Companies increasingly use specialists to make complex accounting estimates. Unfortunately, such complexity poses a risk of material misstatement. To make matters worse, auditors often use specialists to test management’s accounting estimates, and the audit standards governing that use date back to the 1970s, when the American Institute of Certified Public Accountants (AICPA) originally issued the standards. And the Public Company Accounting Oversight Board (PCAOB) didn’t update the standards when it was formed in 2003. Now PCAOB officials are asking whether the time has come to refresh the existing audit guidance on the use of specialists — including professionals hired by the audit team to test accounting estimates and those hired by the audit client to help make accounting estimates.
Audit guidance under review
At its June meeting, the PCAOB’s Standing Advisory Group discussed Staff Consultation Paper No. 2015-01, The Auditor’s Use of the Work of Specialists. Public comments on this paper are due on July 31.
“The use of the work of specialists is important to investors because it can help an auditor detect material misstatements in complex areas of a company’s financial statements,” said PCAOB Chairman James Doty. “We want our standards to keep pace with realities in the marketplace, and I look forward to receiving public comment on this important topic.”
Auditing Standard (AS) No. 10, Supervision of the Audit Engagement, currently lays out basic principles regarding how to oversee the work of specialists. But it doesn’t provide specific direction for applying the requirements.
Interim Auditing Standard (AU) Section 336, Using the Work of a Specialist, also deals with auditors’ oversight of third-party specialists. The guidance extends to the auditor’s use of an in-house specialist or a professional hired by an auditing client. It requires auditors to evaluate the relationship of a specialist to the client, including situations that might impair the specialist’s objectivity. But it doesn’t provide specific requirements for carrying out the evaluation.
Examples of specialists that auditors and their clients may use include:
- Actuaries to determine employee benefit obligations,
- Engineers to determine obligations regarding environmental remediation,
- Appraisers to determine the value of intangible assets or real estate,
- Geologists to estimate mineral deposits or oil reserves for mining and energy companies, and
- Lawyers to forecast the potential losses from a legal proceeding.
When supervising these specialists, more specific direction might help minimize the risk of misstatement, especially when specialists aren’t subject to the audit firm’s training, resources and quality control systems.
The PCAOB staff consultation paper — which was published on May 28 — provides alternative approaches to improve the existing audit standards. One option is that the PCAOB would write an updated standard for using the work of an auditor’s specialist, including requirements for both in-house and third-party specialists. The principles in AS 10 would continue to apply, but a new standard would spell out detailed requirements.
Under a second alternative, the board would extend the supervision requirement in AS 10 to third-party specialists. This approach would integrate third-party specialists into the engagement team.
The staff paper also discusses alternatives to how an auditor should treat estimates an audit client makes based on the work of specialists that management hires. For example, the PCAOB has proposed removing certain provisions that limit the auditor’s responsibilities for evaluating the work of a company’s specialists. The provision of AU Section 336 that requires auditors to understand the methods and assumptions used by the specialist a client hires would be clarified and strengthened.
The PCAOB might even rescind AU Section 336 without replacing it. Instead, auditors would look to other standards for guidance, including those that deal with accounting estimates. Under this alternative, evidence provided by a company’s specialist would be evaluated similarly to the evidence provided by the company to the auditor.
Link between the use of specialists and accounting estimates
The use of specialists and accounting estimates are interrelated topics. During its review of the audit guidance on the use of specialists, the PCAOB will draw upon comments submitted in response to the August 2014 Staff Consultation Paper, Auditing Accounting Estimates and Fair Value Measurements. Ultimately, the board may decide to issue a proposal for auditing accounting estimates after it reviews the comments submitted in response to the staff paper on specialists. Stay tuned for more information on changes to the auditing standard on specialists and accounting estimates.
Sidebar: Coming soon: Fair value credentials
In May, the American Institute of Certified Public Accountants’ governing council approved the development of two specialty credentials for fair value measurement. The credentials — scheduled to launch in 2016 — will cover 1) fair value measurement for business and intangible assets and 2) fair value measurement for financial instruments.
Accountants seeking the credentials will be required to demonstrate a high level of knowledge in valuation approaches and methods, fair value standards, best practices for fair value accounting, valuation reports in the audit process and the mandatory performance framework, which is currently under development.
This framework will address how much work is required to prepare “professional” valuation work, including such details as:
- Scope of work,
- Depth of analysis,
- Extent of due diligence,
- Consideration of contrary evidence, and
- Workpaper documentation and recordkeeping.
These credentials are not intended for financial statement auditors. They’re intended for accountants and other qualified professionals who specialize in providing fair value measurements. The goal of establishing these credentials is to increase the quality, consistency and transparency of valuation work so that auditors can easily read and understand an appraisal report and its underlying documentation.