of the specialist and the
entity that employs the specialist, if applicable, in the relevant
field and experience with previous work of the specialist;
Professional or industry associations and organizations,
which may provide information on: (1) Qualification requirements,
technical performance standards, and continuing professional education
requirements that govern their members; (2) the specialist's education
and experience, certification, and license to practice; and (3)
recognition of, or disciplinary actions taken against the specialist;
Information provided by the specialist about matters
regarding the specialist's understanding of the financial reporting
framework, experience in performing similar work, and the methods and
assumptions used in the specialist's work the auditor plans to
evaluate;
The specialist's responses to questionnaires about the
specialist's professional credentials; and
Published books or papers written by the specialist.
Requirements applicable to a specialist pursuant to legislation or
regulation also could help inform the auditor's assessment of the
specialist's knowledge, skill, and ability.
The purpose of the assessment of the auditor-engaged specialist's
knowledge, skill, and ability is two-fold: (1) To determine whether the
specialist possesses a sufficient level of knowledge, skill, and
ability to perform his or her assigned work; and (2) to help determine
the necessary extent of the review and evaluation of the specialist's
work. AS 1210.04, as amended, emphasizes the importance of engaging a
sufficiently qualified auditor's specialist by expressly providing that
the auditor should not use the work of an engaged specialist who does
not have a sufficient level of knowledge, skill, and ability.
The assessment of the specialist's knowledge, skill, and ability by
the engagement partner and, as applicable, other engagement team
members performing supervisory activities is also a factor when
determining the necessary extent of the review and evaluation of the
specialist's work.\109\ The auditor's evaluation of the work of a
specialist may be more extensive if the specialist generally has
sufficient knowledge, skill, and ability in the relevant field of
expertise, but less experience in the particular area of specialty
within the field. For example, a valuation specialist may possess
sufficient knowledge, skill, and ability in business valuation, but may
not be well-versed in the application of business valuation for
financial reporting purposes.
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\109\ See AS 1210.10, as amended.
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Objectivity
See AS 1210.05 and .11, as Amended
Requirements in existing AS 1210 related to the auditor's
evaluation of a specialist's objectivity are described above with
regard to a company's specialist. Those requirements are the same for a
company's specialist and an auditor-engaged specialist.
The Proposal built on the requirements for assessing objectivity in
the existing standard and provided that the engagement partner and, as
applicable, other engagement team members performing supervisory
activities would assess whether the specialist and the entity that
employs the specialist have the necessary objectivity, which includes
evaluating whether the specialist or the entity that employs the
specialist has a relationship to the company (e.g., through employment,
financial, ownership, or other business relationships, contractual
rights, family relationships, or otherwise), or any other conflicts of
interest relevant to the work to be performed.
The proposed requirements differed from the existing requirements
in two primary respects. First, they articulated the concept of
objectivity for purposes of proposed AS 1210, as referring to the
specialist's ability ``to exercise impartial judgment on all issues
encompassed by the specialist's work related to the audit.'' Second,
they expanded the list of matters that the auditor would consider in
assessing objectivity to include financial and business relationships
with the company and other conflicts of interest.
Some commenters supported the proposed approach. Other commenters
expressed concern that the proposed requirement implied that the
assessment of whether the specialist had the necessary objectivity was
a binary decision. These commenters expressed a preference for
describing objectivity as an attribute that exists along a spectrum.
Some of these commenters asserted that an auditor should not be
precluded from using the work of a less objective specialist, as long
as the auditor performed additional procedures in those circumstances.
After considering the comments received, the requirement has been
revised to allow auditors to assess the specialist's level of
objectivity along a spectrum and use the work of a less objective
specialist if the auditor performs additional procedures to evaluate
the specialist's work. In revising this requirement, the Board took
into account the need for auditors to assess the objectivity of
auditor-engaged specialists, while allowing auditors, where
appropriate, to engage specialists who have certain relationships with
a company that may raise questions as to their level of objectivity.
The final amendments also require the auditor to perform procedures
that are commensurate with, among other things, an engaged specialist's
degree of objectivity.\110\ Under the final amendments, if the
specialist or the entity that employs the specialist has a relationship
with the company that affects the specialist's objectivity, the auditor
should (1) perform additional procedures to evaluate the data,
significant assumptions, and methods that the specialist is responsible
for testing, evaluating, or developing consistent with the
understanding established with the specialist pursuant to AS 1210.06,
as amended, or (2) engage another specialist. The necessary nature and
extent of the additional procedures would depend on the degree of
objectivity of the specialist. As the degree of objectivity increases,
the evidence needed from additional procedures decreases.\111\ If the
specialist has a low degree of objectivity,\112\ the auditor should
apply the procedures for evaluating the work of a company's
specialist.\113\ For example, if the specialist's employer has a
significant ownership interest in the company, the specialist's ability
to exercise objective and impartial judgment might be low and,
therefore, the auditor should evaluate the data, significant
assumptions, and methods used by the
[[Page 13467]]
specialist under the requirements in Appendix A of AS 1105, as amended.
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\110\ See first note to AS 1210.05, as amended. See also AS
1210.10, as amended, for a description of other factors affecting
the necessary extent of the auditor's review.
\111\ See AS 1210.11, as amended.
\112\ The concept of a ``low degree of objectivity'' is used in
paragraph .18 of AS 2201, An Audit of Internal Control Over
Financial Reporting That Is Integrated with An Audit of Financial
Statements, and, therefore, should be familiar to auditors.
\113\ See AS 1210.11, as amended.
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Some commenters on the Proposal suggested the Board should provide
additional guidance to specify the steps to be performed by auditors to
assess the objectivity of an auditor-engaged specialist, as well as
what constitutes sufficient appropriate evidence to support this
assessment. One commenter asserted that auditors would face challenges
in assessing the objectivity of the entity that employs the specialist,
as required under the Proposal, and suggested that auditors may be
unable to obtain the policies, procedures, and systems, if any, of the
entity employing the specialist. This commenter suggested either
omitting the requirement to consider the objectivity of the
specialist's employer or limiting the requirement to performing inquiry
of the specialist.
After considering these comments, the Board has eliminated the
assessment of the objectivity of the entity that employs the specialist
as a separate requirement under the final requirements. Instead, the
auditor is required to evaluate relationships between the company and
both the specialist and the specialist's employer to determine whether
either has a relationship with the company that may adversely affect
the specialist's objectivity.\114\ This is consistent with existing AS
1210, under which a specialist may be either an individual or an
entity. Additionally, outreach to specialist entities and audit firms
suggests that audit firms have policies and procedures for evaluating
relationships between a specialist entity that they engage and the
company. Accordingly, the concept of assessing relationships between a
company and an entity that employs specialists should be familiar to
auditors.
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\114\ See AS 1210.05, as amended. For example, the specialist's
employer might have an ownership or other financial interest with
respect to the company, or other business relationships that might
be relevant to the auditor's assessment of the specialist's ability
to exercise objective and impartial judgment.
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As under the Proposal, the final amendments do not prescribe the
procedures the auditor must perform to obtain information relevant to
the auditor's assessment. In response to questions raised by
commenters, the Board added a note to clarify that the evidence
necessary to assess the specialist's objectivity depends on the
significance of the specialist's work and the related risk of material
misstatement.\115\ Under this principles-based approach, as the
significance of the specialist's work and the risk of material
misstatement increase, the persuasiveness of the evidence the auditor
should obtain for this assessment also increases.
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\115\ See second note to AS 1210.05, as amended.
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In addition, the note includes non-exclusive examples of potential
sources of information that could be relevant to the auditor's
assessment of the relationship to the company of both the specialist
and the specialist's employer.\116\ These examples include responses to
questionnaires provided to the specialist regarding relationships
between the specialist, or the specialist's employer, and the company.
As with the auditor's assessment of a specialist's knowledge, skill,
and ability, certain sources of information may provide more persuasive
evidence than others. In situations where more persuasive evidence is
required, it may be appropriate to perform procedures to obtain
evidence from multiple sources.
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\116\ Id. These examples were based on examples set forth in the
Proposal, but have been refined to better reflect their application
in practice.
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Comparison With Standards of Other Standard Setters
Paragraph 9 of ISA 620 provides that in the case of an auditor's
external expert, the evaluation of objectivity shall include inquiry
regarding interests and relationships that may create a threat to that
expert's objectivity.
AU-C Section 620 contains requirements that are similar to those in
ISA 620.
Informing the Specialist of the Work To Be Performed, Determining the
Extent of Review, and Evaluating the Work of the Specialist
See AS 1210.06-.12, as Amended
As is the case with respect to an auditor-employed specialist, the
auditor uses an auditor-engaged specialist to assist the auditor in
obtaining and evaluating audit evidence. Given the similar role of an
auditor-employed and an auditor-engaged specialist in the audit, the
final requirements for the auditor-engaged specialist are parallel to
the requirements for the auditor-employed specialist when determining
the extent of the auditor's review, informing the auditor-engaged
specialist of the work to be performed, and evaluating the work of the
auditor-engaged specialist. These final requirements are discussed in
additional detail above.
Some commenters on the Proposal commented on the impact of certain
proposed changes solely with respect to auditor-engaged specialists.
These comments are discussed below.
One commenter on the Proposal expressed concern that the auditor
may have limited access to proprietary models used by auditor-engaged
specialists. This commenter recommended that the Board include
statements made in the Proposal regarding the auditor's access to such
models and the impact on the auditor's performance obligations in the
final amendments. Similar to the Proposal, the final amendments do not
require the auditor to have full access to a specialist's proprietary
model or to reperform the work of the specialist, but instead require
the auditor to evaluate the work of that specialist in accordance with
the final standard. Under AS 1210.10, as amended, the necessary extent
of the evaluation of the specialist's work, including a determination
of the necessary access to a specialist's model, depends upon (1) the
significance of the specialist's work to the auditor's conclusion
regarding the relevant assertion; (2) the risk of material misstatement
of the relevant assertion; and (3) the knowledge, skill, and ability of
the specialist. For example, if the specialist used a proprietary model
to develop an independent expectation, the auditor would need to obtain
information from the specialist to assess whether the specialist's
model was in conformity with the applicable financial reporting
framework and to evaluate differences between the independent
expectation and the company's recorded estimate.
Another commenter recommended including a requirement to inform
auditor-engaged specialists of the need to apply professional
skepticism, similar to the requirement for auditor-employed specialists
in proposed AS 1201.C6. A different commenter recommended that the
requirements for informing the specialist of the work to be performed
should include communicating the auditor's need to exercise
professional skepticism to the auditor-engaged specialist, so that the
specialist is aware that relevant information should be passed on to
the auditor.
The Board considered these comments and determined to adopt the
requirement to inform the specialist of the work to be performed
substantially as proposed. Due professional care in the performance of
audit procedures requires the auditor to exercise professional
skepticism, including a questioning mind and a critical assessment of
audit evidence.\117\ The Board did not propose extending the auditing
standard on due professional care to auditor-engaged specialists and,
[[Page 13468]]
therefore, no change has been made to AS 1210, as amended. While there
is no requirement for auditors to make the engaged specialist aware of
the auditor's responsibility to exercise professional skepticism,
auditors nevertheless may decide to communicate the auditor's
responsibility to the auditor-engaged specialist.
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\117\ See AS 1015.07.
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Some commenters asserted that the discussion of the auditor's
assessment of disclaimers, limitations, and restrictions related to the
report of a company's specialist was equally applicable to the report
of the auditor-engaged specialist and recommended similar guidance be
provided when using the report of an auditor-engaged specialist. Under
the final amendments, the auditor's evaluation of the specialist's
report or equivalent documentation includes considering the effect of
any restrictions, limitations, or disclaimers in the specialist's
report or equivalent documentation on both (1) the relevance and
reliability of the audit evidence the specialist's work provides and
(2) how the auditor can use the report of the specialist.\118\ For
example, a specialist's report that states ``the values in this report
are not an indication of the fair value of the underlying assets''
generally would not provide sufficient appropriate evidence related to
fair value measurements. On the other hand, a specialist's report that
indicates that the specialist's calculations were based on information
supplied by management may still be appropriate for use by the auditor
to support the relevant assertion, since the auditor would be required
to test the data that was produced by the company and used in the
specialist's calculations
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\118\ See note to AS 1210.12, as amended.
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Comparison With Standards of Other Standard Setters
The comparative requirements of the IAASB and the ASB were
discussed above.
Other Considerations
The Board proposed to rescind two auditing interpretations.\119\
The Board has taken commenters' views into account and determined not
to rescind these interpretations at this time. The Board is
incorporating key elements of each interpretation, however, in the
final amendments. These matters are discussed below, along with certain
requirements in existing AS 1210 that are not specifically addressed in
the final amendments.
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\119\ Auditing interpretations provide guidance the auditor
should be aware of and consider related to specific areas of the
audit. See paragraph .11 of AS 1001, Responsibilities and Functions
of the Independent Auditor.
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Auditing Interpretation AI 11, Using the Work of a Specialist: Auditing
Interpretations of AS 1210
The Board proposed to rescind AI 11 in the Proposal. AI 11 provides
guidance for auditing transactions involving transfers of financial
assets, such as in securitizations that are accounted for under
Statement of Financial Accounting Standards No. 140.\120\ The
interpretation addresses an auditor's use of a legal opinion obtained
from a company's legal counsel on matters that may involve the U.S.
Bankruptcy Code, rules of the Federal Deposit Insurance Corporation
(``FDIC''),\121\ and other federal, state, or foreign law to determine
whether ``transferred assets have been isolated from the transferor--
put presumptively beyond the reach of the transferor and its creditors,
even in bankruptcy or other receivership,'' which affects the
accounting for the transaction under FAS No. 140. AI 11 also reiterates
certain requirements in generally accepted accounting principles and
PCAOB auditing standards. In addition, the interpretation includes
illustrative examples of legal isolation letters based on FAS No. 140
and certain provisions of the FDIC's original rule, both of which have
been subsequently amended.
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\120\ See Financial Accounting Standards Board (``FASB''),
Statement of Financial Accounting Standards (``FAS'') No. 140,
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. This standard was subsequently
amended by FAS No. 166, Accounting for Transfers of Financial
Assets--an amendment of FASB Statement No. 140, and codified into
FASB Accounting Standards Codification (``ASC''), Topic 860,
Transfers and Servicing.
\121\ Subsequent to the Board's adoption of AI 11, the FDIC rule
regarding the treatment of financial assets transferred by an
institution in connection with a securitization or participation was
amended in 2010.
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A few commenters supported the proposed rescission. A number of
other commenters, however, expressed concern about the proposed
rescission of AI 11, stating that it continues to provide useful
guidance to auditors regarding the necessary audit evidence to support
management's assertion that a transfer of financial assets has met the
isolation criterion of ASC 860-10-40, Transfers and Servicing. One
commenter asserted that companies would struggle to anchor their
accounting conclusions to guidance on the existing auditing standards
if AI 11 was rescinded.
After considering comments and the continued use of the
interpretation in practice, the Board determined not to rescind AI 11
at this time. The final amendments have been revised to include
conforming changes to AI 11 to remove outdated references to existing
AS 1210, which has been replaced and retitled.
The amended standards for using the work of a company's specialist
also incorporate certain principles from AI 11. As discussed in AI 11,
legal opinions are sometimes necessary evidence to support an auditor's
conclusion about the proper accounting for transfers of financial
assets. Accordingly, the final amendments clarify that Appendix A of AS
1105, as adopted, applies in situations when an auditor uses the work
of a company's attorney as audit evidence in other matters relating to
legal expertise, such as when a legal interpretation of a contractual
provision or a legal opinion regarding isolation of transferred
financial assets is necessary to determine appropriate accounting or
disclosure under the applicable financial reporting framework.\122\ The
provision emphasizes the importance of legal opinions as audit evidence
in certain contexts and clarifies the requirements the auditor should
be applying in such circumstances.
---------------------------------------------------------------------------
\122\ See second note to AS 1105.A1, as adopted.
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Auditing Interpretation AI 28, Evidential Matter Relating to Income Tax
Accruals: Auditing Interpretations
The Board also proposed to rescind AI 28 in the Proposal. AI 28
provides guidance about matters related to auditing the income tax
accounts in a company's financial statements. Topics covered by the
interpretation include restrictions on access to the company's books
and records related to its income tax calculation, documentation of
evidence obtained in auditing the income tax accounts, and use of tax
opinions from company legal counsel and tax advisors. The
interpretation also reiterates certain requirements from PCAOB auditing
standards.
Most commenters did not express a view regarding the proposed
rescission of AI 28. A few commenters supported the proposed
rescission. Two commenters asserted that AI 28 provides useful guidance
to auditors regarding tax specialists and tax working papers and should
be retained. The Board has considered these comments and determined not
to rescind AI 28 at this time.
The Board recognizes that written advice or opinions of a company's
tax advisor or tax legal counsel on material tax matters are sometimes
necessary evidence to support the auditor's
[[Page 13469]]
conclusions on income tax accounts. Accordingly, the Board revised the
final amendments to acknowledge such situations and to clarify that, if
an auditor plans to use an opinion of legal counsel or the advice of a
tax advisor on specific tax issues as audit evidence, it is not
appropriate for the auditor to rely solely on that opinion or advice
with respect to those tax issues.\123\ Instead, the auditor needs to
evaluate the analysis underlying the tax opinion or tax advice to
determine whether it provides relevant and reliable evidence, taking
into account the requirements of the applicable financial reporting
framework.
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\123\ See footnote 1 to AS 1105.A1, as adopted; note to AS
2505.08, as amended.
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Certain Requirements of Existing AS 1210--Discussion of Remaining
Requirements Not Specifically Addressed in the Final Amendments
Decision to use a specialist. Existing AS 1210 states that an
auditor may encounter complex or subjective matters that are
potentially material to the financial statements. It further provides
that such matters, examples of which are provided, may require special
skill or knowledge and in the auditor's judgment require using the work
of a specialist to obtain appropriate evidential matter.\124\ The final
amendments do not retain this language, as this issue is already
addressed in AS 2101. Specifically, AS 2101.16 requires the auditor to
determine whether specialized skill or knowledge is needed to perform
appropriate risk assessments, plan or perform audit procedures, or
evaluate audit results.
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\124\ See existing AS 1210.06.
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Reporting requirements. Existing AS 1210 prohibits auditors from
making reference to the work or findings of a specialist in the
auditor's report, unless such reference will facilitate an
understanding of the reason for an explanatory paragraph, a departure
from an unqualified opinion, or a critical audit matter (``CAM''). A
CAM is defined as any matter arising from the audit of the financial
statements that was communicated or required to be communicated to the
audit committee and that relates to accounts or disclosures that were
material to the financial statements and involved especially
challenging, subjective, or complex auditor judgment.\125\ Depending on
the circumstances, the description of such CAMs might include a
discussion of the work or findings of a specialist.
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\125\ See AS 3101.11-.17.
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No commenters objected to omitting the prohibition in existing AS
1210 from the proposed amendments. For the reasons discussed above, the
Board did not make changes to the final amendments to incorporate these
extant requirements.
Other Aspects of the Final Amendments
The Board adopted additional amendments to conform its standards to
the final requirements in AS 1105, AS 1201, and AS 1210, as amended.
Those conforming amendments to AS 1015, AS 2301, AS 2310, The
Confirmation Process, AS 2401, Consideration of Fraud in a Financial
Statement Audit, AS 2610, Initial Audits--Communications Between
Predecessor and Successor Auditors, AT 601, Compliance Attestation, and
AT 701, Management's Discussion and Analysis, do not change the meaning
of existing requirements.
Effective Date
The Board determined that the final amendments take effect, subject
to approval by the SEC, for audits of financial statements for fiscal
years ending on or after December 15, 2020.
The Board sought comment on the amount of time auditors would need
before any amendments would become effective, if adopted by the Board
and approved by the SEC. A number of commenters supported an effective
date of two years after SEC approval of final amendments, asserting
that this would allow firms sufficient time to develop tools, update
methodologies, and provide training on the new requirements. A few
commenters also emphasized the importance of having the same effective
date for any new standards on using the work of specialists and
auditing accounting estimates.
While recognizing other implementation efforts, the effective date
determined by the Board is designed to provide auditors with a
reasonable period of time to implement the final amendments, without
unduly delaying the intended benefits resulting from these improvements
to PCAOB standards. The effective date is also aligned with the
effective date of the related standards and amendments being adopted in
the Estimates Release.
D. Economic Considerations and Application to Audits of Emerging Growth
Companies
The Board is mindful of the economic impacts of its standard
setting. This economic analysis describes the baseline for evaluating
the economic impacts of the final amendments, analyzes the need for the
final amendments, and discusses potential economic impacts of the final
amendments, including the potential benefits, costs, and unintended
consequences. The analysis also discusses alternatives considered.
In the Proposal, the Board had requested input from commenters on
their views pertinent to the economic considerations, including the
potential benefits and costs, discussed in the Proposal. One commenter
stated that it believed the Proposal can be effectively implemented
with minimal cost. Several commenters expressed concern, however, that
the cost of the Proposal would be relatively greater for smaller audit
firms and certain smaller companies. Some commenters also asserted that
the Proposal would adversely affect the ability of smaller firms to
compete in the audit services market. A number of commenters suggested
that the incremental cost of certain aspects of the Proposal would
outweigh any increase in audit quality. Finally, some commenters
expressed concern that the Proposal could result in a shortage of
qualified specialists due to, for example, a potential increase in the
demand for specialists by some audit firms under the proposed
requirements.\126\
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\126\ See below for a discussion of revisions to the proposed
requirements in the final amendments to address this concern.
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The Board has considered all comments received, and has made
certain changes to the final amendments to reflect those comments,
including changes that mitigate some of the concerns expressed above
with respect to the Proposal. The Board has also sought to develop an
economic analysis that evaluates the potential benefits and costs of
the final amendments, as well as facilitates comparisons to alternative
Board actions. There are limited data and research findings available
to estimate quantitatively the economic impacts of discrete changes to
auditing standards in this area, and furthermore, no additional data
was identified by commenters that would allow the Board to generally
quantify the expected economic impacts (including expected incremental
costs related to the Proposal) on audit firms or companies.\127\
Accordingly, the Board's discussion of the economic impact is
qualitative in nature.
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\127\ One commenter provided anecdotal data on certain aspects
of the Proposal that was limited to the commenter's experience in
one specialized area. The data provided by this commenter,
therefore, could not be used to quantify expected economic impacts
that would generally apply to the use of the work of specialists.
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[[Page 13470]]
Baseline
Section C above discusses existing PCAOB requirements for using the
work of specialists and existing practice in the application of those
requirements. This section addresses from an economic perspective: (1)
The prevalence and significance of audits involving specialists; (2)
the existing audit requirements that apply to the use of the work of
specialists; and (3) the quality of audits that involve specialists,
based on observations from regulatory oversight and academic
literature.
Prevalence and Significance of Audits Involving Specialists
Evidence From PCAOB Inspections Data
The Proposal observed that the PCAOB staff's analysis of
inspections data for audits of issuers suggests that larger audit firms
extensively use the work of specialists, in particular auditor-employed
specialists, while smaller audit firms generally have a lower
percentage of audit engagements in which they use the work of a
company's specialist or an auditor's specialist.
The conclusion regarding larger audit firms was based on a PCAOB
staff analysis of the 274 issuer audits \128\ by U.S. audit firms
affiliated with global networks \129\ that were selected for inspection
in 2015. This analysis found that auditors used the work of at least
one auditor-employed specialist in about 85 percent of those audits.
For the 85 percent of those audits that involved the use of auditor-
employed specialists, an average of four to five individual specialists
performed some work on each audit. In addition, on each of those
audits, specialists performed work in one to two fields of expertise on
average.\130\ The results indicate that such audits typically had more
than one specialist performing work in the same area of expertise.
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\128\ This analysis was performed on engagement-level data
obtained through PCAOB inspections. The audits inspected by the
PCAOB are most often selected based on risk rather than selected
randomly, and these numbers may not represent the use of the work of
specialists across a broader population of companies. On average,
the engagements selected for inspection are more likely to be
complex (and thus more likely to involve the use of the work of a
specialist) than the overall population of audit engagements.
\129\ These firms consist of those U.S. audit firms that are
registered with the PCAOB and affiliated with one of the six largest
global networks, based on information on network affiliations
reported by U.S. audit firms on Form 2 in 2017 and identified on the
``Global Networks'' overview page, available on the Board's website.
\130\ The data used in this analysis did not indicate how
frequently the auditor used the work of an auditor-engaged
specialist.
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The Proposal further noted that PCAOB inspections data for issuer
audits suggested that, in contrast to larger audit firms, smaller U.S.
audit firms generally have fewer audit engagements in which they use
the work of a company's specialist or an auditor's specialist.
Specifically, the PCAOB staff analyzed data from the 361 audits
performed by U.S. audit firms not affiliated with one of the global
networks that were selected for inspection by the PCAOB in 2015. Of
those 361 issuer audits, the PCAOB staff identified: (1) 36 Audits
(i.e., about 10% of the analyzed audit engagements) in which the
auditor used the work of a company's specialist but did not use the
work of an auditor's specialist; (2) 24 audits (i.e., about 7% of the
analyzed audit engagements) in which the auditor used the work of an
auditor's specialist but did not use the work of a company's
specialist; (3) 30 audits (i.e., about 8% of the analyzed audit
engagements) in which the auditor used the work of a company's
specialist and an auditor's specialist; and (4) 271 audits (i.e., about
75% of the analyzed audit engagements) in which the auditor neither
used the work of a company's specialist nor used an auditor's
specialist.
A PCAOB staff analysis of the 700 issuer audits by audit firms that
were selected for inspection in 2017 is broadly consistent with the
conclusions in the Proposal regarding the prevalence and significance
of audits involving specialists.\131\ The results of this analysis are
summarized in the table below:
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\131\ The discussion in note 128 that applies to the 2015
analysis--regarding the selection of inspected audit engagements and
how such engagements likely compare to the overall population of
audit engagements--likewise applies to this 2017 analysis. Unlike
the 2015 analysis, the engagement-level data selected for the
analysis of PCAOB inspections performed in 2017 included data on
issuer audit engagements conducted by non-U.S. as well as U.S. audit
firms. In addition, this engagement-level data was based on specific
focus areas, such as recurring audit deficiencies and audit areas
that may involve significant management or auditor judgment, for
issuer audit engagements selected for inspection. For a more
detailed discussion of PCAOB inspection focus areas, see PCAOB,
Staff Inspection Brief: Information about 2017 Inspections, Vol.
2017/3 (Aug. 2017).
Figure 5--Audits Performed by U.S. and Non-U.S. Audit Firms That Were Selected for Inspection by the PCAOB in
2017, Categorized by Use of the Work of Specialists
----------------------------------------------------------------------------------------------------------------
% (number) of
% (number) of % (number) of % (number) of audits by
audits by larger audits by audits by larger smaller audit
audit firms smaller audit audit firms firms (non-
(U.S.) firms (U.S.) (non-U.S.) U.S.)
----------------------------------------------------------------------------------------------------------------
(1) auditor used the work of a company's 8% (26) 10% (28) 8% (7) 6% (1)
specialist but did not use the work of
an auditor's specialist................
(2) auditor used the work of an 20% (66) 2% (6) 34% (29) 0% (0)
auditor's specialist but did not use
the work of a company's specialist.....
(3) auditor used the work of both a 41% (136) 6% (17) 29% (25) 0% (0)
company's specialist and an auditor's
specialist.............................
(4) auditor neither used the work of a 31% (102) 81% (216) 29% (25) 94% (16)
company's specialist nor used an
auditor's specialist \132\.............
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Total \133\......................... 100% (330) 100% (267) 100% (86) 100% (17)
----------------------------------------------------------------------------------------------------------------
Source: PCAOB.
As indicated by Figure 5, auditors used the work of an auditor's
specialist in 61% and 63% of the analyzed audit engagements (the sum of
categories (2) and (3) above) by larger audit firms--U.S. and non-U.S.
firms, respectively--selected for inspection in 2017. Auditors used the
work of a company's specialist without also using the work of an
auditor's specialist (category (1) above) in only 8% of the analyzed
audit engagements of larger audit firms--both
[[Page 13471]]
U.S. and non-U.S. firms, respectively--selected for inspection in 2017.
These results are also consistent with the anecdotal evidence discussed
in section C (i.e., that larger audit firms generally require their
engagement teams to evaluate the work of a company's specialist,
including the specialist's methods and significant assumptions, and
often employ specialists to assist their audit personnel in evaluating
that work).
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\132\ The audit engagements not included in the preceding three
categories were included in the fourth category.
\133\ The total for the values shown in categories (1) through
(4) may not add to 100% due to rounding.
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The results for smaller audit firms in Figure 5 are also consistent
with the analysis in the Proposal and suggest that the work of an
auditor's specialist or a company's specialist is used in relatively
few audits. Specifically, in 81% and 94% of the audits by smaller audit
firms--U.S. and non-U.S. firms, respectively--the auditor neither used
the work of a company's specialist nor used an auditor's specialist
(category (4) above), possibly because those audits did not involve
circumstances that warranted the use of specialists by companies or
their auditors. Consistent with the analysis of the issuer audits
selected for inspection in 2015, the results for smaller audit firms in
Figure 5 further suggest that, when smaller audit firms use the work of
a company's specialist, they often use that work without concurrently
using the work of an auditor's specialist. In 62% of the audits by
smaller U.S. firms that involved the use of the work of a company's
specialist, the audit firm did not concurrently use the work of an
auditor's specialist.\134\ An auditor's specialist also was not
concurrently involved in the only audit by a smaller non-U.S. firm that
involved the use of the work of a company's specialist (category (1)
above).
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\134\ Specifically, out of the 45 audit engagements of smaller
U.S. firms that involved the use of the work of a company's
specialists (the sum of categories (1) and (3) in Figure 5), 28
engagements did not concurrently involve the use of the work of an
auditor's specialist (category (1) in Figure 5).
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Evidence From the Academic Literature
Consistent with the results of the PCAOB staff analysis, the
academic literature suggests that, when a company uses a company's
specialist, some larger audit firms also tend to use the work of an
auditor's specialist, at least in the context of audits involving
challenging fair value measurements.\135\ Furthermore, the academic
literature also suggests that the use of valuation specialists is
prevalent for at least some audits. One recent study of audits by the
four largest firms that involved challenging fair value measurements
found that 86% of audit teams used an auditor's specialist, including
employed and engaged specialists.\136\ In addition, 60% of the
companies in this study used a company's specialist, including employed
and engaged specialists.\137\ The audits that were included in this
study may not be representative of all audit engagements, because they
were selected in order to study engagements that involved material,
highly challenging fair value measurements. However, the results
suggest that the use of an auditor's specialist is at least prevalent
among audits performed by the four largest U.S. firms where a company's
specialist is used to assist in the development of highly challenging
and material fair value measurements, which may also be audit areas
with a high risk of material misstatement and thus a need for greater
audit attention.\138\
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\135\ See, e.g., Nathan H. Cannon and Jean C. Bedard, Auditing
Challenging Fair Value Measurements: Evidence From the Field, 92 (4)
The Accounting Review 81 (2017) (study using an experiential
questionnaire involving audit partners and managers of Big 4 firms
in audits involving challenging fair value measurements).
\136\ See Cannon and Bedard, Auditing Challenging Fair Value
Measurements: Evidence From the Field 90. In another study of how
auditors use valuation specialists, auditors from seven large U.S.
audit firms who were interviewed stated that, on average, 61% of
their engagements in the prior year involved a valuation specialist,
including auditor-employed and/or auditor-engaged specialists. See
Emily E. Griffith, Auditors, Specialists, and Professional
Jurisdiction in Audits of Fair Values 13 (July 2016) (working paper,
available in Social Science Research Network (``SSRN'')).
\137\ See Cannon and Bedard, Auditing Challenging Fair Value
Measurements: Evidence From the Field 90.
\138\ Another recent qualitative study conducted through
interviewing audit partners, managers, and seniors also observed
that auditors in the six large audit firms in Canada consider
factors such as the ``client's regulatory environment and other
general risk factors,'' ``lack of subject matter expertise within
the audit team,'' and ``complexity of the engagement'' when
determining whether to use a specialist. See J. Efrim Boritz,
Natalia Kochetova-Kozloski, Linda A. Robinson, and Christopher Wong,
Auditors' and Specialists' Views About the Use of Specialists During
an Audit 28, 35 (Mar. 2017) (working paper, available in SSRN).
---------------------------------------------------------------------------
Furthermore, the academic literature also corroborates the
characterizations discussed in section C regarding the current practice
of audit firms when using specialists. Academic studies suggest that,
at least among the audits that were studied where specialists were
used, larger firms were more likely to use the work of auditor-employed
specialists than auditor-engaged specialists in their engagements,\139\
while even among the larger firms there are differences in the extent
of their use of the work of auditor-engaged specialists.\140\
---------------------------------------------------------------------------
\139\ See, e.g., Steven M. Glover, Mark H. Taylor, and Yi-Jing
Wu, Current Practices and Challenges in Auditing Fair Value
Measurements and Complex Estimates: Implications for Auditing
Standards and the Academy, 36 (1) Auditing: A Journal of Practice &
Theory 63, 75 (2017) (``[R]esults indicate that approximately two-
thirds (one-third) of our participants reported that they use in-
house (third-party) valuation specialists to support the audit work
performed for financial FVMs [i.e., fair value measurements].
Moreover, approximately 87 percent (13 percent) of the audit
partners indicated that they use in-house (third-party) valuation
specialists to support the audit work for nonfinancial FVMs.''); see
also Emily E. Griffith, Jacqueline S. Hammersley, and Kathryn
Kadous, Audits of Complex Estimates as Verification of Management
Numbers: How Institutional Pressures Shape Practice, 32 Contemporary
Accounting Research 833, 836 (2015) (``[A]uditors [from the U.S.
audit firms affiliated with the six largest global networks]
typically enlist audit-firm specialists in auditing estimates
because they do not have valuation expertise. . .'').
\140\ See Griffith, Auditors, Specialists, and Professional
Jurisdiction in Audits of Fair Values 58. In this study, all
participating auditors from Big 4 audit firms indicated that they
used internal valuation specialists (i.e., auditor-employed
valuation specialists) and did not use any external valuation
specialists (i.e., auditor-engaged valuation specialists). In
contrast, only 40% of the auditors from the three other audit firms
that participated in the study indicated that they exclusively used
internal valuation specialists.
---------------------------------------------------------------------------
A possible explanation for the tendency of larger firms to use the
work of auditor-employed specialists (instead of auditor-engaged
specialists) is that larger firms, due to the greater number of their
audit engagements or their existing non-auditing practices, have
sufficient demand for the services of specialists to warrant hiring
specialists who work for them full-time. In contrast, smaller firms may
not have many audit engagements where the auditor requires the use of
an auditor's specialist, so that engaging an auditor's specialist only
as needed may be economically more advantageous. In addition, the
tendency of smaller firms to look to the work of a company's specialist
without using the work of an auditor's specialist may reflect the fact
that existing AS 1210 enables the auditor to use the work of a
company's specialist in a wide range of situations, without imposing
obligations on the auditor that might call for the retention of an
auditor's specialist.\141\
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\141\ Similarly, the final amendments enable the auditor to use
the work of a company's specialist in a wide range of situations,
without necessarily obligating the auditor to retain an auditor's
specialist.
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PCAOB Auditing Standards Regarding Use of the Work of Specialists
As discussed in more detail in section C, under existing standards,
the auditor's primary responsibilities with respect to a company's
specialist are set forth in existing AS 1210. That standard also
imposes the same responsibilities on auditors with respect to an
auditor-engaged specialist, even though an auditor-engaged specialist
has a
[[Page 13472]]
fundamentally different role than a company's specialist. While the
auditor's specialist performs work to assist the auditor in obtaining
and evaluating audit evidence, the company's specialist performs work
that is used by the company in preparing its financial statements and
that the auditor may use as audit evidence.
The professional relationships between an auditor and a company's
specialist, and between an auditor and an auditor's specialist, differ,
among other things, in terms of who is employing or engaging the
specialist (i.e., the company in the case of a company's specialist and
the auditor in the case of an auditor's specialist). Therefore, the
level of control and oversight an auditor is able to exercise over the
specialist also differs. Given these differences, which expose a
company's specialist and an auditor-engaged specialist to different
incentives and biases (e.g., pressure to conform to management
bias),\142\ requirements would ideally differentiate between the two
types of specialists, but existing requirements do not do so.
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\142\ For a discussion of pressures facing a company's
specialist, see Divya Anantharaman, The Role of Specialists in
Financial Reporting: Evidence from Pension Accounting, 22 Review of
Accounting Studies 1261, 1299-300 (2017) (concluding that ``client
pressure and opinion shopping'' affect the work product of actuaries
used by company management, which ``suggests potentially greater
effects for other specialists not subject to the same levels of
oversight (e.g., experts in valuing complex financial instruments
and other untraded assets)'' and that ``economically important
clients of their actuaries use more aggressive (obligation-reducing)
discount rates [than] less important clients of the same actuary'').
---------------------------------------------------------------------------
In contrast, existing PCAOB requirements for using the work of an
auditor-employed specialist, who is subject to supervision under AS
1201, differ from the requirements that apply to using the work of an
auditor-engaged specialist. Auditor-employed and auditor-engaged
specialists may differ in their economic dependency on the auditor and,
by extension, could face different incentives to acquiesce to certain
auditor decisions, such as a decision by the auditor to downplay or
suppress unfavorable information in order to accommodate a conclusion
sought by the auditor.\143\ While anecdotal evidence from the academic
literature related to a company's specialists suggests that employed
specialists may face stronger incentives to do so than engaged
specialists,\144\ it is difficult to generalize as to whether auditor-
employed specialists have a greater economic dependency on auditors
than auditor-engaged specialists.\145\ Any potential bias by auditor-
employed and auditor-engaged specialists arising from economic
dependency on the auditor may be mitigated by the responsibility
imposed directly on the engagement partner under AS 1201 for
supervision of the work of engagement team members and compliance with
PCAOB standards, including those regarding using the work of
specialists. In addition, AS 1220 requires the engagement quality
reviewer to ``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.''
Such significant judgments may include areas where auditors used the
work of an auditor-employed or auditor-engaged specialist.
---------------------------------------------------------------------------
\143\ See, e.g., Griffith, Auditors, Specialists, and
Professional Jurisdiction in Audits of Fair Values 32 (``[A]udit
teams delete extraneous information in specialists' memos when that
information contradicts what the audit team has documented in other
audit work papers . . .'') and 33 (``Auditors and specialists
described several defensive behaviors by auditors that restrict
specialists' access to information . . . Restricting specialists'
access to information can influence how specialists do their work,
what work they do, and what conclusions they reach.'').
\144\ See, e.g., J. Richard Dietrich, Mary S. Harris, and Karl
A. Muller III, The Reliability of Investment Property Fair Value
Estimates, 30 Journal of Accounting and Economics 125, 155 (2001)
(``[O]ur investigation reveals that the reliability of fair value
estimates varies according to the relation between the appraiser and
the [company] (internal versus external appraiser) . . . We find
evidence that appraisals conducted by external appraisers result in
relatively more reliable fair value accounting estimates (i.e.,
lower conservative bias, greater accuracy and lower managerial
manipulation).'').
\145\ The extent of economic dependency of an auditor-employed
specialist on the auditor will depend, for example, on how much of
the specialist's work and the specialist's compensation is related
to audits (as opposed to non-audit services), which may vary for
different auditor-employed specialists. Similarly, the extent of
economic dependency of an auditor-engaged specialist on the auditor
will depend on how much of the specialist's overall work or income
is connected to the particular audit firm, which may vary for
different auditor-engaged specialists.
---------------------------------------------------------------------------
Furthermore, auditor-employed and auditor-engaged specialists serve
similar roles in helping auditors obtain and evaluate audit evidence.
Given their similar roles, it seems appropriate that the auditor would
follow similar requirements when using both types of specialists,
though existing requirements differ for the two types of specialists. A
notable difference in the relationship of the auditor with auditor-
employed and auditor-engaged specialists, however, relates to the
integration of auditor-employed specialists (as compared with auditor-
engaged specialists) in an audit firm's or network's quality control
systems, which allows the auditor greater visibility into any
relationships that might affect the auditor-employed specialist's
independence, as well as greater visibility into the auditor-employed
specialist's knowledge, skill, and ability. The final requirements with
respect to evaluating the objectivity, as well as knowledge, skill, and
ability, of an auditor-engaged specialist, therefore, sought to reflect
that difference by providing the auditor with specific requirements to
assess whether the auditor-engaged specialist has both the necessary
objectivity to exercise impartial judgment on all issues encompassed by
the specialist's work related to the audit and the level of knowledge,
skill, and ability to perform the specialist's work related to the
audit.
As discussed in more detail below, given the similar role of an
auditor-employed and an auditor-engaged specialist in the audit, the
auditor's procedures for reaching an understanding with the specialist
and evaluating the work to be performed by the specialist should be
similar. However, due to the differences in the auditor's ability to
assess the specialist's independence, as well as the specialist's
knowledge, skill, and ability, the Board is adopting separate, but
parallel, requirements for using the work of an auditor-employed
specialist and an auditor-engaged specialist. It is expected that there
would be few differences in the procedures undertaken by the auditor
when using an auditor's specialist, whether employed or engaged, with
such differences limited to the auditor's assessment of the knowledge,
skill, ability, and objectivity of an auditor-engaged specialist (where
the auditor may not be able to leverage an audit firm's or network's
quality control system to perform these assessments).
Quality of Audits That Involve Specialists
As discussed in section C, PCAOB oversight of audit engagements in
which auditors used the work of a company's or an auditor's specialist
and SEC enforcement actions have identified instances of noncompliance
with PCAOB standards, e.g., situations where auditors did not
appropriately evaluate the work of specialists. For issuer audit
engagements, PCAOB staff have more recently observed a decline in the
number of instances in which auditors at some audit firms did not
perform sufficient procedures related to the work of an auditor's
specialist. There are some preliminary indications that some, but not
all, firms with observed deficiencies have undertaken remedial actions
in response to such findings,
[[Page 13473]]
which may have contributed, at least in part, to improvements in audit
quality related to the auditor's use of an auditor's specialist.
Relatively few empirical academic studies have explicitly examined
the relationship between the use of specialists and perceptions of
audit quality by investors and auditors.\146\ This may be because it is
difficult, especially for investors, to assess the effect of using
specialists on audit quality independently from the effects of other
relevant factors, such as the quality of the company's financial
reporting or internal controls.\147\ However, available studies have
investigated the relationship between the quality of financial
statement estimates, which often are provided with the assistance of a
company's specialist, and the usefulness of such estimates to
investors. These studies find that less reliable estimates tend to be
less useful to investors.\148\ Other studies suggest that some
estimates are also more likely to be discounted by investors.\149\
Because investors' perceptions of the credibility of financial
statements are influenced by their perceptions of audit quality, the
auditor's appropriate use of the work of specialists should increase
the credibility of the accounting estimates included in the financial
statements.
---------------------------------------------------------------------------
\146\ See, e.g., Brant E. Christensen, Steven M. Glover, Thomas
C. Omer, Marjorie K Shelley, Understanding Audit Quality: Insights
from Audit Professionals and Investors, 33 Contemporary Accounting
Research 1648, 1667 (2016) (``Audit professionals [that were
surveyed as part of the study] associate the use of both external
experts and internal specialists with higher audit quality.'').
Relatedly, one recent academic study examined the relationship
between the use of forensic accountants (described by the authors as
``specialists'') and the value of their involvement as perceived by
the auditor. While forensic accountants are not specialists within
the scope of this standard, the authors of the study argued that the
findings ``likely translate into understanding other specialist
domains.'' The authors suggested that the involvement of forensic
accountants is accompanied by the ``incremental discovery of . . .
material misstatements,'' and further stated that ``our results
indicate both auditors and forensic specialists recognize the value
and additional comfort that come from forensic specialist
involvement on audits.'' See J. Gregory Jenkins, Eric M. Negangard,
and Mitchell J. Oler, Getting Comfortable on Audits: Understanding
Firms' Usage of Forensic Specialists, Contemporary Accounting
Research, in-press 4 (2017).
\147\ While not directly assessing the relationship between the
use of specialists and perceptions of audit quality, academic
literature has investigated factors that influence an auditor's
approach to auditing accounting estimates, including the decision
whether to use the work of specialists. See, e.g., Jennifer R. Joe,
Scott D. Vandervelde, Yi-Jing Wu, Use of High Quantification
Evidence in Fair Value Audits: Do Auditors Stay in their Comfort
Zone?, 92 (5) The Accounting Review 89 (2017); Emily E. Griffith,
When Do Auditors Use Specialists' Work to Improve Problem
Representations of and Judgments about Complex Estimates?, 93 (4)
The Accounting Review 177 (2018).
\148\ See, e.g., Scott A. Richardson, Richard G. Sloan, Mark T.
Soliman, and Irem Tuna, Accrual Reliability, Earnings Persistence
and Stock Prices, 39 Journal of Accounting and Economics 437, 437-
438 (2005) (finding that ``less reliable accruals lead to lower
earnings persistence . . . leading to significant security
mispricing'').
\149\ See, e.g., Chang Joon Song, Wayne B. Thomas, and Han Yi,
Value Relevance of FAS No. 157 Fair Value Hierarchy Information and
the Impact of Corporate Governance Mechanisms, 85 The Accounting
Review 1375 (2010). Furthermore, the academic literature notes that
auditing estimates with extreme uncertainty can pose significant
challenges for auditors. See, e.g., Brant E. Christensen, Steven M.
Glover, and David A. Wood, Extreme Estimation Uncertainty in Fair
Value Estimates: Implications for Audit Assurance, 31 (1) Auditing:
A Journal of Practice & Theory 127 (2012).
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Need for the Rulemaking
From an economic perspective, the primary cause for market failure
\150\ that motivates the need for the final amendments is the moral
hazard \151\ affecting the auditor's decisions on how to implement
audit procedures related to the use of the work of a specialist, which
increases the risk of lower audit quality from the investor's
perspective.
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\150\ For a discussion of the concept of market failure, see,
e.g., Francis M. Bator, The Anatomy of Market Failure, 72 The
Quarterly Journal of Economics 351 (1958); and Steven G. Medema, The
Hesitant Hand: Mill, Sidgwick, and the Evolution of the Theory of
Market Failure, 39 History of Political Economy 331 (2007).
\151\ The moral hazard problem is also referred to as a hidden
action, or agency problem, in economics literature. The term ``moral
hazard'' refers to a situation in which an agent could take actions
(such as not working hard enough) that are difficult to monitor by
the principal and would benefit the agent at the expense of the
principal. To mitigate moral hazard problems, the agent's actions
need to be better aligned with the interests of the principal.
Monitoring is one mechanism to mitigate these problems. See, e.g.,
Bengt Holmstr[ouml]m, Moral Hazard and Observability, 10 The Bell
Journal of Economics 74 (1979).
---------------------------------------------------------------------------
As described in the Proposal, the moral hazard problem related to
the use of the work of a specialist generally manifests in the auditor
not performing appropriate procedures, even though such procedures
would improve audit quality by increasing the auditor's attention,
because the auditor may not perceive sufficient economic benefit
(compared to the corresponding costs \152\ and efforts) from such
actions. Specifically, when auditors use the work of a company's
specialist, moral hazard may take the form of the auditor failing to
evaluate data, significant assumptions, and methods used by the
specialist to an extent that would be commensurate with the risk of
material misstatement inherent in the specialist's work. Moral hazard
in the context of auditors using the work of a company's specialist
might also take the form of the auditor failing to appropriately assess
relationships between the company's specialist and the company.\153\ In
addition, when auditors use the work of an auditor's specialist, moral
hazard may, for example, take the form of not performing procedures, or
performing insufficient procedures, to communicate and reach an
understanding with the specialist regarding the specialist's
responsibilities and the objectives of the specialist's work, or
insufficiently evaluating that work.\154\
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\152\ For a discussion of the effect of cost pressures on audit
quality, compare James L. Bierstaker and Arnold Wright, The Effects
of Fee Pressure and Partner Pressure on Audit Planning Decisions, 18
Advances in Accounting 25, 40 (2001) (finding, as the result of
their experiment, that ``auditors significantly reduced budgeted
hours . . . and planned tests . . . in response to fee pressure'')
with Bernard Pierce and Breda Sweeney, Cost-Quality Conflict in
Audit Firms: An Empirical Investigation, 13 European Accounting
Review 415 (2004) (finding, in relation to the Irish market, that
``dysfunctional behaviours'' are related to time pressure and
performance evaluation).
\153\ See Anantharaman, The Role of Specialists in Financial
Reporting: Evidence from Pension Accounting, at 1265 (describing
empirical evidence that suggests that auditors ``have difficulty in
screening out relationships'' that might impair the ``objectivity''
of company specialists).
\154\ Alternatively, it is conceivable that, in some situations,
moral hazard may take the form of the auditor either influencing the
findings or conclusions that specialists reach or modifying the
specialist's work after the fact to support the conclusions sought
by the auditor. See supra note 143.
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In such contexts, moral hazard is made possible by the information
asymmetry \155\ that exists due to the lack of transparency about the
nature of the auditor's work (i.e., between the auditor on the one
hand, and investors on the other hand). Investors typically do not know
whether an auditor used the work of a specialist and, if so, how the
work of the specialist was used. Because of this information asymmetry,
the auditor may face little to no scrutiny from investors or others
(e.g., audit committees) regarding his or her audit procedures when
using the work of specialists,\156\ and may perceive limited
[[Page 13474]]
economic benefits (e.g., gains in revenue, gains in professional
reputation, or a reduction in potential liability) in incurring costs
to perform additional audit work. Hence, the moral hazard problem
between the auditor and investors may have a detrimental impact on
audit quality.\157\
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\155\ Economists often describe ``information asymmetry'' as an
imbalance, where one party has more or better information than
another party. For a discussion of the concept of information
asymmetry, see, e.g., George A. Akerlof, The Market for ``Lemons'':
Quality Uncertainty and the Market Mechanism, 84 The Quarterly
Journal of Economics 488 (1970).
\156\ This is true for other aspects of the audit engagement as
well and hence the audit can be thought of providing investors with
a credence service. Credence services are difficult for users of the
service (such as investors in the context of company audit services)
to value because their benefits are difficult to observe and
measure. See Monika Causholli and W. Robert Knechel, An Examination
of the Credence Attributes of an Audit, 26 Accounting Horizons 631
(2012). See also Alice Belcher, Audit Quality and the Market for
Audits: An Analysis of Recent UK Regulatory Policies, 18 Bond Law
Review 1, 5 (2006) (An ``audit is a credence service in that its
quality may never be discovered by the company, the shareholders or
other users of the financial statements. It may only come into
question if a `clean' audit report is followed by the collapse of
the company.'').
\157\ Additionally, such situations may occur because the
auditor made an error in judgment assessing the audit risk involved
when using the work of an auditor's specialist or a company's
specialist. In situations in which ``objectives and the actions
needed to achieve them are complex and multifaceted, it is
inevitable that different people . . . will . . . interpret . . .
them in different ways . . .'' See John Hendry, The Principal's
Other Problems: Honest Incompetence and the Specification of
Objectives, 27 Academy of Management Review 98, 107-108 (2002). When
people are choosing their actions in such situations, Hendry argues
that the predicted actions (and hence resulting problems) are more
or less the same, whether one assumes that they are unselfish yet
``prone to mak[ing] mistakes,'' or instead are self-interested and
opportunistic yet unlikely to make mistakes. Id. at 100.
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Because market forces (e.g., pressure and demands from investors)
may not be effective in making the auditor more responsive to investor
interests with respect to the use of the work of specialists,\158\ from
an economic perspective, the situation absent standards would be
characterized as a form of market failure. While existing standards
regarding the use of the work of a company's specialist and an auditor-
engaged specialist are intended to address and mitigate potential
auditor moral hazard, they could be aligned more closely with the risk
assessment standards, which could enhance audit quality. In addition,
while auditor-employed specialists are supervised under a risk-based
approach, specifying requirements for applying that approach when using
an auditor-engaged specialist could promote an improved, more uniform
approach to supervision. Additionally, if the work of an auditor's
specialist is not properly overseen or evaluated (or the work of a
company's specialist is not properly evaluated), there may be a
heightened risk that the auditor's work will not be sufficient to
detect a material misstatement in significant accounts and disclosures.
---------------------------------------------------------------------------
\158\ The degree of responsiveness of the auditor to investor
interests, such as increasing audit effort in some circumstances
when using the work of specialists, may also be related to, among
other things, the auditor's ability to pass on cost increases to
companies (and, ultimately, to investors) in the form of higher
audit fees. See infra note 175 for a further discussion of cost
pass-through.
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Furthermore, the auditor does not engage or employ a company's
specialist and does not supervise the work of a company's specialist.
This makes the auditor's use of the work of a company's specialist
different from the auditor's use of an auditor's specialist in several
important ways. First, because of the different relationships the
auditor has with a company's specialist and with an auditor's
specialist, the auditor's assessment of the qualifications and
relationships of a company's specialist requires greater effort by the
auditor compared to the auditor's equivalent procedures with respect to
an auditor's specialist. Second, the auditor's consideration of data,
significant assumptions, and methods used by the company's specialist
may also be more challenging (for example, due to the specialist's use
of proprietary data), compared to equivalent procedures performed by
the auditor when using a specialist with whom the auditor has an
employment or contractual relationship. Third, an auditor is generally
more likely to be familiar with an auditor's specialist than with a
company's specialist (e.g., with the professional qualifications,
reputation, and work), which reduces the costs associated with the
ongoing monitoring of the specialist's work. Given these differences,
the standards would ideally differentiate between the two types of
specialists, but existing AS 1210 currently does not do so.
Accordingly, the potential for moral hazard relating to the auditor's
use of the work of a company's specialist is a particular focus of the
requirements in the final amendments to AS 1105.
The need to enhance existing standards is further heightened by the
fact that it may be particularly challenging for the auditor to
evaluate the work of either an auditor's specialist or a company's
specialist or to supervise an auditor's specialist. The work of a
company's specialist or an auditor's specialist often involves
professional judgment, the nature of which the auditor may not fully
appreciate when evaluating the work of the specialist. In particular,
the specialist's work is highly technical in nature and often is not
entirely transparent to the auditor, who may not have complete access
to the specialist's work \159\ or the same level of knowledge and skill
in the specialist's field.\160\ Thus, due to the potential that an
auditor would incur relatively higher cost to supervise an auditor's
specialist or to evaluate the work of a company's or an auditor's
specialist, the auditor may have incentives to forego procedures
related to the use of the work of specialists that could be beneficial
to investors.
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\159\ For example, as further discussed in section C, some
commenters on the Proposal expressed concern that the auditor may
have limited access to proprietary information used by a company's
specialist or an auditor-engaged specialist (as compared with
information used by an auditor-employed specialist). The final
amendments do not require the auditor to obtain such proprietary
information, but instead to obtain sufficient information to assess
whether the model is in conformity with the applicable financial
reporting framework.
\160\ See, e.g., Griffith, Auditors, Specialists, and
Professional Jurisdiction in Audits of Fair Values 23 (``[Results]
show[ ] that many auditors review specialists' work for general
understanding and sufficiency of the work performed, rather than
reviewing in detail as they would in other areas of the audit. They
approach the review this way because they cannot fully understand
specialists' work.'').
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The potential negative impact on audit quality of the auditor's
incentives to forgo procedures is compounded by the possibility that an
auditor's specialist may perceive little benefit (compared to the
corresponding costs and efforts) in fully carrying out their
responsibilities, including the objectives of the work to be
performed.\161\ Alternatively, the specialist may in some instances
believe that he or she faces few negative consequences (such as an
increase in potential liability) when performing low quality work or,
as one commenter on the Proposal asserted, an auditor's specialist may
not set forth conclusions anticipated to be rejected by the auditor.
However, any such concerns are at least partially alleviated to the
extent specialists are subject to codes of conduct, standards, and
disciplinary processes of their own profession or could perceive a risk
of reputational damage.\162\
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\161\ To the extent that an auditor's specialist has a stronger
relationship with the auditor (e.g., repeated business interactions
between the specialist and the auditor), the potential for moral
hazard arising in the context of the auditor using such an auditor's
specialist could be higher. However, a stronger relationship between
the auditor and the auditor's specialist may also result in the
specialist's work being more commensurate with the risk of material
misstatement associated with the financial statement assertion and,
therefore, improve audit quality.
\162\ See, e.g., Letter from American Academy of Actuaries (Aug.
29, 2017), at 1-2, available on the Board's website in Docket 044
(stating that the Academy's members ``are subject to a code of
professional conduct, standards of qualification and practice, and a
disciplinary process'' and that ``our profession has a specific
standard that defines appropriate practice for actuaries during the
course of an audit'').
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The Proposal stated that enhanced performance standards regarding
the use of the work of specialists might improve audit quality and
benefit investors. One commenter asserted that the Proposal had not
articulated a pervasive problem that would be solved by a change in
auditing standards. This commenter further stated that it was not
persuaded
[[Page 13475]]
that a change in the audit framework for the auditor's use of
specialists was necessary, based on its view that a significant amount
of audit work is currently being performed. The Board believes,
however, that the changes in the final amendments described in section
C are needed (and preferable to other policy-making approaches) \163\
because market forces alone cannot mitigate the moral hazard problem
described above.
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\163\ See below for a discussion of why the Board believes that
standard setting is preferable to other policy-making approaches.
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Strengthening the requirements for evaluating the work of a
company's specialist, as well as applying a risk-based supervisory
approach when using the work of both auditor-employed and auditor-
engaged specialists, will prompt auditors to plan and perform audit
procedures commensurate with the risk of material misstatement inherent
in the specialist's work, and thereby mitigate the moral hazard
problem. The final amendments direct more audit attention and effort,
when using the work of specialists, to areas where the specialist's
work is more significant to the auditor's conclusion on a financial
statement assertion and the risk of material misstatement is higher.
Specifically, as discussed in section C, the final amendments
mitigate the moral hazard problem by linking the auditor's
responsibilities for determining the necessary evidence when evaluating
the work of the company's specialist, including the data, significant
assumptions, and methods used by the specialist, to four factors: The
risk of material misstatement of the relevant assertion; the
significance of the specialist's work to the auditor's conclusion
regarding that assertion; the level of knowledge, skill, and ability of
the specialist; and the ability of the company to significantly affect
the specialist's judgments about the work performed, conclusions, or
findings.
Further, the final amendments mitigate the moral hazard problem in
the context of the use of the work of an auditor's specialists by
clarifying the auditor's supervisory responsibilities over auditor-
employed specialists and establishing parallel requirements when
auditors use the work of auditor-engaged specialists, as discussed in
section C. In addition, the necessary extent of supervision under the
final amendments depends on factors similar to those that govern the
necessary auditor effort in evaluating the work of a company's
specialist.
Economic Impacts
The magnitude of the benefits and costs of the final amendments
will be affected by the nature of and risks involved in the work
performed by specialists, because more complex work and work in areas
of greater risk will likely require greater audit effort, holding all
else constant. In addition, benefits and costs are likely to be
affected by the degree to which auditors have already adopted audit
practices and methodologies that are similar to those that the final
amendments will require.\164\
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\164\ Additionally, the new standard and related amendments in
the Estimates Release, supra note 20, may affect the future
prevalence and significance of the use of the work of specialists
and, therefore, have an impact on the benefits and costs of the
final amendments discussed in this section.
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The remainder of this subsection discusses the potential benefits,
costs, and unintended consequences that may result from the final
amendments the Board is adopting.
Benefits
The requirements in the final amendments are expected to benefit
investors and auditors by directing auditors to devote more attention
to the work of specialists and enhancing the coordination between
auditors and their specialists. This should mitigate the problem of
auditor moral hazard discussed in the preceding section and contribute
to improved audit quality. The final amendments are intended to
accomplish this, and increase the likelihood that auditors will detect
material misstatements, through requirements that take into account
current auditing practices by some larger audit firms and more strongly
align auditors' interests with the interests of investors when auditors
use the work of specialists. At the same time, by fostering improved
audit quality, the final amendments should increase investors'
perception of the credibility of a company's financial statements, and
help address uncertainty about audit quality and the potential risks
associated with the use of the work of company specialists, auditor-
employed specialists, and auditor-engaged specialists.
The Board believes that investors will benefit from the final
amendments because the application of the requirements should result in
more consistently rigorous practices among auditors when using the work
of a company's specialist in their audits, as well as a more consistent
approach to the supervision of auditor-employed and auditor-engaged
specialists. The current divergence in practices related to the
auditor's use of the work of specialists, combined with a lack of
information about such divergence, could mean that investors are unable
to distinguish the quality of each audit separately, which in turn
could lead investors to discount the quality of all audits. Conversely,
greater consistency in such practices--such as would be promoted by the
final amendments--could mitigate those concerns by both enhancing the
quality of less rigorous audits and correcting the inappropriate
discounting of more rigorous audits. From an investor's perspective,
and as one commenter concurred, the increase in audit quality that
should result from the final amendments should contribute to investor
protection. Specifically, an increase in audit quality may increase the
quality of the information provided in a company's financial statements
and decrease the cost of capital for that company,\165\ especially if
less information is available about the company because it has a
shorter financial reporting history.\166\
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\165\ See, e.g., Richard A. Lambert, Christian Leuz, and Robert
E. Verrecchia, Accounting Information, Disclosure, and the Cost of
Capital, 45 Journal of Accounting Research 385, 386-7 (2007)
(``[A]ccounting information influences a [company's] cost of capital
. . . where higher quality accounting information . . . affects the
market participants' assessments of the distribution of future cash
flows''); see also Randolph P. Beatty, Auditor Reputation and the
Pricing of Initial Public Offerings, 64 The Accounting Review 693,
696 (1989) (``Since auditing firms that have invested more in
reputation capital have greater incentives to reduce application
errors, the information disclosed in the accounting reports audited
by these firms will be more precise, ceteris paribus. This reduction
in measurement error will allow uninformed investors to estimate
more precisely the distribution of firm value.'').
\166\ See, e.g., Jeffrey A. Pittman and Steve Fortin, Auditor
Choice and the Cost of Debt Capital for Newly Public Firms, 37
Journal of Accounting and Economics 113, 114 (2004) (``[E]ngaging
[an audit firm with] a brand name reputation for supplying higher-
quality audit that enhances the credibility of financial statements,
enables young [companies] to reduce their borrowing costs . . .
[O]ur research suggests that the economic value of auditor
reputation declines with age as [companies] shift toward exploiting
their own reputations to reduce information asymmetry.'').
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From a broader capital markets perspective, an increase in the
information quality of a company's financial statements because of
improved audit quality can increase the efficiency of capital
allocation decisions. In other words, an increase in the information
quality of companies' financial statements can reduce the non-
diversifiable risk to investors and generally should result in
investment decisions by investors that more accurately reflect the
financial position
[[Page 13476]]
and operating results of each company.\167\
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\167\ See, e.g., Lambert et al., Accounting Information,
Disclosure, and the Cost of Capital 388 (finding that information
quality directly influences a company's cost of capital and that
improvements in information quality by individual companies
unambiguously affect their non-diversifiable risks.); Ahsan Habib,
Information Risk and the Cost of Capital: Review of the Empirical
Literature, 25 Journal of Accounting Literature 127, 128 (2006) (``A
commitment to increased level [and quality] of disclosure reduces
the possibility of information asymmetries and hence should lead to
a lower cost of capital effect. . . . In addition, high quality
auditing . . . could provide credible information in the market
regarding the future prospect of the [company] and hence could
reduce the cost of capital in general, and cost of equity capital in
particular.'' (footnote omitted)).
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In addition to the general benefits to investors and the capital
markets described above, the final amendments should result in specific
benefits to auditors. In particular, the final amendments should lead
to improvements in the ability of auditors to supervise auditor-
employed and auditor-engaged specialists and evaluate their work, to
the extent that auditors devote more attention to the work of auditor-
employed and auditor-engaged specialists and enhance the coordination
with those specialists. The final amendments with regard to the use of
the work of a company's specialist should also lead to improvements in
the auditor's understanding of the data, significant assumptions, and
methods used by the company's specialist. As auditors are better able
to identify and detect potential risks of material misstatement, this
may also spur companies and their specialists over time to improve the
quality of financial reporting and their work.
The final amendments may also contribute to the aggregate benefits
of the auditing standards (i.e., by enhancing auditors' understanding
of, and compliance with, other PCAOB auditing standards), in addition
to the other improvements in audit quality described above. For
example, the final amendments to evaluate the work of a company's
specialist should result in some auditors developing a better
understanding of the company's accounting estimates in significant
financial statement accounts and disclosures. In turn, this may also
result in improved communications with audit committees.\168\
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\168\ See paragraphs .12c and .13c of AS 1301, Communications
with Audit Committees, for the auditor's communication requirements
related to the company's critical accounting estimates.
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The magnitude of the benefits discussed in this section resulting
from improved audit quality will likely vary to the extent that current
practices are aligned with the final amendments. Based on observations
from the Board's oversight activities, most firms would need to enhance
their methodologies, but to varying degrees. In general, both the
greatest changes and the greatest benefits are likely to occur with
auditors that need to enhance their methodologies the most.
Costs
The Board recognizes that the benefits of the final amendments will
come at additional costs to auditors and the companies they audit. As
with any changes to existing requirements, it is anticipated that there
will be one-time costs for auditors associated with updating audit
methodologies and tools, preparing new training materials, and
conducting training.\169\ The final amendments could also give rise to
recurring costs in the form of additional time and effort spent on any
individual audit engagement by specialists and engagement team members.
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\169\ The PCAOB has observed that larger firms are likely to
update their methodologies using internal resources, whereas smaller
firms are more likely to purchase updated methodologies from
external vendors.
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The most significant impact of the final amendments on costs for
auditors is expected to result from the requirements to evaluate the
work of a company's specialist. This area of potential impact was also
noted by some commenters on the proposed requirements for testing and
evaluating the work of a company's specialist.
Compared with the existing requirements,\170\ the auditor will be
required under the final amendments to evaluate the significant
assumptions used by the company's specialist whenever the specialist's
work is used, rather than only in certain circumstances,\171\ as well
as the methods used by the specialist. In practice, these requirements
may result in auditors performing more work or using an auditor's
specialist to assist them in evaluating the work of a company's
specialist. This may lead to significant changes in practice for some
firms, particularly smaller firms that currently do not employ
specialists and follow methodologies solely based on existing AS 1210,
even though the final amendments do not require the auditor to use the
work of an auditor's specialist.
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\170\ See existing AS 1210.12.
\171\ In circumstances when an auditor is auditing fair value
measurements and disclosures in accordance with AS 2502, footnote 2
of that standard provides that management's assumptions include
assumptions developed by a specialist engaged or employed by
management. Therefore, the auditor is currently required to evaluate
the reasonableness of significant assumptions developed by the
company's specialist when auditing a fair value measurements and
disclosures.
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Compared to the Proposal, however, the final amendments clarify the
auditor's responsibility when evaluating the work of the company's
specialist and, therefore, should further limit any incremental cost to
circumstances where increases in audit quality can be reasonably
expected. For example, as detailed in section C, the final amendments
reflect changes to the Proposal relating to the auditor's evaluation of
the data, significant assumptions, and methods used by the company's
specialist. These revisions clarify that the focus of the auditor's
evaluation does not require reperforming the specialist's work.
Instead, the auditor's responsibility is to evaluate whether the
specialist's work provides sufficient appropriate evidence to support a
conclusion regarding whether the corresponding accounts or disclosures
in the financial statements are in conformity with the applicable
financial reporting framework.
In addition, some of the expected cost increases for auditors due
to the final amendments are likely to be offset by the implementation
of more risk-based audit approaches in practice (e.g., more targeted
procedures when using the work of specialists). More risk-based audit
approaches reduce the risk to the auditor of failing to detect material
misstatement and thus could lead to a reduction in costs resulting from
potential liability or reputational loss faced by auditors.
The final amendments' impact on costs for auditors could also vary
based on the size and complexity of an audit engagement. Holding all
else constant, anticipated costs generally would be higher for larger,
more complex audits than for smaller, less complex audits.\172\ As
discussed above, a smaller portion of audits performed by smaller audit
firms tend to involve use of the work of specialists, compared with
audits performed by larger audit firms. Accordingly, it is reasonable
to infer that relatively fewer audits of smaller firms will be impacted
by the final amendments than audits of larger firms.
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\172\ See Letter from American Academy of Actuaries (July 31,
2015), at 18, available on the Board's website in Docket 044
(stating that ``smaller audit firms also tend to have clients that
require fewer special needs'' and thus implying that audit
engagements of smaller audit firms tend to be less complex than
audit engagements of larger audit firms).
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The impact of the final amendments would also likely vary, however,
depending on the extent to which elements of the final amendments have
already been incorporated in an audit
[[Page 13477]]
firm's methodologies or applied in practice by individual engagement
teams. For auditors that have already implemented elements of the final
amendments, the costs of implementing the final amendments will be
lower than for firms that currently perform more limited audit
procedures. For example, some firms employ procedures to reach and
document their understanding with an auditor's specialist about, among
other things, the responsibilities of the auditor's specialist and the
nature of the work to be performed. Firms that do not already employ
such procedures may incur additional costs under the final amendments.
Similarly, the incremental impact of the final amendments on costs
incurred by auditors would likely vary depending on, among other
things, how many of an audit firm's engagements involve the use of the
work of specialists. Among audit firms that use the work of specialists
on their engagements, the anticipated costs would likely be higher for
those firms that use the work of specialists more frequently or
extensively than for firms that do so less frequently or extensively.
Larger audit firms generally perform a larger number of audit
engagements, however, and the incremental impact of the final
amendments on their costs per engagement should be lower than for
smaller firms that generally perform a smaller number of audit
engagements. This would be the case regardless of whether the audit
engagements of the larger and smaller firms involve the use of the work
of specialists, since larger firms, due to their existing economies of
scale \173\ and scope,\174\ would tend to be able to distribute the
overall cost impact of the final amendments over a larger number of
audit engagements.
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\173\ See Economies of Scale and Scope, The Economist, Oct. 20,
2008 (available at https://www.economist.com/news/2008/10/20/economies-of-scale-and-scope) (``Economies of scale are factors that
cause the average cost of producing something to fall as the volume
of its output [i.e., number of audit engagements] increases.''). In
this context, the average cost would likely fall with the number of
audit engagements, because certain costs, such as the cost of
employing specialists, are not directly related to the number of
audit engagements that an auditor assumes. See also Simon Yu Kit
Fung, Ferdinand A. Gul, and Jagan Krishnan, City-Level Auditor
Industry Specialization, Economies of Scale, and Audit Pricing 87
The Accounting Review 1281, 1287 (2012) (``For an audit firm, the
scale economies can arise from substantial investment in general
audit technology (e.g., audit software development or hardware
acquisition) and human capital development (e.g., staff training),
which are likely to be shared among all of their clients. Once these
investments are in place, additional clients can be serviced at a
lower marginal cost than the cost of servicing the first few
clients.'').
\174\ See Economies of Scale and Scope, The Economist
(``[E]conomies of scope [are] factors that make it cheaper to
produce a range of products together than to produce each one of
them on its own. Such economies can come from businesses sharing
centralised functions . . .'').
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Some commenters argued that the Proposal could lead, in some
instances, to significant (and potentially pervasive) increases in
auditing costs, due to increased audit effort that would not
necessarily be accompanied by corresponding increases in audit quality.
In contrast, one commenter asserted that the requirements could be
implemented effectively with minimal costs. In adopting the final
amendments, the Board modified certain of the proposed amendments with
the intent that the final amendments be risk-based and scalable, and
that any cost increases be accompanied by commensurate improvements in
audit quality. For example, as discussed earlier in this subsection,
the final amendments reflect changes to the Proposal relating to the
auditor's evaluation of the data, significant assumptions, and methods
used by the company's specialist. These changes clarify that the focus
of the auditor's evaluation does not require reperforming the
specialist's work and thus should limit incremental costs to situations
where more auditor involvement is necessary to address the identified
risk of material misstatement.
The final amendments might result in additional costs for some
companies, compared to costs incurred under current requirements, to
the extent that the final amendments lead auditors to raise their audit
fees.\175\ Such additional costs could vary for the same reasons as
described above relating to the final amendments' potential impact on
costs incurred by auditors. The final amendments could also give rise
to new recurring costs for management, to the extent that the final
amendments result in the need for companies to devote more time and
resources to respond to auditor inquiries and requests. Some commenters
on the Proposal expressed concern about the potential cost to
companies, including smaller companies. For example, one commenter
suggested that companies might need to provide more support for their
discount rate assumptions under the proposed amendments. On the other
hand, another commenter suggested that, in the context of the size of
the U.S. fixed income market, consistent use of methodologies compliant
with fair value accounting requirements by companies would be a small
cost to bear.
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\175\ It is not clear to what extent the final amendments will
result in higher audit fees. The Board is aware of public reports
that have analyzed historical and aggregate data on audit fees and
suggest that audit fees generally have remained stable in recent
years, notwithstanding the fact that the Board and other auditing
standard setters have issued new standards and amended other
standards during that period. See, e.g., Audit Analytics, Audit Fees
and Non-Audit Fees: A Fifteen Year Trend (Dec. 2017). For a general
discussion of cost pass-through, see, e.g., James Bierstaker, Rich
Houston, Arnold Wright, The Impact of Competition on Audit Planning,
Review, and Performance, 25 Journal of Accounting Literature 1, 12
(2006) (summarizing research on the market for audit services and
finding ``there is evidence of lower fee premiums when clients
switch auditors, suggesting that auditors are less able to pass on
the increased costs associated with new audits in a more competitive
environment''); and RBB Economics, Brief 48: The Price Effect of
Cost Changes: Passing Through and Here to Stay 1, 3 (Dec. 2014).
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For many companies (and, indirectly, investors), however, the final
amendments should not result in significant additional costs or
significantly increased audit fees, particularly recurring costs, as
their auditors, especially if they are larger audit firms, may have
already incorporated many or all elements of the final amendments into
their audit methodologies, and individual engagement teams may already
be applying many or all of the final amendments in practice. In
addition, the changes from the Proposal reflected in the final
amendments, which clarify the auditor's responsibility when evaluating
the work of the company's specialist, should mitigate some of the
potential additional costs suggested by commenters.
Unintended Consequences
In addition to the benefits and costs discussed above, the final
amendments could have unintended economic impacts, the possibility of
which the Board has taken into account in adopting the final
amendments. The discussion below describes the potential unintended
consequences that were identified in the Proposal or by commenters, as
well as the Board's consideration of such consequences in adopting the
final amendments. The discussion also addresses, where applicable,
factors that mitigate the potential negative consequences, including
revisions to the proposed amendments reflected in the final amendments
and the existence of other countervailing factors.
Potential Adverse Impact on the Ability of Smaller Firms To Provide
Audit Services
In instances where the final amendments would increase the need of
some audit firms to use the work of an auditor's specialist (rather
than only use the work of a company's specialist under existing AS
1210), the final amendments might result in some smaller firms
accepting fewer audit engagements that would require the use
[[Page 13478]]
of an auditor's specialist. Relatedly, in such instances, some smaller
firms might be inhibited from expanding their audit services for
similar reasons. The Board had acknowledged the possibility of such
unintended consequences in the Proposal, and some commenters also
expressed the view that the proposed amendments might adversely impact
the ability of smaller firms to provide audit services in certain
situations.
In particular, to the extent that auditors at smaller audit firms
have less experience evaluating the work of a company's specialist than
auditors at larger firms, some auditors may have an increased need to
use the work of an auditor's specialist for certain engagements.
Potentially, such firms would be unable to take advantage of the
economies of scale and scope available to larger firms (for example, if
they did not employ their own specialists and had to identify and
engage qualified specialists), and find it economically less attractive
to accept such engagements. In addition, some commenters on the
Proposal suggested more broadly that the ability of smaller firms to
compete in the audit services market would be adversely affected. The
Board acknowledges that the final amendments could have a more
significant impact on smaller firms than on larger firms. However, the
Board believes that two factors will lessen any such adverse impact of
the final amendments on smaller firms.
First, as described earlier in this section, the evidence from
PCAOB inspections data indicates that smaller audit firms generally
have comparatively few audit engagements in which they use the work of
a company's specialist or an auditor's specialist. For example, the
results for smaller audit firms in Figure 5 above indicate that the
auditors did not use the work of either a company's specialist or an
auditor's specialist in 81% and 94% of the audits of smaller audit
firms--U.S. and non-U.S. firms, respectively--inspected in 2017, and
that the auditors used the work of a company's specialist without also
using the work of an auditor's specialist \176\ in only 10% and 6% of
the audits of smaller audit firms--U.S. and non-U.S. firms,
respectively--inspected in 2017.\177\ These results suggest that the
number of engagements where smaller firms might be faced with using an
auditor's specialist for the first time to evaluate the work of a
company's specialist under the final amendments is a relatively small
proportion of audits subject to the Board's standards.
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\176\ The fact that the auditor did not use the work of an
auditor's specialist does not imply that the auditor should have
used the work of an auditor's specialist.
\177\ Furthermore, given that the engagements selected for
inspection are on average more likely to be complex (and thus more
likely to involve the use of the work of a specialist) than the
overall population of audit engagements of smaller audit firms, the
percentage results shown above for audits involving the use of the
work of specialists are likely greater than the actual percentage of
the overall population of audit engagements of smaller audit firms.
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Second, there is some evidence that smaller and larger audit firms
do not directly compete with one another in some segments of the audit
market.\178\ To the extent smaller audit firms compete in different
segments of the audit market than larger audit firms, the competitive
impact of the final amendments on smaller firms would be lessened.
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\178\ See, e.g., GAO Report No. GAO-03-864, Public Accounting
Firms: Mandated Study on Consolidation and Competition (July 2003).
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Taking into consideration the factors described above, the final
amendments further mitigate the potential adverse impact on the ability
of smaller firms to provide audit services involving, or compete for
audit engagements that require, the use of the work of specialists. For
example, the clarifications in the final amendments for evaluating the
work of a company's specialist, such as limiting the use of the term
``test'' to procedures applied to company-produced information used by
the specialist, should alleviate concerns expressed by certain
commenters on the Proposal that auditors would be required to reperform
the work of a company's specialist. In addition, under the final
amendments, auditors are allowed to assess the objectivity of an
auditor-engaged specialist along a spectrum, rather than make a binary
determination whether they can use the work of an auditor-engaged
specialist.\179\
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\179\ Similarly, the final amendments recognize that a company's
ability to significantly affect the judgments of a company's
specialist may vary and provide for the auditor to evaluate along a
spectrum the company's ability to significantly affect those
judgments.
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Potential Diversion of Auditor Attention From Other Tasks That Warrant
Attention
In some audit engagements involving specialists, the final
amendments might lead auditors to devote more of their attention and
resources to the work of a company's specialists (including the related
training of audit personnel) and to enhancing the coordination with an
auditor's specialists, and less time and resources to other tasks that
warrant greater attention.
The potential impact on overall audit quality might vary as the re-
orientation of attention would occur in different ways for each audit
engagement. Any potential adverse impact on overall audit quality is
mitigated, however, by the risk-based approach in the final amendments
to using the work of specialists. To the extent that the re-orientation
of the auditor's attention leads to more effort in areas with the
greatest risk of material misstatement to the financial statements,
overall audit quality would be expected to increase. Furthermore, if
auditors devote more attention to the work of specialists and enhancing
the coordination with their specialists, the final amendments will
result in some auditors acquiring greater expertise, which could
positively affect the quality of audit work performed by such auditors.
Such auditor specialization could lead some audit firms to seek fewer
audit engagements involving specialists, while other firms might seek
more such engagements. In such a market, the competitive effects of
increased specialization would likely be highly dependent on the
circumstances.
Potential for Unnecessary Effort by the Auditor or the Auditor's
Specialist
Under the final amendments, the potential exists that auditors
might interpret the final requirements to suggest that they should use
the work of an auditor's specialist in situations where the auditor had
already obtained sufficient appropriate evidence with respect to a
relevant assertion of a significant account or disclosure. The Proposal
also identified this potential consequence, and some commenters
expressed concern that auditors might feel compelled to do more work
than was necessary or optimal under the proposed requirements. This
unintended consequence might also arise under the final amendments if
an auditor had already evaluated the work of a company's specialist,
but decided to employ or engage its own specialist to perform
additional procedures. For example, the auditor might ask an auditor's
specialist to develop or assist in developing an independent
expectation of an estimate in order to further demonstrate his or her
diligence or err on the side of caution. In some instances, it is
possible that the auditor might do so even though the auditor believes
the costs of using the work of an auditor's specialist will outweigh
the expected benefits in terms of audit quality.
The final amendments, however, mitigate this risk in several
respects. In particular, the final amendments do not require the
auditor to use the work of an
[[Page 13479]]
auditor's specialist. Moreover, the final amendments regarding the
nature, timing, and extent of the evaluation of the work of the
company's specialist are designed to be risk-based and scalable to
companies of varying size and complexity. In addition, as discussed
above, the final amendments clarify the requirements for evaluating the
work of a company's specialist and assessing the objectivity of an
auditor-engaged specialist, which should avoid unnecessary effort by
the auditor or auditor's specialist. Accordingly, any increases in
effort should be accompanied by improvements in audit quality.
Potential Shift in the Balance Between the Work of a Company's
Specialist and the Work of an Auditor's Specialist
In audit engagements involving specialists, the potential exists
that the final amendments could affect the balance between the work of
a company's specialist and the work of an auditor's specialist. The
Proposal also identified this potential consequence, and some
commenters expressed concern that companies might, in some instances,
choose not to engage or involve a company's specialist if they expected
that the auditor would use an auditor's specialist to perform
additional procedures.\180\
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\180\ See, e.g., Letter from Duff & Phelps (Aug. 30, 2017), at
4, available on the Board's website in Docket 044 (``situations may
arise where management may feel compelled to invest less time, costs
and effort in supporting certain assertions in the financial
statements by not engaging a specialist when one would otherwise be
called for--especially given the expectation that the auditor's
specialist would perform extensive testing and calculations as part
of the audit'').
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The final amendments do not change management's responsibility for
the financial statements or their obligation to maintain effective
internal control over financial reporting. Anticipating the use of an
auditor's specialist for the audit engagement, however, some issuers
may decide to use a company's specialist to a lesser extent (or not at
all) when preparing financial statements and some company specialists
may exhibit a reduced sense of responsibility. In such instances, the
auditor's specialist may have to perform more work in order to
adequately evaluate potential audit evidence provided by the issuer,
including the work of a company's specialist if the issuer continues to
use such a specialist. Alternatively the auditor may decide not to use
the work of a company's specialist or use that work to a lesser extent.
If the situations described above were to occur, audit quality might be
reduced, not enhanced, in some instances.
The change in the balance between the work of a company's
specialist and the work of an auditor's specialist, however, would
likely be limited, as companies control the work of a company's
specialist over information to be used in the financial statements, but
lack similar control over an auditor's specialist. Companies generally
are likely, therefore, to prefer to continue their use of a company's
specialist. In addition, the final amendments do not require auditors
to use an auditor's specialist when using the work of a company's
specialist. Moreover, compared to the Proposal, the final amendments
clarify the requirements for evaluating the work of a company's
specialist. For example, the final amendments clarify the auditor's
responsibilities for evaluating the methods and significant assumptions
used by the company's specialist, and limit the use of the term
``test'' to procedures applied to company-produced information used by
the specialist. These clarifications should alleviate concerns
expressed by certain commenters.
Potential Reduction in the Availability of Specialists
Some commenters on the Proposal suggested that the proposed
amendments, if adopted, would not affect the pool of qualified
specialists available to serve as auditors' specialists. Other
commenters, however, expressed concern that the proposed amendments
might result in a shortage of, or strains on, the pool of qualified
auditors' specialists, especially in situations where an audit firm
currently uses the work of a company's specialist, but does not
concurrently use an auditor's specialist.\181\ Situations that involved
the auditor's use of the work of a company's specialist, but did not
concurrently involve the use of an auditor's specialist, comprised a
small percentage of audit engagements, ranging from 6% to 10% of the
audit engagements of smaller and larger audit firms--U.S. and non-
U.S.--that were selected for inspection in 2017 (category (1) of Figure
5 above).
---------------------------------------------------------------------------
\181\ Commenters did not specify whether such shortages would be
permanent, or instead would reflect a temporary disruption to which
the market would adjust over time.
---------------------------------------------------------------------------
Similar to the proposed amendments, the final amendments do not
require auditors to use an auditor's specialist when using the work of
a company's specialist. Moreover, in comparison to the proposed
amendments, auditors are allowed under the final amendments to assess
the objectivity of an auditor-engaged specialist along a spectrum,
rather than make a binary determination whether they can use the work
of an auditor-engaged specialist.\182\ This change should also reduce
the possibility of a shortage of qualified auditors' specialists.
Accordingly, the Board believes that the final amendments should not
result in a shortage of, or strains on, the pool of qualified
specialists available to serve as auditors' specialists.
---------------------------------------------------------------------------
\182\ Additionally, the final amendments provide for the auditor
to evaluate along a spectrum the company's ability to significantly
affect the judgments of the company's specialist. Furthermore, as
discussed above, the final amendments reflect changes to the
Proposal relating to the evaluation of the data, significant
assumptions, and methods used by the company's specialist that
clarify that the focus of the auditor's evaluation does not require
the auditor to reperform the specialist's work.
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Alternatives Considered, Including Key Policy Choices
The development of the final amendments involved considering a
number of alternative approaches to address the problems described
above. This subsection explains: (1) Why standard setting is preferable
to other policy-making approaches, such as providing interpretive
guidance or enhancing inspection or enforcement efforts; (2) other
standard-setting approaches that were considered by the Board; and (3)
key policy choices made in determining the details of the proposed
standard-setting approach.
Why Standard Setting Is Preferable to Other Policy-Making Approaches
The Board's policy tools include alternatives to standard setting,
such as issuing additional interpretive guidance or an increased focus
on inspections or enforcement of existing standards. One commenter
stated that the Board should be proactive and supported the Board's
preference for standard setting over other policy tools, while other
commenters noted that other policy tools, such as the issuance of staff
guidance and inspections activity, should also be considered.
While other policy tools may complement auditing standards, the
Board has determined that providing additional guidance or increasing
its inspection or enforcement efforts, without also amending the
existing requirements regarding the auditor's responsibilities for
using the work of specialists, would not be effective corrective
mechanisms to address concerns with the evaluation of the work of a
company's specialist, the
[[Page 13480]]
supervision of an auditor's specialists, and the sources of market
failure discussed previously. In addition, while devoting additional
resources to such activities might focus auditors' attention on
existing requirements, it would not provide the benefits associated
with improving the standards discussed above. Thus, the final approach
reflects the conclusion that standard setting is needed to fully
achieve the benefits resulting from improvement in audits involving
specialists. The Board will, however, monitor the implementation of the
final amendments by audit firms and, if appropriate, consider the need
for additional guidance.
Other Standard-Setting Alternatives Considered
Several alternative standard-setting approaches were also
considered, including: (1) Retaining the existing framework but
requiring the auditor to disclose when the auditor used the work of
specialists in the audit; or (2) targeted amendments to existing
requirements.
Disclosing When the Work of a Specialist Is Used
As an alternative to amending AS 1105 and AS 1201 and replacing
existing AS 1210 in its entirety, the Board considered amending
existing AS 1210 to remove the current limitations in existing AS
1210.15 on disclosing that a specialist was involved in the audit.
Under this approach, the auditor would have been required to disclose
this fact. Investors might benefit from such a requirement, since it
would inform investors, at a minimum, that the auditor had evaluated
the need for specialized skill or knowledge in order to perform an
audit in accordance with PCAOB standards. Such disclosures could, in
theory, positively affect audit practice, as auditors might face more
scrutiny from investors regarding their decisions whether or not to use
specialists.
Disclosure alone, however, would be unlikely to achieve the Board's
objectives, which includes effecting more consistently rigorous
practices among auditors when using the work of a company's specialist
in their audits, as well as effecting a more consistent approach to the
supervision of auditor-employed and auditor-engaged specialists. For
example, with disclosure alone, some auditors might not evaluate the
significant assumptions and methods of a company's specialist, even in
higher risk audit areas.
Moreover, in a separate rulemaking, the Board has adopted a new
auditing standard that requires the auditor to communicate CAMs in the
auditor's report. A CAM is defined as any matter arising from the audit
of the financial statements that was communicated or required to be
communicated to the audit committee and that relates to accounts or
disclosures that were material to the financial statements and involved
especially challenging, subjective, or complex auditor judgment.\183\
Depending on the circumstances, the description of such CAMs might
include a discussion of the work or findings of a specialist. While it
is not yet clear how frequently the use of the work of specialists will
be disclosed in the auditor's report as part of CAMs, these disclosure
requirements are complemented by amending AS 1105 and AS 1201 and
replacing existing AS 1210 to improve performance requirements over the
use of the work of specialists. As discussed above, this should
directly mitigate auditor moral hazard and change certain elements of
audit practice observed by PCAOB oversight activities that have given
rise to concern, such as situations where auditors did not apply
appropriate professional skepticism when using the work of specialists.
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\183\ See The Auditor's Report on an Audit of Financial
Statements When the Auditor Expresses an Unqualified Opinion and
Related Amendments to PCAOB Standards, PCAOB Release No. 2017-001
(June 1, 2017).
---------------------------------------------------------------------------
Targeted Amendments to Existing Requirements for Using the Work of an
Auditor's Specialists
The Board considered, but is not adopting, two alternative
approaches for an auditor's use of the work of an auditor's specialist,
as discussed in further detail in the Proposal. The first alternative
was to develop a separate standard for using the work of an auditor's
specialist. This approach would have created a new auditing standard
for using the work of an auditor's specialist, whether employed or
engaged by the auditor, similar to the approach in ISA 620 and AU-C
Section 620 (and thereby separating the requirements for using the work
of an auditor-engaged specialist from those for using the work of a
company's specialist). One commenter on the Proposal supported this
approach. The second alternative was to extend the supervisory
requirements in AS 1201 to an auditor-engaged specialist. This approach
would have amended existing AS 1210 to remove all references to an
auditor-engaged specialist and amended AS 1201 to include all
arrangements involving auditor-employed and auditor-engaged
specialists.
Given the similar role of an auditor-employed and an auditor-
engaged specialist in the audit, the Board determined that the
auditor's procedures for reaching an understanding with the specialist
and evaluating the work to be performed by the specialist should be
similar. Accordingly, the Board has adopted separate, but parallel,
requirements for using the work of an auditor-employed specialist and
an auditor-engaged specialist related to reaching an understanding and
evaluating the work to be performed. However, as discussed above, the
auditor's relationship to an auditor-employed specialist differs in
certain respects from the auditor's relationship to an auditor-engaged
specialist, which may affect the auditor's visibility into the
specialist's knowledge, skill, and ability, as well as into any
relationships that might affect the specialist's independence or
objectivity. Accordingly, the final amendments address these
differences by requiring the auditor to perform procedures in AS 1210,
as amended, to evaluate the knowledge, skill, ability, and objectivity
of auditor-engaged specialists, while recognizing that the auditor
evaluates the knowledge, skill, ability, and independence of auditor-
employed specialists in accordance with the same requirements that
apply to other engagement team members.
Key Policy Choices
Given the preference for creating separate requirements for using a
company's specialist, an auditor-employed specialist, and an auditor-
engaged specialist, the Board considered different approaches to
addressing key policy issues.
Scope of the Final Amendments
The Board considered a variety of possible approaches to the scope
of the final amendments, including the treatment of persons with
specialized skill or knowledge in certain areas of IT and income taxes.
See section C for a discussion of the Board's considerations. In
particular, after considering comments on the Proposal, the Board has
clarified the scope and application of the final amendments in the rule
text and discussion in its adopting release. The Board, while mindful
of advances in technology that could fundamentally impact the audit
process (and hence what is understood to be skill and knowledge in
specialized areas of accounting and auditing), believes that the final
amendments are sufficiently principles-based and flexible to
accommodate continued technological advances that could impact audit
practice in the future.
[[Page 13481]]
Evaluating the Work of a Company's Specialist
The Board considered a variety of possible approaches relating to
the auditor's evaluation of the work of a company's specialist. See
section C for a discussion of the Board's considerations. In
particular, after considering the comments on the Proposal, the Board
is retaining the fundamental approach in the Proposal, under which the
auditor evaluates the data, significant assumptions, and methods used
by the specialist. The final amendments, including the revisions to the
proposed requirements described in section C, retain the benefits
resulting from the use of a risk-based audit approach, while at the
same time directing the auditor to consider the quality of the source
of information when determining his or her audit approach.
Evaluating the Qualifications and Independence of the Auditor-Employed
Specialist
The Board considered a variety of possible approaches to evaluating
the knowledge, skill, ability, and independence of auditor-employed
specialists. See section C for a discussion of the Board's
considerations. In particular, after considering the comments on the
Proposal, the Board eliminated from the final amendments certain
paragraphs that could have been misinterpreted as suggesting a
different process for evaluating the qualifications and independence of
auditor-employed specialists than for other engagement team members.
Instead, the final amendments acknowledge that an auditor-employed
specialist is a member of the engagement team and that existing
requirements for assessing the qualifications and independence of
engagement team members apply equally to auditor-employed specialists.
Assessing the Qualifications and Objectivity of the Auditor-Engaged
Specialist
The Board considered a variety of possible approaches to assessing
the knowledge, skill, ability, and objectivity of auditor-engaged
specialists. See section C for a discussion of the Board's
considerations. In particular, after considering the comments, the
Board made revisions in adopting the requirements described in section
C to allow auditors to assess the objectivity of auditor-engaged
specialists along a spectrum, rather than make a binary determination.
The Board believes the final amendments in this area should limit any
incremental cost to circumstances where increases in audit quality can
be reasonably expected and thereby mitigate any adverse economic impact
from potential unintended consequences of the final amendments. For
example, requiring the auditor to perform additional procedures to
evaluate the data, significant assumptions, and methods used by the
specialist when the specialist has a relationship with the company that
affects the specialist's objectivity should increase audit quality and
reduce the risk that a material misstatement could go undetected.
Special Considerations for Audits of Emerging Growth Companies
Pursuant to Section 104 of the Jumpstart Our Business Startups
(``JOBS'') Act, rules adopted by the Board subsequent to April 5, 2012,
generally do not apply to the audits of EGCs, unless the SEC
``determines that the application of such additional requirements is
necessary or appropriate in the public interest, after considering the
protection of investors, and whether the action will promote
efficiency, competition, and capital formation.'' \184\ As a result of
the JOBS Act, the rules and related amendments to PCAOB standards the
Board adopts are generally subject to a separate determination by the
SEC regarding their applicability to audits of EGCs.
---------------------------------------------------------------------------
\184\ See Public Law 112-106 (Apr. 5, 2012). See Section
103(a)(3)(C) of the Sarbanes-Oxley Act, as added by Section 104 of
the JOBS Act. Section 104 of the JOBS Act also provides that any
rules of the Board requiring (1) mandatory audit firm rotation or
(2) a supplement to the auditor's report in which the auditor would
be required to provide additional information about the audit and
the financial statements of the issuer (auditor discussion and
analysis) shall not apply to an audit of an EGC. The final
amendments do not fall within either of these two categories.
---------------------------------------------------------------------------
The Proposal sought comment on the applicability of the proposed
requirements to audits of EGCs. Commenters generally supported applying
the proposed requirements to audits of EGCs. These commenters asserted
that consistent requirements should apply for similar situations
encountered in any audit of a company, whether that company is an EGC
or not, as well as that the benefits described in the Proposal would be
applicable to EGCs. One commenter suggested ``phasing'' the
implementation of the requirements for such audits to reduce the
compliance burden.
The Board also notes that any new PCAOB standards and amendments to
existing standards determined not to apply to the audits of EGCs would
require auditors to address the differing requirements within their
methodologies, which would also create the potential for confusion.
To inform consideration of the application of auditing standards to
audits of EGCs, the PCAOB staff has also published a white paper that
provides general information about characteristics of EGCs.\185\ As of
the November 15, 2017 measurement date, the PCAOB staff identified
1,946 companies that had identified themselves as EGCs in at least one
SEC filing since 2012 and had filed audited financial statements with
the SEC in the 18 months preceding the measurement date.
---------------------------------------------------------------------------
\185\ See PCAOB white paper, Characteristics of Emerging Growth
Companies as of November 15, 2017 (Oct. 11, 2018) (``EGC White
Paper''), available on the Board's website.
---------------------------------------------------------------------------
Overall, the discussion of benefits, costs, and unintended
consequences above is generally applicable to audits of EGCs. EGCs
generally tend to have shorter financial reporting histories than other
exchange-listed companies. As a result, there is less information
available to investors regarding such companies relative to the broader
population of public companies.\186\
---------------------------------------------------------------------------
\186\ Id.
---------------------------------------------------------------------------
Although the degree of information asymmetry between investors and
company management for a particular issuer is unobservable, researchers
have developed a number of proxies that are thought to be correlated
with information asymmetry, including small issuer size, lower analyst
coverage, larger insider holdings, and higher research and development
costs.\187\ To the extent that EGCs exhibit one or more of these
properties, there may be a greater degree of information asymmetry for
EGCs than for the broader population of companies, which increases the
importance to investors of the external audit to enhance the
credibility of management disclosures.\188\ The final amendments
[[Page 13482]]
relating to the auditor's use of the work of specialists, which are
intended to enhance audit quality, could contribute to an increase in
the credibility of financial statement disclosures by EGCs.
---------------------------------------------------------------------------
\187\ See, e.g., David Aboody and Baruch Lev, Information
Asymmetry, R&D, and Insider Gains, 55 Journal of Finance 2747
(2002); Michael J. Brennan and Avanidhar Subrahmanyam, Investment
Analysis and Price Formation in Securities Markets, 38 Journal of
Financial Economics 361 (1995); Varadarajan V. Chari, Ravi
Jagannathan, and Aharon R. Ofer, Seasonalities in Security Returns:
The Case of Earnings Announcements, 21 Journal of Financial
Economics 101 (1988); and Raymond Chiang, and P. C. Venkatesh,
Insider Holdings and Perceptions of Information Asymmetry: A Note,
43 Journal of Finance 1041 (1988).
\188\ See, e.g., Molly Mercer, How Do Investors Assess the
Credibility of Management Disclosures?, 18 Accounting Horizons 185,
189 (2004) (``[Academic studies] provide archival evidence that
external assurance from auditors increases disclosure credibility. .
.These archival studies suggest that bankers believe audits enhance
the credibility of financial statements . . .'').
---------------------------------------------------------------------------
When confronted with information asymmetry, investors may require a
larger risk premium, and thus increase the cost of capital to
companies.\189\ Reducing information asymmetry, therefore, can lower
the cost of capital to companies, including EGCs, by decreasing the
risk premium required by investors.\190\
---------------------------------------------------------------------------
\189\ See supra notes 165 and 167.
\190\ For a discussion of how increasing reliable public
information about a company can reduce risk premium, see David
Easley and Maureen O'Hara, Information and the Cost of Capital, 59
The Journal of Finance 1553 (2004).
---------------------------------------------------------------------------
Furthermore, an analysis by PCAOB staff, the results of which are
summarized in Figure 6 below, suggests that the prevalence and
significance of the use of the work of specialists in audits of EGCs is
comparable to the prevalence and significance of the use of the work of
specialists in audits of non-EGCs, for audit engagements by both
smaller audit firms and larger audit firms.\191\
---------------------------------------------------------------------------
\191\ The staff analysis was based on engagement-level data from
the subset of 74 audit engagements of EGCs by U.S. and non-U.S.
audit firms that were selected for inspection in 2017 presented
above.
Figure 6--Audits Performed by U.S. and Non-U.S. Audit Firms of EGCs That Were Selected for Inspection by the
PCAOB in 2017, Categorized by Use of the Work of Specialists
----------------------------------------------------------------------------------------------------------------
% (number) of
% (number) of % (number) of % (number) of audits by
audits by larger audits by audits by larger smaller audit
audit firms smaller audit audit firms firms (non-
(U.S.) firms (U.S.) (non-U.S.) U.S.)
----------------------------------------------------------------------------------------------------------------
(1) auditor used the work of a company's 0% (0) 9% (3) 11% (1) 13% (1)
specialist but did not use the work of
an auditor's specialist................
(2) auditor used the work of an 8% (2) 0% (0) 22% (2) 0% (0)
auditor's specialist but did not use
the work of a company's specialist.....
(3) auditor used the work of both a 29% (7) 12% (4) 22% (2) 0% (0)
company's specialist and an auditor's
specialist.............................
(4) auditor neither used the work of a 63% (15) 79% (26) 44% (4) 88% (7)
company's specialist nor used an
auditor's specialist \192\.............
-----------------------------------------------------------------------
Total \193\......................... 100% (24) 100% (33) 100% (9) 100% (8)
----------------------------------------------------------------------------------------------------------------
Source: PCAOB
As indicated in Figure 6, the staff analysis observed that 41 (or
about 55%) of the audit engagements were performed by U.S. and non-
U.S., smaller audit firms. Among those 41 audit engagements, only four
(or about 10%) involved the use of the work of a company's specialist
but did not concurrently involve the use of the work of an auditor's
specialist (category (1) above). In comparison, 33 of the 41 audit
engagements (or about 80%) did not involve the use of the work of
either a company's specialist or an auditor's specialist (category (4)
above) and four of the 41 audit engagements (or about 10%) involved the
use of both a company's specialist and an auditor's specialist
(category (3) above). In none of those 41 audit engagements did the
auditor use the work of an auditor's specialist without also
concurrently using the work of a company's specialist (category (2)
above). Among the 33 audit engagements of EGCs (or about 45%) performed
by larger firms, both U.S. and non-U.S. firms, one (or about 3%)
involved the use of the work of a company's specialist but did not
concurrently involve the use of the work of an auditor's specialist
(category (1) above); 19 (or about 58%) did not involve the use of the
work of either a company's specialist or an auditor's specialist
(category (4) above); nine (or about 27%) involved the use of both a
company's specialist and an auditor's specialist (category (3) above);
and four (or about 12%) involved the use of the work of an auditor's
specialist, but did not concurrently involve the use of work of a
company's specialist (category (2) above).
---------------------------------------------------------------------------
\192\ The audit engagements not included in the preceding three
categories were included in the fourth category.
\193\ The total for the values shown in categories (1) through
(4) may not add to 100% due to rounding.
---------------------------------------------------------------------------
Thus, the Board believes that the need for the final amendments
discussed earlier and the associated benefits of the final amendments
generally apply also to audits of EGCs.
While for small companies (including EGCs), even a small increase
in audit fees could negatively affect their profitability and
competitiveness, many EGCs are expected to experience minimal impact
from the final amendments. In particular, some EGCs do not use a
company's specialist and, for those EGCs that do use a company's
specialist, the final amendments relating to the auditor's use of the
work of such specialists are risk-based and designed to be scalable to
companies of varying size and complexity.
In addition, the analysis presented in the EGC White Paper observed
that about 40% of audits of EGCs are performed by firms that provided
audit reports for more than 100 issuers and were required to be
inspected on an annual basis by the PCAOB.\194\ These firms tend to
already have practices for using the work of specialists that are
consistent with many or all elements of the final amendments. For such
audit firms, the costs on a per engagement basis of adopting the final
amendments should also be low, for the reasons discussed above.
---------------------------------------------------------------------------
\194\ See EGC White Paper, at 3.
---------------------------------------------------------------------------
For the other 60% of audits of EGCs, the PCAOB staff analysis
summarized in Figure 6 above suggests that the proportion of EGC audit
engagements that involve the use of the work of company specialists,
but do not involve the use of the work of an auditor's specialist, is
small and comparable to the proportion of similar issuer audit
engagements described previously. As discussed above, auditors on such
audit engagements may experience the most significant cost impact of
the final amendments. However, only a small proportion of audits of
EGCs are expected to be significantly affected by the final amendments.
In addition, the final amendments clarify the requirements for
evaluating the work of a company's specialist and assessing the
objectivity of an auditor-engaged specialist, which should avoid
[[Page 13483]]
unnecessary effort by the auditor or auditor's specialist. Accordingly,
any increase in effort should be accompanied by improvements in audit
quality.
The Board has provided this analysis to assist the SEC in its
consideration of whether it is ``necessary or appropriate in the public
interest, after considering the protection of investors and whether the
action will promote efficiency, competition, and capital formation,''
to apply the final amendments to audits of EGCs. This information
includes data and analysis of EGCs identified by the Board's staff from
public sources.
For the reasons explained above, the Board believes that the final
amendments are in the public interest and, after considering the
protection of investors and the promotion of efficiency, competition,
and capital formation, recommends that the final amendments should
apply to audits of EGCs. Accordingly, the Board recommends that the
Commission determine that it is necessary or appropriate in the public
interest, after considering the protection of investors and whether the
action will promote efficiency, competition, and capital formation, to
apply the final amendments to audits of EGCs. The Board stands ready to
assist the Commission in considering any comments the Commission
receives on these matters during the Commission's public comment
process.
Applicability to Audits of Brokers and Dealers
The Proposal indicated that the proposed amendments would apply to
audits of brokers and dealers, as defined in Sections 110(3)-(4) of the
Sarbanes-Oxley Act. The Board solicited comment on any factors
specifically related to audits of brokers and dealers that may affect
the application of the proposed amendments to those audits. Commenters
that addressed the issue agreed that amendments to the standards for
the auditor's use of the work of specialists should apply to these
audits, citing benefits to users of financial statements of brokers and
dealers and the risk of confusion and inconsistency if different
methodologies were required under PCAOB standards for audits of
different types of entities.
After considering comments, the Board determined that the final
amendments, if approved by the SEC, will be applicable to all audits
performed pursuant to PCAOB standards, including audits of brokers and
dealers. The Board's determination is based on the observation that the
information asymmetry between the management of brokers and dealers and
their customers about the brokers' and dealers' financial condition may
be significant and of particular interest to customers, as a broker or
dealer may have custody of customer assets, which could become
inaccessible to the customers in the event of the insolvency of the
broker or dealer.
In addition, unlike the owners of brokers and dealers, who
themselves may be managers and thus be subject to minimal or no
information asymmetry, customers of brokers and dealers may, in some
instances, be large in number and may not be expert in the management
or operation of brokers and dealers. Such information asymmetry between
the management and the customers of brokers and dealers makes the role
of auditing important to enhance the reliability of financial
information.
Accordingly, the discussion above of the need for the final
amendments, as well as the costs, benefits, alternatives considered and
potential unintended consequences to auditors and the companies they
audit, also applies to audits of brokers and dealers. In particular,
PCAOB staff analysis of inspections data for audits of brokers and
dealers indicates that auditors of brokers and dealers do not
frequently use the work of specialists, whether company specialists or
an auditor's specialists.\195\ Hence, the results suggest that only a
small percentage of audits of brokers and dealers will be impacted by
the final amendments. In addition, with respect to the impact of the
final amendments on customers of brokers and dealers, the expected
improvements in audit quality described previously would benefit such
customers, along with investors, capital markets and auditors, while
the final requirements are not expected to result in any direct costs
or unintended consequences to customers of brokers and dealers.
---------------------------------------------------------------------------
\195\ The staff analysis is based on 116 audit engagements of
brokers and dealers performed by audit firms that were selected for
inspection in 2017. The results of the analysis found that the
auditor did not use the work of a specialist in about 90% of the
broker or dealer audits. This analysis also found that auditors used
the work of at least one auditor's specialist in about 8% of the
audits analyzed and used the work of at least one company specialist
in about 2% of those audits.
---------------------------------------------------------------------------
III. Date of Effectiveness of the Proposed Rules and Timing for
Commission Action
Pursuant to Section 19(b)(2)(A)(ii) of the Exchange Act, and based
on its determination that an extension of the period set forth in
Section 19(b)(2)(A)(i) of the Exchange Act is appropriate in light of
the PCAOB's request that the Commission, pursuant to Section
103(a)(3)(C) of the Sarbanes-Oxley Act, determine that the proposed
rules apply to the audits of EGCs, the Commission has determined to
extend to July 3, 2019 the date by which the Commission should take
action on the proposed rules.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed
rules are consistent with the requirements of Title I of the Act.
Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/pcaob.shtml); or
Send an email to [email protected]. Please include
File Number PCAOB-2019-03 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number PCAOB-2019-03. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (https://www.sec.gov/rules/pcaob.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rules that are filed
with the Commission, and all written communications relating to the
proposed rules between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, on official business days
between the hours of 10:00 a.m. and 3:00 p.m. Copies of such filing
will also be available for inspection and copying at the principal
office of the PCAOB. All comments received will be posted without
charge. Persons submitting comments are cautioned that we do not redact
or edit personal identifying information from comment submissions. You
should submit only information that you wish to make available
publicly. All submissions should refer to File Number PCAOB-2019-03 and
[[Page 13484]]
should be submitted on or before April 25, 2019.
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\196\ 17 CFR 200.30-11(b)(1) and (3).
For the Commission, by the Office of the Chief Accountant, by
delegated authority.\196\
Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-06425 Filed 4-3-19; 8:45 am]
BILLING CODE 8011-01-P