PCAOB proposes far-reaching requirements for audit firm reporting

The Public Company Accounting Oversight Board voted to propose an extensive set of new reporting requirements to impose on auditing firms during a meeting Tuesday, even as the auditing overseer is facing pushback over some of its earlier proposed rules on noncompliance with laws and regulations.

The new requirements come in the form of two related proposals, one on Firm and Engagement Metrics and the other on Firm Reporting. The Firm and Engagement Metrics proposal involves a standardized set of 11 metric areas for every firm that audits at least one public company classified as either an “accelerated filer” or a “large accelerated filer” to disclose every year.

They include information about firms’ overall audit practice, such as how partners’ quality performance ratings affect their compensation, and information about individual engagements, for example the time incurred by partners and managers on the engagement team related to areas of significant risks, critical accounting policies and practices, and critical accounting estimates.

“Collectively, these metrics would help investors make more informed decisions about how they invest their money. And they would provide audit committees with consistent data to analyze and compare as they are selecting and monitoring audit firms, ” said PCAOB chair Erica Williams during Tuesday’s open meeting. “Firms could use these standardized metrics about themselves and their peers to assist in designing, implementing, monitoring and remediating their systems of quality control.”

She acknowledged the PCAOB could also benefit from having such information on hand in a consistent, comparable format for use in its inspections program and standard-setting initiatives.

The proposal, if adopted, would require PCAOB-registered public accounting firms that audit one or more issuers that qualify as an accelerated filer or large accelerated filer to publicly report specified metrics relating to such audits and their audit practice.

The proposal envisions standardized firm- and engagement-level metrics to create a data set for investors and other stakeholders for analysis and comparison. The proposed metrics cover (1) partner and manager involvement, (2) workload, (3) audit resources (4) experience of audit personnel, (5) industry experience of audit personnel, (6) retention and tenure, (7) audit hours and risk areas (engagement-level only), (8) allocation of audit hours, (9) quality performance ratings and compensation (firm-level only), (10) audit firms’ internal monitoring, and (11) restatement history (firm-level only).

The proposal would require reporting of firm-level metrics annually on a new Form FM, for firms that serve as the lead auditor for at least one accelerated filer or large accelerated filer. Reporting of engagement-level metrics for audits of accelerated filers and large accelerated filers would be done on a revised Form AP, which would be renamed “Audit Participants and Metrics.” The proposal would allow, but not require, limited narrative disclosures on both Form FM and Form AP to provide context and explanation for the required metrics.

Firm reporting proposal

The other proposal, on firm reporting, covers five main areas, and would require an extensive amount of new reporting by firms. The first area is financial Information. All PCAOB-registered firms would need to report actual dollar amounts of various fee categories, as opposed to the percentages that are currently required. The new requirements would also provide more disaggregated fee information that is more consistent and easier to compare across firms. 

“Fee reporting would help investors, audit committees and other stakeholders better understand how a firm’s audit practice fits into its overall business and the incentives that may influence resource allocation within the firms,” said Williams.

The largest registered firms would also need to confidentially submit their financial statements to the PCAOB. “These firms play an essential role in our capital markets and overall economy,” said Williams. “Their financial stability impacts their ability to invest in resources necessary to ensure quality audits and to withstand various financial events.”

Another area of disclosure involves audit firm governance Information. The proposal would require all PCAOB-registered firms to report more public information about their leadership, legal structure, ownership and other governance information, including information on the structures and policies that would govern a change in the form of the organization.

The PCAOB also wants to find out more information about firm networks, such as the Big Four. The proposal would require a more detailed public description of firms’ network arrangements, to provide more insight about the accountability and oversight structure the firm is subject to in addition to the resources the firm has available to devote to its audit work.

In addition, the PCAOB wants a shorter timeline on special reporting of events such as whether a firm is the subject of a lawsuit or regulatory action. The proposal would shorten the timeframe for special reporting from 30 days to 14 days or more promptly as warranted. Some of the information would need to be made available to investors, audit committees, and the PCAOB inspection and investigation staff in a timelier manner.

Firms would also need to provide more detailed information about any financial issues they are facing, as well as upcoming mergers, acquisitions and restructuring.

“In addition to the existing special reporting requirements, the proposal would add a new confidential special reporting requirement for events material to a firm’s organization, operations, liquidity or financial resources, or provision of audit services,” said Williams. “These events have the potential to significantly impact audit quality and investor protection, yet they are not covered under the current standard. For example, the additional requirement might include a determination that there is substantial doubt about the firm’s ability to continue as a going concern; or a planned or anticipated acquisition of the firm, change in control, or restructuring.”

Cybersecurity issues would also need to be disclosed to the PCAOB. “Cybersecurity threats are among the greatest risks to many businesses in today’s world, and audit firms are particularly attractive targets,” said Williams. “The proposal would require public reporting of a brief description of the firm’s policies and procedures, if any, to identify and manage cybersecurity risks, and confidential reporting of significant cybersecurity events to the PCAOB within five business days.”

The firm reporting proposal would, if adopted, amend the PCAOB’s annual and special reporting requirements to facilitate the disclosure of more complete, standardized, and timely information by registered public accounting firms. As is current practice, much information would be disclosed publicly, and some would be available to the PCAOB only for oversight.

The PCAOB is proposing to enhance the required reporting of information by registered firms on the PCAOB’s public Annual Report Form, also known as Form 2, and the Special Reporting Form, also known as Form 3, in several key areas.

1. Financial information: Under the proposal, all registered firms would report on the public Annual Report Form additional fee information. The largest registered firms would also be required to confidentially submit financial statements annually to the PCAOB.
2. Audit firm governance information: The proposal would require all PCAOB-registered firms to report on the public Annual Report Form additional information regarding their leadership, legal structure, ownership, and other governance information, including information that would govern a change in the form of the organization.
3. Network information: The proposal would require on the public Annual Firm Report a more detailed description of any network arrangement to which a registered firm is subject, including describing the legal and ownership structure of the network, network-related financial obligations, information-sharing arrangements between the network and registered firm, and network governing boards or individuals to which the registered firm is accountable.
4. Special reporting: The proposal would shorten the timeframe for all reporting on the Special Reporting Form from 30 days to 14 days (or more promptly as warranted) and implement a new confidential special reporting requirement for events material to a firm’s organization, operations, liquidity or financial resource, or provision of audit services. Examples of events that would need to be confidentially reported under the new Special Reporting framework include (1) a determination that there is substantial doubt about the firm’s ability to continue as a going concern; (2) a planned or anticipated acquisition of the firm, change in control, or restructuring, including external investment and planned acquisition or disposition of assets or of an interest in an associated entity; or (3) entering into or disposing of a material financial arrangement that would affect the firm’s liquidity or financial resources.
5. Cybersecurity: The proposal would require confidential reporting on the Special Reporting Form of significant cybersecurity events within five business days and periodic public reporting of a brief description of the firm’s policies and procedures, if any, to identify and manage cybersecurity risks.

Separately, the proposal includes amendments to facilitate a provision under the QC 1000 proposal that would require firms to report their revised quality control policies and procedures if QC 1000 were to be adopted.
PCAOB board member Christina Ho voted in support of the Firm and Engagement Metrics proposal but against the Firm Reporting proposal. But although she voiced cautious support of the Firm and Engagement Metrics proposal, she also had some questions about it.

“The proposal does not articulate clearly what the PCAOB is going to do with all this information,” said Ho. “We are proposing to mandate that firms submit this information by the respective due dates, but what are the PCAOB’s due dates to publish? Will we analyze the information we collect and share our analysis with the public?”

She was more critical of the Firm Reporting proposal. “I am profoundly worried that the board’s apparent zeal to impose, in each new proposed standard or rule, new burdens on firms, without sufficient tailoring and without quantifying the estimated burdens, may end up breaking the public company auditing profession’s back, particularly for small firms,” said Ho. “If we ‘break’ the profession in the name of investor protection, are we really protecting investors?”

Another PCAOB board member, George Botic, supported the Firm and Engagement Metrics proposals. “My consideration of this proposal has led me to believe that the ultimate value of many of the proposed metrics would likely be realized over a longer time horizon,” he said. “Trends across and within both firms and engagements may emerge. Such trends could provide not only information for the acquirors of audit services and the users of financial statements, but also direction to the academic community about potential research areas, which in turn could provide further insights into the overall audit market and also assist our work.”

He also voted in support of the Firm Reporting proposal. “As part of our ongoing oversight activities, we have received important information about firms’ operations on a voluntary ad-hoc basis in which firms may call and ‘alert’ various PCAOB staff of pending matters or firm actions,” he said. “Having been the recipient of many of these voluntary calls, I can confirm how helpful this information was. It allowed the staff to be more informed and able to respond and ask further probing questions and perform other oversight procedures, as warranted. This proposal takes the insights gained from those interactions and standardizes them to allow for comparable and timely collection that facilitates access and efficient sharing with offices and staff across the PCAOB.”

The PCAOB is asking for comments on both proposals by June 7 and noted that the basic framework for its annual and special reporting requirements has not been substantively reevaluated since its adoption in 2008.