Washington, D.C. (June 30, 2023) – On June 6, 2023, the Public Company Accounting Oversight Board (PCAOB) announced the proposed implementation of sweeping new rules for the purpose of strengthening the detection and prevention of fraud in financial reporting. As PCAOB Chair Erica Y. Williams explained, "By catching and communicating noncompliance sooner, auditors can help companies course correct and better protect investors from risk." PCAOB states that it bases its new rules on the fact that they found a year-over-year increase in the number of audit deficiencies dating back to 2021, and that since 2022, they found an increase in comment forms highlighting bad trends in audit quality.
Goals and Highlights of the Proposed Rules
The goal of the proposed rules is to enhance the integrity of audits and restore investor confidence. Moreover, if adopted, the proposal will strengthen the requirements to identify, evaluate, and communicate possible or actual noncompliance with laws and regulations. These rules, following on the heels of PCAOB's proposed standard for auditors' use of the confirmation process (AS2310 - published on December 20, 2022), are quite broad in scope and effect, and require a significant amount of extra audit preparation, analysis, and communication with audit committees and management prior to and during the engagement.
The highlights of the 2023 PCAOB proposed rules against fraud will address:
- Risk Assessment Procedure Expansion, designed to create a deeper understanding of the entity's internal controls while also evaluating management's programs that are designed to detect and prevent fraud by establishing specific requirements for auditors to identify laws and regulations that could affect financial statements.
- Emphasis on Professional Skepticism, by enforcing that auditors enter the audit process with exceptional judgment and a skeptical mindset so that they will be able to critically evaluate the evidence obtained and challenge management to better detect and respond to fraudulent activities.
- Improved Communication with Audit Committees, with auditors establishing open and ongoing communication with the committees, which includes communicating fraud risks, significant findings related to fraud, and the auditor's evaluation on internal controls. This will ensure that audit committees are well-informed about potential fraud risks and are equipped to take the appropriate action.
- Revised Documentation Requirements, pursuant to which auditors will be required to adequately document fraud risk assessments, responses to the risk, and judgments made during the audit process. This documentation process will ensure transparency and enforce effective review and evaluation aligning with the PCAOB inspectors and other stakeholders.
- Quality Control and Monitoring, including a requirement that auditing firms implement profound quality control systems to ensure businesses are in compliance with auditing standards. The PCAOB plans to intensify the inspections of audit procedures by also requiring the number of inspections to increase for certain firms.
The deadline for public comment on the proposed rules is August 7, 2023.
Implications of the Proposed Rules if Adopted
If adopted, these new rules, broadly worded and broad in scope, will affect every level of the audit process: negotiating terms of engagement, audit planning, risk and fraud assessment, gathering and review of documentation, confirmation, preparation of workpapers, communications with management and the audit committees, drafting and signing the audit opinion, and documenting all levels of the review and audit. Public audit firms would be wise to take a fresh look at their internal and auditing procedures to make sure that they have the knowledge, understanding, resources, and personnel required to comply with these expansive new confirmation and audit requirements. Lewis Brisbois is prepared and available to assist in any such effort. Please contact the author of this alert for further information regarding this topic.
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