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The effect of PCAOB regulation on your audit firm
 

The effect of PCAOB regulation on your audit firm

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Understand the current regulatory environment and how it impacts your relationship with your audit firm. Also, gain insight into SEC comment letters and handling internal control deficiencies.

Understand the current regulatory environment and how it impacts your relationship with your audit firm. Also, gain insight into SEC comment letters and handling internal control deficiencies.

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    The effect of PCAOB regulation on your audit firm The effect of PCAOB regulation on your audit firm Presentation Transcript

    • 22nd Annual Health SciencesTax ConferenceWorking with your financial statement auditor:the effect of PCAOB regulation of your audit firmDecember 5, 2012
    • Disclaimer► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.Page 2 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • DisclaimerErnst & Young refers to the global organization of member firms of Ernst & Young GlobalLimited, each of which is a separate legal entity. Ernst & Young LLP is a client-servingmember firm of Ernst & Young Global Limited operating in the US. For more informationabout our organization, please visit www.ey.com.This presentation is © 2012 Ernst & Young LLP. All rights reserved. No part of thisdocument may be reproduced, transmitted or otherwise distributed in any form or by anymeans, electronic or mechanical, including by photocopying, facsimile transmission,recording, rekeying, or using any information storage and retrieval system, without writtenpermission from Ernst & Young LLP. Any reproduction, transmission or distribution of thisform or any of the material herein is prohibited and is in violation of US and internationallaw. Ernst & Young LLP expressly disclaims any liability in connection with use of thispresentation or its contents by any third party.Views expressed in this presentation are not necessarily those of Ernst & Young LLP.Page 3 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Presenters► Dave Courtney ► Angela Evans Ardent Health Services Ernst & Young LLP Nashville, TN Atlanta, GA +1 404 817 5130 angela.evans@ey.com► Doug Rabe Tenet Healthcare Corporation ► Wade McGregor Dallas, TX Ernst & Young LLP Nashville, TN +1 615 252 2045 wade.mcgregor@ey.comPage 4 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Regulatory influences on the audit► Various regulators continue to influence the scope and extent of the audit effort, impacting the audit of income taxes: ► Public Company Accounting Oversight Board (PCAOB) ► Standard setting ► Policy and agenda matters ► Inspections ► Securities and Exchange Commission (SEC) matters ► Other regulatory influencesPage 5 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • PCAOB background► The PCAOB is a nonprofit corporation established by Congress through the Sarbanes-Oxley Act of 2002 (the Act). It oversees the audits of public companies in order to protect investors and the public interest by promoting informative, accurate and independent audit reports. The PCAOB also oversees the audits of broker-dealers.► The five members of the PCAOB, including the chairman, are appointed to staggered five-year terms by the SEC after consultation with the Chairman of the Board of Governors of the Federal Reserve System and the Secretary of the Treasury.► The SEC has oversight authority over the PCAOB, including the approval of its rules, standards and budget.► The Act established funding for PCAOB activities, primarily through annual fees assessed on public companies in proportion to their market capitalization and on brokers and dealers based on their net capital.Page 6 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • PCAOB standard setting
    • PCAOB standard setting — recently issuedstandards► Engagement Quality Review (EQR) ► Was effective for 2010 audits and interim reviews (Ernst & Young LLP (EY) adopted early in mid 2009) ► Expanded EQR’s focus and review of the audit approach, high risk areas and Internal Controls over Financial Reporting (ICFR) ► Requires expanded documentation of EQR review► Risk Assessment Standards ► Were effective for 2011 audits ► Expand auditor’s documentation requirements for auditor’s assessment of business and financial statement risks ► Additional test of details and assessment of personnel ► Added emphasis on auditor’s assessment of disclosuresPage 8 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • PCAOB policy and agenda matters
    • PCAOB policy and agenda matters► Auditor’s reporting model (concept release)► Mandatory firm rotation (concept release)► Transparency of the audit (proposed standard)► Communications with audit committees (proposed standard)► Related parties and related amendments (proposed standard)► Other planned agenda itemsPage 10 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • PCAOB policy and agenda matters —other planned agenda items► Part of the audit performed by other auditors► Assignment and documentation of firm supervisory responsibilities► Quality control standards► Codification of PCAOB standards► Auditing fair value measurements► Auditing accounting estimates► Specialists► Confirmations► Going concern► Subsequent events► Audits of broker-dealersPage 11 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • PCAOB inspections
    • PCAOB inspections► In addition to standard setting, the PCAOB defines audit quality through its rigorous annual inspection process. ► Part 1 (public) and Part 2 (non-public) sections of inspection reports► As a result of inspection findings, EY often modifies its policies and procedures in response. ► Additional training, additional mandated audit procedures, changes to EY guidance or revision to EY tools and enablers► In recent years, all of the Big Four accounting firms have experienced increases in the number of Part 1 findings. ► Auditing fair value estimates of hard-to-value securities ► Testing and precision of internal controls ► Testing electronic evidence, such as management reportsPage 13 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • SEC matters
    • SEC matters► International Financial Reporting Standards (IFRS) ► SEC has deferred decision. It has indicated completion of the majority of fieldwork related to its IFRS Work Plan and the need for a few additional months. ► SEC has discussed concept of endorsement approach. ► Financial Accounting Standards Board and International Accounting Standards Board said current model of joint deliberations is not sustainable. ► SEC has suggested endorsement process and retention of US generally accepted accounting principles (GAAP) rather than adoption of IFRS mandate. ► SEC staff could recommend to Commission in the coming months. ► EY continues to support the goal of a single set of high-quality, globally accepted accounting standards.Page 15 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • SEC matters► Use of pricing service information ► SEC and the PCAOB have stressed management’s responsibility to understand and be able to support valuation assertions for investments that are not exchange traded and for when companies use a third-party pricing source. ► SEC continues to issue comment letters requesting further information on the controls in place by management, especially regarding third-party pricing sources. ► Regulators are interested in how auditors evaluate management valuation assertions and related controls. ► EY had revised its audit guidance in this area to address views of the SEC and PCAOB.Page 16 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Other regulatory influences
    • Other regulatory influences► European Commission (EC) — legislative proposals ► Published on 30 November 2011 ► Stems from EC Green Paper ► Includes: ► Measures to strengthen audit committees ► Mandatory audit firm rotation ► Enhanced tendering requirements ► Significant restrictions on non-audit services ► Audit-only firms ► Measures to remove barriers for smaller firms ► Enhanced auditor reporting ► Will be a lengthy process (several years) ► EY supportive of proposals that will enhance audit quality but concerned with certain proposals that would increase costs with no added valuePage 18 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Other regulatory influences► Committee on Sponsoring Organizations of the Treadway Commission (COSO) ► COSO recently released for public comment an update to the 1992 Internal Control Integrated Framework. ► Committee would codify the 1992 framework into 17 principles and supporting attributes. ► Current framework has been recognized by SEC for purposes of management’s evaluation of ICFR. ► SEC’s reaction to updated framework is not yet known and will be key driver on whether new framework will be allowed, prohibited or required. ► Comment period ended 31 March 2012. Plan was to release final framework in the fall of 2012 but recently extended to Q1 of 2013.Page 19 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Impact of regulatory influences on the auditof income taxes
    • Impact of regulatory influences on the auditof income taxes► The expected level of precision related to auditing of income and other taxes continues to increase substantially.► Increased detail testing is required.► Increased documentation of various tax positions (e.g., remitted earnings, recoverability of deferred tax assets (DTAs)) is required.► Increased level of persuasive audit evidence is required.Page 21 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Recent income tax accounting quality-relatedoccurrences
    • Recent income tax accounting quality-relatedoccurrences► Quality issues continually problematic for financial reporting ► Restatements ► SEC comment letters ► Internal control deficienciesPage 23 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Recent income tax accounting quality-relatedoccurrences► Accounting for income taxes continues to be a challenging area for both companies and auditors, and errors in accounting for income taxes were the leading cause of annual restatements in 2011 at EY as well as at many other large firms.► 20% of the 2011 restatements by public companies audited by the largest firms were related to income taxes.► Recently, one in three EY engagements for which income taxes were reviewed (either by Assurance Quality Review or PCAOB) had a finding related to income taxes. The level of income tax findings has increased over the past several years.Page 24 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Recent income tax accounting quality-relatedoccurrences► The reasons for quality occurrences related to accounting for income taxes include: ► Accounting for income taxes requires knowledge of both technical tax matters and financial accounting — a unique challenge as this is not a common trait often possessed by a single employee or department. ► The accounting model under Accounting Standards Codification 740, which includes a number of requirements and exceptions that must be considered, is complex. ► Detailed accounting records of the tax basis of all assets and liabilities (i.e., a tax basis balance sheet) must be maintained. Computing the tax basis requires technical understanding of the tax law, including for multiple taxing jurisdictions.Page 25 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Recent income tax accounting quality-relatedoccurrences► Common problem areas include: ► Incorrect tax basis calculations ► Application of attribute rules (carrybacks, §382, etc.) ► Insufficient support for DTA realizability ► Outside basis differences ► Support for timing of uncertain tax position (UTP) and other changesPage 26 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Sample audit procedures and quality reviewprograms
    • Sample audit procedures and quality reviewprograms► Supplemental audit guidance — firm specific► Substantive procedures► Quality review programs (internal and peer reviews)Page 28 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Sample audit procedures and quality reviewprograms► Sample substantive procedures: ► Obtain a summary of the entity’s significant tax accounting methods, basis for permissibility and acceptance of such methods by the tax authorities. Review for consistency with previous years. Determine if impermissible methods are used and, if so, the potential implications on accrual for UTPs and on the current-year income tax provision calculation. ► Evaluate whether the entity has taken into account current tax legislation, including effects of any uncertainty in foreign income taxes. ► Obtain and review the entity’s analysis and documentation of indefinite investment plans (or evidence of tax-free liquidation), including confirming that the parent entity’s domestic needs are not inconsistent, or in conflict, with the indefinite foreign investment assertion.Page 29 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Sample audit procedures and quality reviewprograms ► Agree and cross reference the current-year tax provision amount to the tax provision workpapers. Prove that the ending payable balance is the amount of income taxes payable or refundable for the current and prior years. ► Evaluate the appropriateness, consistency and reasonableness of the unit of account used to evaluate the tax position for recognition. In EY’s evaluation, we consider whether the selection of other acceptable unit of account measures would result in significantly different recognition and measurement outcomes. ► Evaluate whether appropriate evidence exists (e.g., from new information or some other triggering event, such as the lapse of the applicable status of limitations) for management’s conclusions to subsequently recognize a previously unrecognized benefit, de- recognize a previously recognized benefit or make a change in the measurement of a previously recognized benefit.Page 30 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Sample audit procedures and quality reviewprograms ► Examine support for (i.e., vouch) balances, changes and other movements (e.g., tax effects of share-based payments, investments, pensions), cross reference to the audit workpapers, and evaluate and document the reasons for material changes in the differences. ► Cumulative deferred income tax reconciliation has been performed by management, and all significant deferred items have supporting documentation. That is, the entity maintains book-basis and tax- basis reconciliations and has reconciled the differences of individual assets and liabilities in determining the related deferred income tax asset or liability. Simply rolling forward book and tax differences is not adequate.Page 31 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Sample audit procedures and quality reviewprograms► Sample quality review questions: ► For the indefinite reinvestment assertion, the working papers indicate the reliance on the representation and “positive evidence.” The company’s memorandum does provide support for the conclusion reached, but we do not appear to have obtained the cash flow projections to support the conclusion. Are the cash flow projections contained elsewhere in the company’s file? ► For a captive insurance company, consider documenting that the company meets the qualifications (risk diversification, etc.) under the tax regulations to be considered a captive. Risk is both permanent (states exemption for captives) and temporary (timing difference on loss reserves). ► What is the event that caused management to de-recognize the position? It looks odd for calculations showing closed years supporting the reserve versus fewer years and a higher disallowance as suggested by a memo. ► Management asserts that inside basis is equivalent to outside basis in operating limited partnership. How have we tested management’s assertion?Page 32 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Regulatory interest in ICFR
    • Increased regulatory interest in audit of ICFR► PCAOB inspections of late focus on the extent and nature of internal controls ► Tax processes do not always fit easily into the internal control framework and are therefore viewed as an area of PCAOB inspection risk. ► Auditors are likely to require precise documentation around internal controls.Page 34 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Increased regulatory interest in audit of ICFR► Significant focus area of inspections ► 43% of the PCAOB’s 2010 Part 1 inspection findings for the Big Four firms resulted in a view by the PCAOB that auditors failed to support the opinion on ICFR. Part 1 findings related to failing to support ICFR opinion Issuer audits that failed to support ICFR opinion* 32 Total issuers in Part 1 inspection report* 75 (42.7%) * Per the PCAOB’s 2010 Part 1 Inspection Reports of Big Four FirmsPage 35 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Increased regulatory interest in audit of ICFR► Selecting controls to test and testing design effectiveness of controls ► Expect more challenging of design and documentation of controls, including more robust understanding of, and documentation in, systems narratives, flowcharts and walk-throughs to determine: ► Competence and authority of persons performing the control ► When and how often the control is performed ► What information technology applications, data, reports or other files are used ► What physical evidence of the control operation, if any, is produced ► How misstatements are prevented or detected and corrected ► Expect more thorough walk-throughs to verify flow of transactions and design of controls ► Additional probing questions and requests for documentary support ► More supervision and review of walk-throughs performed by internal auditors or others ► Additional focus on design and effectiveness of group-wide controls, management review controls and controls over non-routine and estimation processesPage 36 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Increased regulatory interest in audit of ICFR► Testing operating effectiveness of controls ► Additional focus on gathering sufficient evidence to evaluate attributes of controls relevant to their design ► Competence, level and authority of persons performing the control ► Inputs and underlying data ► Precision or sensitivity of the control ► Performance of a mix of procedures to support effective functioning of controls (e.g., inquiry, observation, inspection, re-performance) ► Additional evaluation and testing of the precision of monitoring and of management review controls ► Is the data used to perform the control complete and reliable? ► Does the control ever identify errors? Their nature? Examples? ► Does the control trigger follow-up? In what circumstances? Examples? ► Is there contradictory evidence the control is not sufficiently precise (e.g., examples of when the control failed to identify misstatements)? ► Additional probing questions of control owners and requests for supporting documentation to evidence operating effectiveness of controlsPage 37 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Increased regulatory interest in audit of ICFR► Roll-forward of interim tests of controls ► More focus on risks associated with controls in addition to length of intervening period ► Performance of a mix of procedures in addition to inquiryPage 38 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Increased regulatory interest in audit of ICFR► Identification and evaluation of control deficiencies ► Shared/consistent definition of control deficiencies and their implications ► Greater focus on root-cause analysis ► Nature and precision of compensating controls ► Re-evaluation of control risk assessment and scope of substantive procedures ► More thorough aggregation and evaluation of deficienciesPage 39 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Increased regulatory interest in audit of ICFR► Using the work of internal auditors or others ► More extensive challenging of internal auditor objectivity (e.g., to whom does auditor report and how often does reporting take place) ► Closer coordination of audit planning and nature and scope of work and work programs ► More focus on processes for updating process and control documentation ► Supervision and review of walk-throughs ► Challenging use of internal auditors in areas with: ► Higher risk of material misstatement ► More subjective controls ► Re-evaluation of competence and objectivity throughout the audit, considering quality of work and sufficiency of review proceduresPage 40 Working with your financial statement auditor: the effect of PCAOB regulation of your audit firm
    • Questions?