The SEC’s approval of changes to PCAOB standards increases scrutiny of audit professionals, with a goal of ensuring greater investor confidence.

September 05, 2019

The United States Securities & Exchange Commission (SEC), in July, approved several changes ("Proposed Rules") to standards relied upon by the Public Company Accounting Oversight Board (PCAOB). Specifically, the SEC approved amendments to two existing standards and also retitled and replaced a third standard. The Proposed Rules provide for increased oversight and scrutiny of valuation specialists by strengthening the requirements when an auditor relies upon and uses the work of a valuation specialist as audit evidence. The Proposed Rules also aim to ensure the auditor fully understands the processes behind the valuation analysis and report.

The Proposed Rules reinforce the idea of “professional skepticism” whereby information provided by management should not simply be accepted as fact. Instead, the valuation specialist and auditor will be expected to perform detailed and independent research to address any contrary or negative evidence relative to management’s information. This will further support the need for a company to engage independent and trusted valuation specialists. Important to note is that the Proposed Rules will also be applicable to audits of emerging growth companies (ECGs), which is in contrast to the treatment of ECGs in Section 104 of the Jumpstart Our Business Startups Act (commonly known as the JOBS Act) of 2012.

Amendment of AS 1105 (Appendix A: Using the Work of a Company’s Specialist as Audit Evidence)

The Proposed Rules added Appendix A to amend and supplement AS 1105 when, for instance, the auditor uses the work of a company’s specialist as audit evidence. The appendix describes the auditor’s responsibilities with respect to using the work of a company-engaged specialist as audit evidence to support a conclusion regarding a relevant assertion of a significant account or disclosure. The amendment includes three key provisions, which are outlined in Figure 1.

Figure 1. Primary Provisions – Accounting Standard 1105 Appendix A

 

PROVISION

WHAT IT MEANS FOR THE VALUATION SPECIALIST

Auditor should assess the knowledge, skill, and ability of the specialist                     

 

The valuation specialist should be prepared to present their qualifications, including relevant certifications, licenses, or accreditations; the specialist's experience in the type of work being performed; and the reputation and standing of the specialist in the particular field.

 

Auditor should assess the relationship between a specialist and the entity that employs the specialist

 

Maintaining independence is paramount to the credibility of the valuation specialist's work. Auditors may request to review information such as engagement contracts, responses to questionnaires assessing the relationship between a specialist and hiring entity, and disclosures about relationships between the specialist and entity contained within the specialist's report pursuant to requirements of the specialist's profession or regulations.

 

Evaluating the work of a specialist includes the data, significant assumptions, and methods used by the specialist

Thorough documentation of the data requested / received from the client, assumptions and relevant support, and the methodologies utilized will assist the valuation specialist in supporting their work product to the auditor.

 

 

The necessary evidence from the auditor’s evaluation of the specialist’s work to support a conclusion regarding a relevant assertion depends on:

  • The significance of the specialist’s work to the auditor’s conclusion regarding the relevant assertion
  • The risk of material misstatement of the relevant assertion
  • The specialist’s level of knowledge, skill, and ability
  • The ability of the company to significantly affect the specialist’s judgments about the work performed and its conclusions or findings

When evaluating the relevance and reliability of the specialist’s work and whether the specialist’s findings support or contradict the relevant assertion, the auditor should consider the following factors:

  • The results of the auditor’s procedures when evaluating the data and significant assumptions used and methods performed by the specialist
  • The nature of any restrictions, disclaimers, or limitations in the specialist’s report or equivalent communication
  • The consistency of the specialist’s work with other audit evidence obtained by the auditor and the auditor’s understanding of the company and its environment

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 auditor should perform procedures to address the matter. Examples of situations in which additional procedures are often necessary include:

  • The specialist’s findings and conclusions are inconsistent with the results of the work performed by the specialist, other evidence obtained by the auditor, or the auditor’s understanding of the company and its environment
  • The specialist’s report or equivalent communication contains restrictions, disclaimers, or limitations regarding the auditor’s use of the report or communication
  • Exceptions were identified in performing the procedures to evaluate the data, significant assumptions, or methods used by the specialist
  • The auditor has doubts about the specialist’s knowledge, skill, and ability or the company’s effect on the specialist’s judgments
  • The specialist has a conflict of interest relevant to the specialist’s work

Amendment of AS 1201 (Appendix C: Supervision of the Work of Auditor-Employed Specialists)

The Proposed Rules added Appendix C to supplement AS 1201. Required supervisory activities are to be performed in conjunction with the supervision of the work of an auditor-employed specialist who is assisting the auditor in obtaining or evaluating audit evidence. Specifically, these activities include:

  • Informing the auditor-employed specialist of the scope of work to be performed
  • Coordinating the work of auditor-employed specialists with that of other engagement team members
  • 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 the work performed by the specialist)

Additionally, 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 auditor should perform additional procedures as necessary. Examples of situations in which additional procedures are necessary include:

  • 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
  • The specialist’s findings and conclusions are inconsistent with the results of the work performed by the specialist, other evidence obtained by the auditor, or the auditor’s understanding of the company and its environment
  • The specialist lacks a reasonable basis for data or significant assumptions the specialist used
  • The methods used by the specialist were not appropriate

Replacement of AS 1210 (Using the Work of an Auditor-Engaged Specialist)

This new standard is meant to establish requirements related to the use of a specialist that is engaged by the auditor’s firm when assisting the auditor in obtaining or evaluating the audit evidence of a significant account or disclosure and determining whether the work of the specialist is suitable for the auditor’s purpose. The main objectives of this new standard include: 1) assessing the knowledge, skill, ability, and objectivity of the auditor-engaged specialist; 2) informing the auditor-engaged specialist of the work to be performed; and 3) evaluating the work of the auditor-engaged specialist.

The first step under this new standard is for the audit firm’s engagement partner to assess whether the specialist has the knowledge, skill, and ability for the specific type of work under consideration. This assessment is meant to ensure the specialist’s work relied upon by the audit firm was completed by a specialist with sufficient knowledge, skill, and ability. This includes a review of the following:

  • Any professional certification, license, or professional accreditation in a particular field
  • Experience in the type of work under consideration
  • The reputation and standing of the specialist in the specific field

An audit firm’s engagement partner must also perform an assessment on the ability of the specialist to perform the work while maintaining impartiality. While the necessary assessment can vary based on the significance of the specialist’s work and the related risk for material misstatement, the following primary assessments should be included:

  • Engagement contracts between the company and specialist (or its employer)
  • Responses to questionnaires provided by the specialist regarding any relationship(s) between the specialist (or its employer) and the company
  • A written representation by the specialist concerning relationships with the company
  • Disclosures outlining any relationships with the company within the specialist’s report pursuant to requirements promulgated by the specialist’s profession or by legislation or regulation governing the specialist

These assessments are a way for the auditor to establish and document an understanding with the specialist, including with respect to any data, significant assumptions, and methodologies the specialist is responsible for testing, evaluating, or developing.

The second step of this new standard is meant to ensure all parties are on the same page regarding the work to be performed by the specialist. This includes having the audit firm’s engagement partner establish and document an understanding on the following:

  • The responsibilities and objectives of the work to be performed by the specialist
  • The nature of the work to be performed (or assisted in performing)
  • The degree of the specialist’s responsibility as it relates to:
    • testing data produced by the company and/or evaluating the relevance and reliability of the data based on sources external to the company
    • evaluating the significant assumptions utilized by the company
    • reviewing the methodologies utilized by the company
  • The responsibility of the specialist to provide a report to the engagement partner that describes the work performed, results of the work, and the findings or conclusions reached by the specialist

This new step helps implement measures to ensure the proper coordination of the work performed by the specialist and the work performed by the audit engagement team to achieve a proper evaluation of the evidence obtained in reaching conclusions about the relevant assertion.

The last step of this new standard involves evaluating the work of the specialist. The evaluation includes a review of the report (or equivalent document) and determining whether the specialist’s work provides sufficient and appropriate evidence related to whether:

  • The work and report of the specialist are in accordance with the auditor’s understanding
  • The specialist’s findings and conclusions are consistent with the result of the specialist’s work performed, other evidence obtained by the auditor, and the auditor’s understanding of the company and its environment

As it relates to the review of the specialist’s work, there are a few factors that determine the extent of a review that is necessary, including:

  • The significance of the specialist’s work to the auditor’s conclusion regarding the relevant assertion
  • The risk of material misstatement of the relevant assertion
  • The knowledge, skill, and ability of the specialist

To the extent the specialist (or the specialist’s employer) has a relationship with the company that could affect the specialist’s objectivity, the auditor should perform additional procedures evaluating the data, significant assumptions, and methodologies that the specialist is responsible for testing, evaluating, or developing. Alternatively, the audit engagement team may consider engaging another specialist that is impartial. It’s important to note that as the degree of objectivity increases, the evidence and need for additional procedures decreases. That is, if the specialist has a low degree of objectivity, the auditor should apply the same procedures when evaluating the work of a company’s specialist.

In situations where the specialist’s finding or conclusions contradict the relevant assertion or the specialist’s work does not provide sufficient and appropriate evidence, additional procedures should be performed. Examples of scenarios from which these types of issues may arise include:

  • The work was not performed in accordance with the auditor’s instruction
  • The report contains restrictions, disclaimers, or limitations that affect the ability of the auditor to use or rely on the report or work
  • The findings and conclusions are inconsistent with the results of the work, other evidence obtained by the auditor, or the auditor’s understanding of the company and its environment
  • There is a lack of reasonable basis for data or significant assumptions
  • The methodologies utilized were not appropriate

The additional procedures are meant to ensure any contradictions are addressed and resolved such that the audit firm has a reasonable basis and assurance that the specialist’s work may be relied upon as support and audit evidence.

Bringing Equal Treatment to Valuations

Overall, increased oversight and scrutiny ensures all valuations are given the same treatment and attention as other parts of a company’s audit, as this will ultimately allow for greater investor confidence in financial statements and SEC filings. The Proposed Rules are effective for audits issued with a fiscal year date on or after December 15, 2020.

Co-authored by:

Tim Osborne
Vice President, Valuation Advisory
+1.216.373.2999
tosborne@stout.com

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